Question

Part (a) Consider a firm called Health-R-Us that is a monopoly. How does Health-R- Us decide the price to charge and quantity to sell of the good it has a monopoly on? Illustrate your answer using a fully labelled and explained market diagram. Assume Health-R-Us is making monopoly profits and illustrate these on the same diagram. In addition, indicate the area on your diagram that illustrates the efficiency cost (the dead weight loss) of the monopoly, and explain why this dead weight loss arises. Part (b) Assume Health-R-Us is a legal monopoly: it is a monopoly due to legal protection from the government in the form of a patent issued to the company. Imagine that the government withdraws the legal protection for Health-R-Us such that the market becomes competitive. Will a typical individual firm in this competitive market make economic profit in the long run? Why or why not? Use an appropriate firm-level diagram to illustrate and explain your answer. Part (c) Your answers to parts 2a and 2b illustrated different levels of profit made by an individual firm in both a monopoly market structure and a competitive market structure respectively. In part 2a you also indicated the dead weight loss of a monopoly. Assume now that Health-R-Us has discovered a vaccine for coronavirus. Why might the government be willing to grant (and allow to remain in place) a patent to Health- R-Us, despite the dead weight loss and the ensuring monopoly profits caused by such a patent? Explain your answer. For simplicity assume the vaccine is only relevant for the domestic market (i.e., there is no global market for vaccines). [5+5+5 = 15 marks]

Answer 1

Part a)

Health-R-Us is a monopoly and thus having a negativek sloped Average and marginal revenues curves (AR and MR curves respectively). Marginal cost (MC) curve represents the supply curve of the firm. Being a monopolist, the firm sells its product Q8 amount in the market at a price P* for each unit. The price and quantity in determined by the intersection of the MC and the MR curves. Price is set equalling with AR of the firm. The price is higher than what is charged in the competitive market.

Hence, a deadweight loss is created represented by the area A+B in the diagram. The efficiency loss arises for not setting the price at the comeptitive level. Due to higher price, a group of consumers is not able to buy the product and thus a part of the consumer surplus is lost, which is not even add with the increase part of the producer surplus. Therefore, a deadweight loss is created in the market.

The shaded retangular area is the amount of monopoly profit earned by Health-R-Us.

Part b) When government withdraws the legal protection for Health-R-Us, the market becomes competitive as large number of firms can enter into the market. Therefore, price of the product eventually decreases and settles at the point where AR and MC curve intersents each other. In this market, AR and MR merge together and becomes horizontal as no firm can individually influence the market price. Hence, AR = MR.

As more firms enter into the market, the supply of the product increases and creates a downward pressure on price. Ar= MR line shifts downward. In the long run, the price drops and becomes tangent to the minimum point of average cost curve. At this point output sold by each firm drops and profits earned by eah firm is just the economic profit in the long run.

Part C)

Patent is a legal right in the form of intellectual property right to the firm that invented the vaccine for coronavirus. Using the patent, the company can produce the vaccine and can get an incentive to invest more on reserach and development despite having a monopoly. Another benefit of the patent is to restrict the vaccine to become public good, which has characteristic of ineffcient use of resources without paying for it.

Another objective of patent is to making the knowledge of new technology public for generating awareness. In the absance of patent, inventor often keep the invention process secret to save it from copying.