discuss monopolistic market， the pricing policies and the role of patents，insights on social welfare and allocative efficiency

[Abstract] Using microeconomic theory， critically discuss the monopolistic market of ISENTRESS?，a kind of integrase inhibitors and the possible pricing policies and the role of patents with insights on social welfare and allocative efficiency

[Keywords] monopolistic market；pricing policies ，social welfare；allocative efficiency

Nowadays， a new label ISENTRESS which is the first integrase inhibitor to be approved by the FDA for the treatment of HIV AIDS infection（Pace and Rowley， 2008）.This drug is produced by a big pharmaceutical company， Merck and is protected by patent. Before discussing the effect of the market structure， it is essential to identify what kind of market structure is this integrase inhibitor. It is believed by most people that there are four main kinds of market structures as shown in Table1： Perfect competition， Monopolistic competition， Oligopoly and Monopoly. This drug is protected by patent and its label is approved， that is to say， only company Merck， the company can produce this drug. On account of only one firm， the market structure of the drug can be regarded as monopoly undoubtedly. It is believed by Harberger（1995） the main effects of monopoly are to misallocate resources， to reduce aggregate welfare， and to redistribute income in favor of monopolists. But it also has some positive effects on social welfare and allocation of resource in some case. Generally speaking， This essay will use basic supply and demand model to analyze the effects of three price policies under monopoly on social welfare and allocative efficiency： price on a uniform basis， price discrimination， limit pricing， comparing to the price policy under perfect competition. Meanwhile， it will also analyze the effect of patent on public interest and efficient allocation of resources.

Section1 Uniform Pricing

As a matter of fact， monopoly has many negative effects on social welfare and allocative efficiency. Firstly， comparing to perfect competition， monopoly makes a higher price and lower output of the drug. A model is applied to explain the reason， which is shown in Figure6.10. Assuming that the market structure of the drug is perfect competition， then MC curve and Supply curve follow the some line. The cross of demand and supply curve represents the price and quantity of the drug which is P2 and Q2 under perfect competition. However， in fact， under the monopoly， the company Merck is price maker. It can gain maximising profit by choosing to produce the quantities where MR=MC. Figure 6.8 shows the details of profit maximising under monopoly. Producing at the point MR=MC， average revenue（price） depends on the corresponding point on demand curve. The area of the square currently which represents the profit is the biggest. As a result， under the monopoly， to achieve the max profit of the firm， higher price and lower output of drugs are made. This definitely reduce the social welfare of the normal people who probably require this drug， they have to pay more for the rarer products. Secondly， due to inefficient allocation of resources， monopoly will cause deadweight loss. In Figure 1， as is analyzed before， under the assumption of perfect competition， the equilibrium is point A with no deadweight loss. The allocative efficiency satisfy Pareto efficiency with rational distribution of resources. However， under monopoly， at the equilibrium point b， the total surplus is smaller and deadweight loss appears. This also demonstrates that the inefficiency of allocation of resources under monopoly. Thirdly， monopoly leads to unequal distribution of income. The high profits of monopolists are considered unfair when comparing to other firms if the size of monopoly of this drug is large. In a word， the monopoly of the drug has lots of negative effects on social welfare and allocative efficiency and makes them imperfect.

Although a foreseeable many negative effects on public interests and allocative efficiency exist， there may also be some positive effects. The first considered is economies of scale. Merck may achieve substantial economies of scale by producing large amount of drugs and administrating centrally. This may results in a higher output and lower price compare to the circumstance of perfect competition. As shown in Figure 6.11， MC curve of monopoly is below that of the same industry under perfect competition. Following the rule of maximazing profit， The monopolist produce at Q1 where MC curve equals to MR. While under perfect competition， equilibrium of industry is Q2 and P2. Obviously， due to the economies of scale， the monopoly may produce a higher output at lower price. It need to be noticed that the MC curve of monopoly below that of perfect competition is the premise. Secondly， if monopolistic company uses part of profits for researching and development， it may be more efficient and have a greater ability to produce with a lower cost. On the other hand， small firms in perfect competition are not able to do this limited by funds. Thus， in this sense monopoly benefits public interests with better products and be more allocative efficiency.

Section 2 Price discrimination

Except for selling the drugs at the equilibrium price MR=MC， Merck can also sell the drug to different customers at different prices which is called price discrimination. The reason for firms do this is to maximise the profit. Price discrimination can be classified into first degree， second degree and three degree. First degree refers to charging each consumer the max price he is willing to pay for each unit of the product. Second degree means that setting different prices to consumers according to the amount of products they buy. Third degree can be explained as charging different prices for different groups of people.

Generally speaking， price discrimination can make better welfare and allocative efficiency. In Figure 2， monopolist rises the output to sell more products at various lower price， and also sell to some people at higher price since they originally are willing to pay more. Thus， the pink area in figure represents the additional revenue. It seems that first degree price discrimination increase firms’ profits at the expense of consumers’ welfare. However， In fact， by first degree price discrimination， there is no consumer surplus and no deadweight loss on account of efficient level of output， and Pareto efficiency can be achieved by maximizing the total surplus. Thus， resources are allocated more efficiently and can maximize social welfare. However， this kind of price discrimination is difficult to achieve， it is hard to know how much is each consumer willing to pay. Second degree also have positive effects on social welfare comparing to the unified price setting under monopoly. Consumers will be encouraged to buy more and this increase the share of market or even improve economic of scale. At the same time ， the social welfare under second degree price discrimination is more than unified price setting under monopoly.

Although price discrimination may make higher allocative efficiency and greater social welfare， some negative effects on consumers also exist. Firstly， Some consumers benefit from it， others lose. That is to say， those people who pay higher price certainly have a lower consumer surplus and they may feel unfair. Otherwise， those people who pay lower price are opposite. Secondly， price discrimination makes firms obtain more profits， it can be seen as an undesirable redistribution of income in society.

Section 3： Limit pricing and role of patent

Patent plays an important role in price policy of monopolist. If there is no patent， some new entrants may enter the market to compete with Merck. Under this circumstance， there may be another price policy launched by monopolist， limiting price. This policy is a competitive behaviors to deter new entrants. Figure 3 shows how does limiting policy works. When new entrants enter the market， on account of enter barriers， the average cost of new entrant is higher than the monopolist. By keeping the price of products down to the lowest level of the the average cost of new entrant， the average revenue is less than average cost， thus new entrants can not make a profit， then they have to exit the market. Although the monopolist have restricted the size of its profits， it can effectively deter new entrants to enter the market. It is difficult to judge whether limit pricing has positive or negative social welfare. It deters the entrance the other firms， however， at the same time， it reduce the price of products which is beneficial to consumers.

In fact， this drug is protected by patent， it means in short run， there will not be competitors. In one hand， governments allow existence of patent to protect the intellectual property right and encourage people make innovations. In other hand， the patent may cause high price of monopolistic products which is harmful to social welfare in short run. However， the day when patent runs out will come. Then， this drug and label is not protected， new entrants will enter. Merck may limit the price to deter this as explained before.Or even， it is believed by Bresnahan and Reiss（1990） that， in some cases second entrant faces no entry barriers and the monopoly variable profits do not fall by much. In this circumstance， market structure probably changes to perfect competition which may leads to lower price and more output. Thus， in this sense， patent is not positive to social welfare and allocative efficiency.

To be concluded， it is definite that in most circumstances， monopoly of this drug is harmful to social welfare and allocative efficiency. As a price maker， to achieve the maximising profit， monopolist set the price at the quantity where MR equals to MC and make higher price and less output， deadweight loss. However， in some circumstance， monopoly may also increase social welfare and allocative efficiency such as economic of scale， or it is hard to judge whether it is positive or negative.Otherwise， monopolist may also apply other price policies like price discrimination and price limiting which are both beneficial to itself. Some of these price policies have positive effects on public interests and efficiency allocation such as first-degree price discrimination. To consider further， monopoly may lead to more serious problems including excessively high price and market confusion. Government’s intervene plays an important role at this time， it can restrict and govern some corruption of monopolist and make a better market environment by antitrust law.

Reference：

[1]Harberger， A. C. （1995） Essential Readings in Economics. London： Springer

[2]Pace P， Rowley M. （2008） Integrase inhibitors for the treatment of HIV infection[J]. Current opinion in drug discovery development， 11（4）， pp. 471-479.

[3]Bresnahan， T. F.， Reiss， P. C. （1990） ‘Entry in Monopoly Markets’， Review of Economic Studies， 57（4）， pp： 531-553.

[4]Sloman， J.， Wride， A. and Garratt， D. （2015） Economics. 9th edn. British： Pearson.

[5] Giannatale， P. D.（ 2016） ‘Market Structure： Monopoly PriceDiscrimination’[PowerPoint presentation]. P11606： Microeconomics for Business A. （Accessed：27th November 2016）.

作者簡介：

李子楊，1996-8-2，男，黑龍江省大慶市，學歷本科大二，研究方向：金融財務與管理，單位寧波諾丁漢大學。