Question

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 HealthR-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).?

Answer 1

Patents usually grant exclusivity for 20 years. That means if you're granted a patent for something, only you have the right to produce and sell it in that period. As soon the patent wears out, competitors can swoop in and begin producing the exact same item.

The problem is that, much like intellectual property in general,
the formula for the vaccine is difficult to arrive at but easy to copy.

It took a lot of funded research manpower, laboratory gear and materials to arrive at the formula. The entity funding this research (here Health-R-Us) will have to recover this cost through sales.

However, if competitors were allowed to replicate the vaccine immediately then they would undercut Health-R-Us in price: they don't have that lumpsum investmenet they're trying to recover through profit markup over marginal cost.

To illustrate with a greatly simplified example, say the research cost $1000 and now it takes $1 to produce vaccine for one person. If Health-R-Us were to turn a profit within 100 sales, they have to charge $11 per person. But competitors can charge any sum more than $1 for a vaccine - $2, $3 . . up to $11 - and still turn a profit, because they got the formula for free and they just have to recover that marginal cost per unit of $1.

THis means that the company which made the investment that led to the vaccine in the first place, has now been driven out of business and is stuck with a net loss. THis is one example of the free-rider problem in the field of Public Finance.

If this situation isn't overcome, no firms will be incentivized to do original research - a major loss for society. Thus the government grants patents to preserve the incentive for private individuals to invest into R&D, which - because intellectual property is often non-excludable non-rival and so counts as a public good - translates to technological progress and thus benefits society in the long run.

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