The Costs and Benefits of Monopoly

The Costs and Benefits of Monopoly


♪ [music] ♪ – [Alex] In our final talk
in monopoly, we’re going to discuss
the costs of monopoly, but also the potential benefits. The major costs of monopoly
is that compared to competition, monopoly is inefficient. It leads to a loss in the gains
from trade or a deadweight loss. Let’s remind ourselves
about the gains from trade under competition
and then we can compare with monopoly. Here we’ll simplify
with a flat supply curve, a constant cost industry. In this case the total gains
from trade go to consumers in this blue area right here. Now let’s see what the total gains
from trade or total welfare is under monopoly. We choose exactly
the same demand curve and the same constant cost curve. We find the profit maximizing price
and quantity in the usual way. Consumers, not surprisingly,
get less under monopoly since the price is higher. Now some of what the consumers lose
is transferred to the monopolist in terms of profit, and as far
as an economist is concerned, at least someone is getting
these gains from trade. So the transfer is neutral. What’s bad however,
is that total welfare falls under monopoly
because no one gets this area, the deadweight loss. These are trades that from a social
point of view are beneficial. The demanders are willing to pay
more than what would be the cost of producing these goods. These trades, however,
don’t happen. Even though they’re socially
beneficial they don’t happen because they aren’t profitable,
they aren’t privately beneficial. Think of a movie theater
that is half empty. Surely there are some people
out there who would value watching the movie at more
than its marginal cost, about zero. So why doesn’t the movie theater
lower the price to these people? Because to do so it would have
to lower the price to everyone and that would reduce
total profits. So the basic lesson is this. Consumers buy a good
so long as the value to them exceeds the price. Under competition, price
is equal to marginal cost, so consumers will buy every unit
such that the value to them is a greater
than the marginal cost. That’s efficient. Under monopoly, consumers
also buy so long as the value to them is greater than the price,
but since price is greater than marginal cost,
we get too few units produced. We get a loss
in the gains from trade. Let’s remind ourselves
what deadweight loss looks like in practice. GSK prices Combivir
at $12.50 per pill. The marginal cost is 50 cents. The deadweight loss is the value
of the trades that do not occur because price is greater
than marginal cost. Some people would be willing
and able to pay $10 per pill or $4, or even $1 per pill
and those prices would more than cover
the cost of producing those pills. But those trades don’t occur because they aren’t
profitable to GSK. Many monopolies around the world
are born of government corruption. In Indonesia, Tommy Suharto,
the president’s son, was given the highly profitable
clove monopoly. He used the profits
from that monopoly to buy Lamborghini. Not a Lamborghini —
he bought the entire company. These kinds of monopolies
are unredeemed. They have costs
and no social benefits at all. Some monopolies however,
do have countervailing benefits. Consider what would happen
if the U.S. eliminated patents for pharmaceuticals. Competition, it’s true,
would drive down the price of existing drugs to marginal cost,
as happens today as soon as patents expire,
usually within 10 to 15 years after the drug first enters
the market. But it costs about
a billion dollars to bring the average new drug
to market in the United States, and R&D costs are not included
in marginal cost. As the saying goes,
it costs about a billion dollars to create the first pill,
50 cents to create the second pill. 50 cents is the marginal cost,
the cost of an additional pill, but to bring that first pill
to market costs about a billion dollars. If price were quickly pushed
down to marginal cost, firms would not be able
to recover their R&D costs, and the result would be
fewer new drugs. Once the drug is created,
the patent, the monopoly, creates inefficiency,
we get too few units produced. But the patent increases
the incentive to produce the new drugs in the first place. So there’s a trade-off. More monopoly
reduces static efficiency, the quantity produced,
but can increase dynamic efficiency, the incentive
to do research and development. This trade-off applies
to other goods with high development cost,
not just pharmaceuticals. Information goods,
goods like music, movies, computer programs,
new chemicals, new materials, new technologies. These typically have high
development costs and low marginal cost
of production. And that suggests there may be
possible benefits to patent or copyright protection. More generally for these types
of goods there’s a policy trade-off which we always want
to keep in mind. That is lower prices today
may generate fewer new ideas in the future. Nobel prize winning
economic historian, Douglas North, for example, has argued,
“The failure to develop systematic property rights
in innovation up until fairly modern times
was a major source of the slow pace
of technological change.” Is there a better way
of navigating this trade-off? Perhaps. Suppose that the government
bought up a pharmaceutical patent for its total monopoly profits
and then they ripped the patent up. Competitors would enter
and drive the price of the drug down to marginal cost,
thus we would have static efficiency. At the same time,
since the government was paying firms
their monopoly profits, we would still have lots
of incentive to do research and development —
dynamic efficiency. Thus we could have
the best of all worlds. Of course, there may be
some downsides as well. Higher taxes to pay
for the patent also have their own deadweight loss,
and it might be difficult to say exactly
how much a patent is worth. And there could be
possible corruption. Nevertheless, this is an idea
we’re thinking about, and perhaps worth
experimenting with. Prizes are another way
of navigating the trade-off. As with patent buyouts,
the idea is that a firm is offered up front its R&D costs. But the government
only pays the firm if it achieves a certain goal. And if that goal is achieved,
the technology goes into the public domain
and could be used by anyone. SpaceShipOne, for example,
won $10 million for being the first privately
developed manned rocket capable of reaching space
and returning in a short period of time. And prizes are being used
more often. The government set up a prize
for better light bulbs, for example,
and that worked quite well. There’s also a third way
of navigating the trade-off. You may have noticed, for example,
that so far we’ve assumed that the monopolist
must charge the same price to everyone. Is this necessarily true? In some cases,
the monopolist can charge different prices
to different people — price discrimination. As we’ll see in the next chapter
and set of lectures, price discrimination explains a lot
about how products are priced and it also has some costs
and some benefits which we’ll be discussing. See you then, thanks. – [Narrator] If you want
to test yourself, click “Practice Questions.” Or if you’re ready to move on,
just click “Next Video.” ♪ [music] ♪

10 Comments

  1. nacoran says:

    It's funny, I've thought about a lot about some of these ideas.  I like the idea of different prices for different people, particularly for things like tickets to live entertainment events.  They do that to an extent with backstage passes and better seats, but once you get to the nosebleed section scalpers get most of the extra money or, if the show doesn't draw enough people to sell out you either get the scalpers trying to dry up the supply (if it's close) or empty seats.  I suspect that, especially since so many arenas can make extra money on concessions once they get people through the door that a carefully constructed auction would work well.  I think I'd start with the prime seats, and set an early close for that auction.  To encourage people to bid during the auction but still make sure all the seats in that block are sold I'd run it as a series of auctions- say you want to deal with the first row seating.  You run an auction, set to end x number of days before the show, you set a reserve and take secret bids.  At the end of the auction you sell to any bidders that met the reserve.  If you have seats left over, you have a second auction, and set your reserve lower.  Repeat as many times as you think it's profitable to do so.  Have any tickets that don't meet those reserves available at the door.  The idea that the seats might go in an earlier auction should get people to bid early.  Do the same for other rows of seating, grouping seats of similar quality together.  Ideally the venue, if they are booking you, should be willing to take some risk on selling the last seats at a discount, since they can still make money on concessions.  Although there is something oddly democratic about the ticket line for a rock show I suspect that the extra revenue would actually let bands play slightly larger arenas, which would mean more fans would actually get to see the show.

    The other place that I'd like to see pricing differences depending on who you are also involves tickets, but not entertainment tickets.  The good old parking ticket/traffic ticket is, in some countries, based on your income.  Seems like a good idea, since their ideally supposed to discourage bad behaviors.  A $75 ticket would ruin some people's monthly budget, but it's not much of a deterrent for someone who is making high six figures.  (Or at least make it so tickets increase in price the more of them you get.  I remember seeing someone who got a ticket every day for parking illegally.  They owned a business nearby.  They just considered it a parking fee.

    For pharmaceuticals, I do like the X prize model a lot.  It seems the other group, besides the government, that might have a vested interest in that would be the HMOs.  It would both lower their drug costs and, if they targeted prizes for things that improved their members health at a better price point (a good cholesterol drug instead of paying for heart surgery) it would give them double savings- the problem there would be trying to either to get a bunch of HMO's to chip in evenly based on market share or to figure out what to do when Kaiser suddenly owns the patent on a wonderful new drug and Blue Shield wants to give it to their patients (perhaps a little quid pro quo if Blue Shield comes up with something?

  2. samuel huerta jr says:

    💯💯

  3. abrahamchapman says:

    What they said about drug prices dropping to marginal cost when patents expire is no longer true. Recently, generic drug companies have been hiking the prices of generic drugs as well. How can this be if there's no longer a monopoly on the drug patent? Obviously profiteering is the rule of the land, not economics

  4. Desert Lizard says:

    monopoly makes you rich regardless of whatever you are talking about

  5. Mazen Al says:

    stating the positive sides of Monopolies is interesting to me as i am not thoroughly convinced by it , for instance pharmaceutical companies have ways to stretch their monopoly pricing power to as long as 20 years or more. Mylan’s EpiPen patent is just one example. They can change the drug’s packaging or method of administration without clinical benefit and extend their patents. They can also pay off generic drug manufacturers not to bring a generic substitute to market.

    When a patent expires, generic drug manufacturers can enter the market. But, prices often still do not come down because of generic drug company monopolies. For that reason, for example, doxycycline’s price increased 90 times in the two years between 2013 and 2015. so its not yet a settle science and we should have discussions about it .

  6. عبدالرحمن جارالله says:

    A monopolist produces less output and sells it at a higher price than a perfectly competitive firm. The monopolists behavior is costly to the consumers who demand the monopolists output .

    Due to the fact that monopolies make lots of profits, it can be used for research and development and to maintain their status as a monopoly

  7. Abu Mshary says:

    A monopolist produces less output and sells it at a higher price than a perfectly competitive firm. The monopolist's behavior is costly to the consumers who demand the monopolist's output
    Due to the fact that monopolies make lots of profits, it can be used for research and development and to maintain their status as a monopoly.

  8. Max Chu says:

    Actually, the pharmacy companies only have two costs, firstly , buy the workout of colleague, such as the drugs formulas, which really costs researchers a long lifetime , secondly, most of the cost of those pharmacy companies was taken into clinical test, they need to seek cheap testing mouse first and spend several month, pay them wages, and finally they can start to sell new drug to make profit.

  9. Jacob Black says:

    There all bad.

  10. JARUIS SANZ says:

    A Rockefeller or Rothschild would laugh at this video… Monopolies are the only way to make real money…

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