1. Definitions
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Basic Research - scientist gain knowledge
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Applied Research - use knowledge for commercial purposes
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Invention - a discovery or device that should work
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Diffusion - the act of dispersing
2. Market Structure
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Competitive markets
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Have an incentive to innovate
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Competition drives profits to zero
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Diffusion occurs rapidly
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Unfortunately, competitive markets may not be innovative
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Monopoly
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Could earn long-run profits
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Has profits to invest in research and development
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Monopolist is not worried about losing consumers
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No competitors
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A monopolist may not keep up with technology
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Oligopoly
3. Present Value
- You will receive $100,000 in 100 years
- You rather have the money today
- The interest rate (or discount rate) is 5%
- The value of the money is:
- It is worth $769.45 to you today
- You could deposit $760.45 in a bank today at 5% interest, and it will grow into $100,000 in 100 years
- We use the present value to evaluate market value of securities
- Alter payment arrangement, etc.
- Used to calculate mortgages, bond prices, annuities, etc.
- Example
- You want to travel to Europe today
- You get $10,000 from a trust fund per year for 10 years
- A finance company offers to cash out your trust fund for 6% per year interest
4. Cost and Benefits of Research
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Costs and benefits of research accrue over time
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C n is the cost in period n
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r is the discount rate
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C pv is the present value of the research cost
5. Dominant firm with competitive fringe
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Dominant firm – a firm possess market power
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Competitive fringe – small firms in market that keep the dominant firm competitive
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Example: Microprocessors
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Dominant firm must stay ahead to remain dominant
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Firms that were dominant
6. Game theory
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1. Patent - grants the right to an inventor or scientist the exclusive right to sell, produce, or withhold invention
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Malaysia and United States: patent is for 20 years
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Once the patent expires, any company can produce and sell the product
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Some companies do not file patents
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Patent is a public record
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Other companies can review patent and try to improve it
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Some countries like China violate patents
2. Scenario 1
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Scientist discovers a new drug
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The holder of the patent can only produce and sell the new drug
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Scientist could retain the patent and start a company
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Scientist could sell his right to a company
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The scientist's employer may hold the right of the patent
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Entry barrier
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The patent grants a monopoly right for 20 years
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The company sells the medicine for a price above marginal costs
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The monopolist can grow into a powerful entity even after the patent expires
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The scientist may obtain patents that are similar to original patent to prevent competition
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Competitors can try to invent something similar by inventing around the patent
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If the competitors are not successful, then patent encourages the growth of a monopoly
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Patent may hinder technological advancement
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Note - Some U.S. pharmaceutical companies stopped producing particular drugs when the patent expired
3. Scenario 2
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A country does not issue patents
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A scientist develops a new drug and a company is interested in producing it
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A company quickly produces and sells the drug to the public
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Competitors can quickly form to produce and sell the new drug
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The industry adapts technology quickly and profits are driven to zero much quicker than a patent system
4. Scenario 3
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A country does not issue patents
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Scientist develops a new drug
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Companies are not interested in the new drug
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Society does not benefit from the scientist's invention
5. Scenario 2 is the best while Scenario 3 is the worse
6. Copyright - protection for artists
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Books, music, films, and software
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United States - protection is creator's life plus 70 years
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Copyright varies for countries
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Developed countries have strong legal protection for copyrights
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Developing countries have weak protection
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China - counterfeit music, movies, software, and pharmaceuticals
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Citizens in developing countries may not have the income to pay for the full price
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Chinese firms may have lower costs because they do not pay full price for copyrighted media
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1. A monopolist faces the demand function, P = 50 - Q. Its long-run AC = MC = 25. The monopolist develops new technology that allows it to lower its long-run AC = MC = 20. How much will the monopolist's profits increases?
(a) Solve for the monopolist's profits before and after the innovation.
(b) Solve for the market prices under both scenarios
(c) Solve for the profits under both scenarios, and calculate the difference. The graph is also shown below:
(d) What happens if this market is purely competitive? The P = MC = 25, so we solve for the quantity, which is Q = 50 - P = 50 - 25 = 25
For the competitive market, the patent holder would earn a profit to compensate him or her for their innovation. The competitive market still has to pay to develop and implement the innovation. Thus, the market price remains at 25 and market quantity remains at 25.
The patent holder would earn the difference in price multiplied over the number of units, or
The competitive market supplies more quantity for a lower price than the innovative monopoly.
2. A problem comparing a purely competitive market, monopoly, x-inefficiency, and research monopoly
(i) Solve for a purely competitive market
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Use P = MC rule
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MC = 10
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Thus, C(Q) = 10 Q
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Set P C = MC = 10
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Use demand function
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P = 100 – Q
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10 = 100 – Q C
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Thus, Q C = 90
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Consumers' surplus = 0.5 (100 – 10)(90 – 0) = 4,050
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Profits = P Q – C(Q) = 10 (90) – 10 (90) = 0
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DWL = 0, because competitive market
(ii) Solve for monopoly with no x-inefficiency
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Thus, MC = 10
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Set MR = MC
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Price
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Consumers' surplus = 0.5 (100 – 55)(45 – 0) = 1,012.50
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Profits = PQ – C(Q) = 55(45) – 10 (45) = $2,025.00
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DWL = 0.5 (55 – 10)(90 – 45) = 1,012.50
(iii) X-inefficiency – monopoly may have higher costs than competitive firm
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Workers are not motivated
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Management problems
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Lack of competition
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No incentive to minimize costs
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Example: Demand function is P(Q) = 100 – Q
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Solve for monopoly with x-inefficiency
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Solve for market quantity
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Solve for the market price
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Consumers' surplus = 0.5 (100 – 60)(40 – 0) = 800.00
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Profits = PQ – C(Q) = 60(40) – 20 (40) = $1,600.00
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DWL = 0.5 (60 – 20)(80 – 40) = 800.00
(iv) Research Monopoly
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Monopoly can earn substantial profits
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Could invest into research and development or expand economies of scale
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Assume MC R = 5
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Set MR = MC
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Price
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Consumers' surplus = 0.5 (100 – 52.5)(47.5 – 0) = $1,128.125
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Profits = PQ – C(Q) = 52.5(47.5) – 5 (47.5) = $2,256.25
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DWL = 0.5 (52.5 – 5)(95 – 47.5) = 1,128.125
Results
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Competitive market gives highest social welfare
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Monopoly with x-inefficiency gives the lowest
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Research monopoly is better than other monopolies
Item |
Pure Competition |
Pure Monopoly |
X-inefficiency |
Research Monopoly |
Market price |
10.0 |
55.0 |
60.0 |
52.5 |
Market Quantity |
90 |
45 |
40 |
47.5 |
Social Welfare |
|
|
|
|
Consumer Surplus |
$4,050.00 |
$1,012.50 |
$800.00 |
$1,128.13 |
Profits |
0 |
$2,025.00 |
$1,600.00 |
$2,256.25 |
Total |
$4,050.00 |
$3,037.50 |
$2,400.00 |
$3,384.38 |
DWL |
0 |
$1,012.50 |
$800.00 |
$1,128.125 |
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