HAT Manifesto Part 1/3 - Rubric Cube - 241201 revision

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5^th Ed.

PART 5 Firm Behavior and the Organization of Industry

Chapter 15 of 36 Monopoly

Section 15 of 33

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Figure 6 here

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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.

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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.

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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.

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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.

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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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