Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 5 Firm Behavior and the Organization of Industry
Chapter
15 of 36 Monopoly
Section
15 of 33
…
Figure
6 here
…
Figure 6 - The Market for Drugs
When a patent
gives a firm a monopoly on the making and sale of a drug the firm charges the
monopoly price.
This price is
well above the marginal cost of making the drug.
When the patent
on a drug runs out new firms enter the market, making the market more
competitive.
The price
eventually falls from the monopoly price to marginal cost.
…
Prices
are determined differently in monopoly markets and competitive markets.
One
way to illustrate this is with the market for pharmaceutical drugs.
This
market has both monopoly and competitive market structures.
Patent
law gives a firm a monopoly on the sale of a new drug it develops.
Eventually
the monopoly firm's patent expires, then any company can make and sell the drug.
The
market changes from monopoly to competitive.
…
Figure
6 shows the market for a typical drug.
At
first the firm has a monopoly because of the patent.
The
monopoly firm maximizes blue area profit by
·
producing the quantity at which marginal revenue equals marginal cost
·
charging a monopoly price well above marginal cost
When
the patent runs out the profit from the drug encourages new firms to enter the
market.
These
other firms begin selling a generic chemically identical product.
As
the market becomes more competitive the price falls to equal marginal cost
and economic
profit falls to zero.
…
Note
the monopoly firm could have charged the marginal cost price from the beginning
and sold the much larger competitive quantity
But it
would have made no economic profit.
The
monopoly firm during the life of the patent was able to choose any
price/quantity point .
It
chose the price where economic profit is maximized, even though the monopoly
quantity sold is much less than competitive quantity.
…
The
expiration of a patent does not cause the monopolist to lose all its market
power.
Some
consumers remain loyal to the original brand name drug perhaps fearing the new
generic drug is not fully identical to and good as the original.
The
former monopolist usually can continue to charge a price somewhat above the
marginal cost.
Keep
in mind patents with resulting economic profits motivate businesses including pharmaceutical,
because of costs businesses would develop much fewer new products without
patents.
… …
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