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PROFESSOR: Once again
to put this in the

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context of where we are.

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00:00:27,830 --> 00:00:30,530
We're talking about
producer theory.

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And we're talking
about how firms

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00:00:31,660 --> 00:00:33,230
decide how much to produce.

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00:00:33,230 --> 00:00:36,810
We started with a perfect
competition, and that nailed

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down the fact that with under
perfect competition we got the

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00:00:40,100 --> 00:00:44,920
zero profit long run perfectly
elastic supply curve.

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00:00:44,920 --> 00:00:47,940
We then, last time, talked
about monopoly as another

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00:00:47,940 --> 00:00:51,440
extreme and talked about how
monopolists choose both their

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00:00:51,440 --> 00:00:53,000
price and their quantity.

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00:00:53,000 --> 00:00:55,750
They set margin around or equal
to marginal cost. That

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00:00:55,750 --> 00:00:56,790
gives them a quantity.

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00:00:56,790 --> 00:00:59,620
And then they choose the price
off the demand curve and how

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that leads to profits and how
that leads to monopolists

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00:01:03,370 --> 00:01:05,960
producing less than the
competitive level.

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00:01:05,960 --> 00:01:08,640
And we also ended by talking
about a perfectly price

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discriminating monopolist, one
that can actually charge each

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00:01:12,520 --> 00:01:15,540
consumer their willingness to
pay and therefore, absorb all

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00:01:15,540 --> 00:01:17,430
the social surplus.

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00:01:17,430 --> 00:01:20,480
Now, I want to come back and
start, this morning, by

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00:01:20,480 --> 00:01:23,620
talking again about price
discrimination and realizing

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00:01:23,620 --> 00:01:26,430
that, in some sense, we know
that there's no such thing as

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00:01:26,430 --> 00:01:27,680
perfect price discrimination.

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00:01:27,680 --> 00:01:29,410
There's no monopolist out there
charging us literally

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00:01:29,410 --> 00:01:31,650
exactly what we're
willing to pay.

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00:01:31,650 --> 00:01:34,090
But there are lots of examples
of price discrimination in the

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00:01:34,090 --> 00:01:35,340
real world.

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00:01:35,340 --> 00:01:38,150
And sometimes they're
kind of obvious.

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00:01:38,150 --> 00:01:39,670
Sometimes they're not.

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00:01:39,670 --> 00:01:43,020
But what they all have in common
is the notion of trying

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00:01:43,020 --> 00:01:46,430
to find some signal of our
willingness to pay and using

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00:01:46,430 --> 00:01:48,200
that to set the price.

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00:01:48,200 --> 00:01:50,070
So instead of being like our
original monopolist, just

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00:01:50,070 --> 00:01:51,130
setting one price.

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00:01:51,130 --> 00:01:53,790
Monopolists are forever trying
to find some signal, some

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00:01:53,790 --> 00:01:56,870
underlying signal of our
willingness to pay and using

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00:01:56,870 --> 00:01:58,420
that to set the price.

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00:01:58,420 --> 00:01:58,930
OK.

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00:01:58,930 --> 00:02:02,970
So for example, a classic
example we know is airlines.

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00:02:02,970 --> 00:02:03,450
OK.

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00:02:03,450 --> 00:02:05,000
What airlines do--

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00:02:05,000 --> 00:02:07,480
Airlines charge you more, for
example, if you book your

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00:02:07,480 --> 00:02:10,370
ticket the last minute.

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00:02:10,370 --> 00:02:13,300
And the notion of course-- or
towards the last minute.

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00:02:13,300 --> 00:02:15,370
At the very last minute they may
end up charging you less.

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But as you get close to the date
when you want to leave,

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00:02:17,740 --> 00:02:19,900
the price goes up.

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00:02:19,900 --> 00:02:24,100
The notion, of course, is that
who is going to buy tickets

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00:02:24,100 --> 00:02:26,523
close to the date they want to
leave. It's largely going to

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00:02:26,523 --> 00:02:31,400
be business people, not
the vacation traveler.

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The vacation traveler is
going to plan ahead

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and buy far in advance.

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The one that's going to buy a
week before is the business

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00:02:36,110 --> 00:02:38,460
person who just got a
meeting scheduled.

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Business people are going to
be less price sensitive.

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They're going to have a higher
willingness to pay.

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They've got to get
to the meeting.

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They're not paying anyway.

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The company's paying.

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And they're just to
do what they need

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to get to the meeting.

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So that's a less price
sensitive population.

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So that's the population
you want to hit

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with a higher price.

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So you want to price up tickets
that you buy towards

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00:02:59,630 --> 00:03:01,270
the end because those are more
likely to be the people who

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are least price sensitive.

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So let's ask another question.

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Somebody tell me why do movie
theaters charge less for

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matinees than for
movies at night?

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Why do movie theaters
charge less?

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00:03:14,540 --> 00:03:16,280
If you go see the first movie
of the day-- and you guys

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probably don't anymore.

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But when you were
kids you did.

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And when I take my take
my kids, I do.

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And that afternoon matinee
movie costs less.

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Why is that?

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00:03:27,730 --> 00:03:29,410
Yeah.

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Anyone want to take
a chance at that?

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00:03:30,590 --> 00:03:33,130
And related to it, you can
also ask the question.

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00:03:33,130 --> 00:03:35,570
Why do restaurants have
early bird specials?

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00:03:35,570 --> 00:03:37,400
Why, when you go to restaurant,
often will they

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00:03:37,400 --> 00:03:39,660
charge you less if you go there
in the early hours as

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00:03:39,660 --> 00:03:40,780
opposed to later?

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00:03:40,780 --> 00:03:41,560
So what's going on with that?

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00:03:41,560 --> 00:03:43,054
Someone tell me.

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00:03:43,054 --> 00:03:43,511
Yeah.

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00:03:43,511 --> 00:03:45,150
AUDIENCE: They're not
using up all their

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00:03:45,150 --> 00:03:46,560
seats in the afternoon.

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00:03:46,560 --> 00:03:48,440
So they might as well
lower the price.

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00:03:48,440 --> 00:03:49,960
PROFESSOR: In the afternoon
they're not.

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00:03:49,960 --> 00:03:52,390
Although the truth is, a lot
of the time they're--

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00:03:52,390 --> 00:03:55,370
If you look at a movie theater
today, it's almost never full,

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00:03:55,370 --> 00:03:58,640
except for like the opening
night of a very popular movie.

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00:03:58,640 --> 00:03:59,530
So that's part of it.

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00:03:59,530 --> 00:04:00,800
But let's talk about
the demand side.

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00:04:00,800 --> 00:04:03,800
What else is special about
the type of people?

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00:04:03,800 --> 00:04:05,990
Why don't you go on what's
special about the type of

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00:04:05,990 --> 00:04:08,480
people who want to see movies or
go to restaurants at those

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00:04:08,480 --> 00:04:09,460
different times?

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00:04:09,460 --> 00:04:10,741
They're not willing
to pay as much.

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00:04:10,741 --> 00:04:12,750
PROFESSOR: Yeah, they're
basically people with a lot of

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00:04:12,750 --> 00:04:14,400
free time on their hands.

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00:04:14,400 --> 00:04:14,940
Right?

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00:04:14,940 --> 00:04:18,149
The people who are going out
to dinner early, the people

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00:04:18,149 --> 00:04:19,690
who see movies in the afternoon,
these are people

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00:04:19,690 --> 00:04:22,089
who are unemployed or
have little kids.

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00:04:22,089 --> 00:04:23,990
And they're just looking
to kill time.

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00:04:23,990 --> 00:04:25,660
And so basically, these
are people who

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are willing to shop.

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00:04:27,590 --> 00:04:30,330
These are people who are going
to say look, I've got to fill

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00:04:30,330 --> 00:04:31,340
in some time.

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00:04:31,340 --> 00:04:32,310
I don't have to go right now.

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00:04:32,310 --> 00:04:33,480
I can go any time.

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00:04:33,480 --> 00:04:36,070
So I'm going to be more
price sensitive.

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00:04:36,070 --> 00:04:37,715
The people who are going to
dinner later, who are going

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00:04:37,715 --> 00:04:39,410
out to the movie at night,
they're working all day.

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00:04:39,410 --> 00:04:40,230
They have no choice.

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00:04:40,230 --> 00:04:42,180
They have to see the
movie at night.

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00:04:42,180 --> 00:04:43,050
Or they're in school all day.

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00:04:43,050 --> 00:04:44,410
They have to see the
movie at night.

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00:04:44,410 --> 00:04:47,280
They're less price elastic.

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00:04:47,280 --> 00:04:48,830
So that's why you want
to set the movie

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00:04:48,830 --> 00:04:50,740
price higher at night.

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00:04:50,740 --> 00:04:54,470
Alternatively, another
reason could be--

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One signal of willingness to
pay is price sensitivity.

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00:04:56,270 --> 00:04:57,520
What's another signal?

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00:04:57,520 --> 00:04:59,000
It's going to be income.

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00:04:59,000 --> 00:05:00,830
Who's going to be seeing the
movies during the day and

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00:05:00,830 --> 00:05:03,520
going to the dinner early?

139
00:05:03,520 --> 00:05:06,520
It's elderly individuals and
families with small kids who

140
00:05:06,520 --> 00:05:09,320
are the most resource
strapped.

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00:05:09,320 --> 00:05:10,840
People who have plenty
of disposable income

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00:05:10,840 --> 00:05:11,540
are going at night.

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00:05:11,540 --> 00:05:11,980
They're working.

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00:05:11,980 --> 00:05:12,500
They're young.

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00:05:12,500 --> 00:05:13,920
They're singles and
young couples.

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00:05:13,920 --> 00:05:15,120
They work all day or are
in school all day.

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00:05:15,120 --> 00:05:15,920
They go at night.

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00:05:15,920 --> 00:05:17,710
They have more disposable
income.

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00:05:17,710 --> 00:05:20,300
The people going during the
day are the elders and the

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00:05:20,300 --> 00:05:22,640
people with young kids who have
less disposable income.

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00:05:22,640 --> 00:05:24,750
And as a result they're going
to be more price sensitive.

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00:05:24,750 --> 00:05:26,690
So you want to charge
them a lower price.

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00:05:26,690 --> 00:05:29,240
So that's another example
of price discrimination.

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00:05:29,240 --> 00:05:33,390
OK, why does Disney World charge
you less if you live in

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00:05:33,390 --> 00:05:37,360
the area than if you do not.

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00:05:37,360 --> 00:05:38,310
This is true fact.

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00:05:38,310 --> 00:05:40,830
Disney World charges you less if
you're from Orlando than if

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00:05:40,830 --> 00:05:42,300
you're not from Orlando.

159
00:05:42,300 --> 00:05:43,550
Why is that?

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00:05:45,520 --> 00:05:46,830
Someone tell me.

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00:05:46,830 --> 00:05:47,060
Yeah.

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00:05:47,060 --> 00:05:49,445
AUDIENCE: I think the Disney
can go any time.

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00:05:49,445 --> 00:05:53,976
So you might as well you
might as well take

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00:05:53,976 --> 00:05:56,600
them to other places.

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00:05:56,600 --> 00:05:58,480
PROFESSOR: I mean, basically
the idea is look, if I just

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00:05:58,480 --> 00:06:01,210
spent a grand on a plane ticket
to take my kids to

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00:06:01,210 --> 00:06:05,150
Orlando to Disney World, I'm not
going to kvetch over $10

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00:06:05,150 --> 00:06:06,980
either way, getting in
or not getting in.

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00:06:06,980 --> 00:06:09,550
But if I live in the area,
I may or may not go.

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00:06:09,550 --> 00:06:10,620
I can go to a park, instead.

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00:06:10,620 --> 00:06:11,820
I can go do something
else, instead.

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00:06:11,820 --> 00:06:14,110
It's just one of many
choices for me.

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00:06:14,110 --> 00:06:16,000
The point is, having paid the
fixed cost of getting to

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00:06:16,000 --> 00:06:19,820
Orlando, I'm going to be much
less price sensitive about

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00:06:19,820 --> 00:06:22,090
getting into the park than other
people who live there,

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00:06:22,090 --> 00:06:25,450
who have lots of
other choices.

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00:06:25,450 --> 00:06:27,390
Likewise, having paid the money
to get there, I have

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00:06:27,390 --> 00:06:29,270
shown I have more disposable
income because I paid the

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00:06:29,270 --> 00:06:29,980
money to get there.

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00:06:29,980 --> 00:06:31,660
I've shown I have enough
disposable income that I'm

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00:06:31,660 --> 00:06:33,440
willing to drop money on a plane
ticket to take my kids

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00:06:33,440 --> 00:06:34,340
to Disney World.

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00:06:34,340 --> 00:06:35,942
So I'm going to have
more income that we

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00:06:35,942 --> 00:06:37,330
are willing to pay.

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00:06:37,330 --> 00:06:40,560
OK, so basically the point
is companies are

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00:06:40,560 --> 00:06:42,510
forever doing this.

187
00:06:42,510 --> 00:06:47,090
The ultimate example was,
briefly, Amazon.com started

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00:06:47,090 --> 00:06:49,470
pricing by IP address.

189
00:06:49,470 --> 00:06:51,820
For a while, it was a
controversy over Amazon

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00:06:51,820 --> 00:06:55,940
started literally charging,
getting people's IP addresses

191
00:06:55,940 --> 00:06:58,337
and literally adjusting prices
based on saying, oh, this

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00:06:58,337 --> 00:06:59,660
person is from a university
library.

193
00:06:59,660 --> 00:07:01,200
University libraries aren't
price sensitive.

194
00:07:01,200 --> 00:07:03,440
We'll charge them
more, et cetera.

195
00:07:03,440 --> 00:07:05,490
That got shut down.

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00:07:05,490 --> 00:07:07,480
But that was the ultimate form
of trying to be price

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00:07:07,480 --> 00:07:08,980
discriminatory.

198
00:07:08,980 --> 00:07:10,725
That was as close as we'll
come to perfect price

199
00:07:10,725 --> 00:07:11,120
discrimination.

200
00:07:11,120 --> 00:07:14,020
The point is, in general, people
with market power,

201
00:07:14,020 --> 00:07:16,840
people that set the price above
marginal cost will in

202
00:07:16,840 --> 00:07:20,900
general be looking for parties
which are high income and low

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00:07:20,900 --> 00:07:23,730
elasticity to which they can
charge a higher price.

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00:07:23,730 --> 00:07:24,010
Yeah.

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00:07:24,010 --> 00:07:26,562
AUDIENCE: Another example, like
MIT, they actually ask

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00:07:26,562 --> 00:07:27,258
for your income statement.

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00:07:27,258 --> 00:07:29,186
And then, based on that, they
give you their price.

208
00:07:29,186 --> 00:07:31,420
PROFESSOR: Well, see that's
very interesting.

209
00:07:31,420 --> 00:07:32,060
That's very interesting.

210
00:07:32,060 --> 00:07:33,480
MIT--

211
00:07:33,480 --> 00:07:35,780
What's tricky about that is--

212
00:07:35,780 --> 00:07:37,660
Is that about exploiting
price sensitivity?

213
00:07:37,660 --> 00:07:39,990
Or is that about equity?

214
00:07:39,990 --> 00:07:42,810
That's a bit harder because
MIT could claim--

215
00:07:42,810 --> 00:07:44,770
And probably, actually,
it's true.

216
00:07:44,770 --> 00:07:45,500
They're not doing it.

217
00:07:45,500 --> 00:07:46,840
Because the truth is,
MIT could charge

218
00:07:46,840 --> 00:07:47,530
whatever they want.

219
00:07:47,530 --> 00:07:48,400
They'd still fill the class.

220
00:07:48,400 --> 00:07:49,020
Right?

221
00:07:49,020 --> 00:07:50,570
So it's not really about--

222
00:07:50,570 --> 00:07:52,530
I think in MIT's case, it's
not really about price

223
00:07:52,530 --> 00:07:53,450
sensitivity.

224
00:07:53,450 --> 00:07:55,990
It's about income redistribution
and some notion

225
00:07:55,990 --> 00:07:57,540
of making sure low income
people can come and

226
00:07:57,540 --> 00:07:58,540
afford to be here.

227
00:07:58,540 --> 00:07:59,700
But that is a good point.

228
00:07:59,700 --> 00:08:03,140
The difficulty with empirical
economics is often,

229
00:08:03,140 --> 00:08:04,480
correlation versus causation.

230
00:08:04,480 --> 00:08:07,580
The same fact can have many
different descriptions, many

231
00:08:07,580 --> 00:08:09,440
different explanations.

232
00:08:09,440 --> 00:08:10,420
OK?

233
00:08:10,420 --> 00:08:12,980
So just wanted to give you some
brief examples to think

234
00:08:12,980 --> 00:08:15,460
about the fact that we see
price discrimination in

235
00:08:15,460 --> 00:08:16,590
reality all the time.

236
00:08:16,590 --> 00:08:19,060
Nonetheless, we do our classic
monopoly model.

237
00:08:19,060 --> 00:08:21,010
We assume there's one price.

238
00:08:21,010 --> 00:08:23,370
And the truth is the one price
monopolist is probably closer

239
00:08:23,370 --> 00:08:25,180
to the truth than the perfectly
price discriminating

240
00:08:25,180 --> 00:08:27,800
monopolist. But the truth, as
often in this course, is going

241
00:08:27,800 --> 00:08:29,800
to be somewhere in between.

242
00:08:29,800 --> 00:08:32,580
OK, questions about that.

243
00:08:32,580 --> 00:08:35,230
What I want to focus on
primarily, for this lecture,

244
00:08:35,230 --> 00:08:39,299
is where do monopolies
come from.

245
00:08:39,299 --> 00:08:40,539
How do monopolies arrive?

246
00:08:40,539 --> 00:08:43,789
How do we end up in this
situation, where instead of

247
00:08:43,789 --> 00:08:47,810
many firms competing to sell
a good, we only have one?

248
00:08:47,810 --> 00:08:52,570
And there's basically two
sources of monopolies, two

249
00:08:52,570 --> 00:08:53,600
sources that give birth to

250
00:08:53,600 --> 00:08:57,260
monopolies in modern societies.

251
00:08:57,260 --> 00:09:01,505
The first source is
cost advantages.

252
00:09:08,140 --> 00:09:10,260
The first source is
cost advantages.

253
00:09:10,260 --> 00:09:15,790
Some markets come with natural
cost advantages, natural

254
00:09:15,790 --> 00:09:19,970
reasons why there's a
benefit to being one

255
00:09:19,970 --> 00:09:21,950
player in the market.

256
00:09:21,950 --> 00:09:25,040
So for example, it could be
that there's, essentially,

257
00:09:25,040 --> 00:09:28,260
only one usable input.

258
00:09:28,260 --> 00:09:30,940
So let's say there's a
rock quarry in town.

259
00:09:30,940 --> 00:09:32,130
You've got to get rocks from.

260
00:09:32,130 --> 00:09:33,720
And there's just one
rock quarry.

261
00:09:33,720 --> 00:09:36,360
And rocks are really expensive
to transport.

262
00:09:36,360 --> 00:09:39,160
So basically, if you live in
that town, the person who owns

263
00:09:39,160 --> 00:09:41,620
that rock quarry is going to be
the monopolist. No one else

264
00:09:41,620 --> 00:09:43,390
is really going to compete
because it would cost them so

265
00:09:43,390 --> 00:09:45,290
much to transport rocks
from another

266
00:09:45,290 --> 00:09:47,210
quarry in another town.

267
00:09:47,210 --> 00:09:48,270
OK?

268
00:09:48,270 --> 00:09:50,080
Basically, the point is.

269
00:09:50,080 --> 00:09:53,340
Sometimes, there are
these fixed costs.

270
00:09:53,340 --> 00:09:57,420
And whoever has paid the fixed
cost has an enormous natural

271
00:09:57,420 --> 00:10:00,040
advantage over other
players, over other

272
00:10:00,040 --> 00:10:01,740
entrants to the markets.

273
00:10:01,740 --> 00:10:04,315
And we call those natural
monopolies.

274
00:10:11,010 --> 00:10:12,470
Natural monopolies--

275
00:10:12,470 --> 00:10:18,300
Natural monopoly is a firm where
for all the relevant

276
00:10:18,300 --> 00:10:23,580
quantities over any relevant
range, the average cost for

277
00:10:23,580 --> 00:10:29,190
one firm is always below the
average cost of a new entrant.

278
00:10:29,190 --> 00:10:32,230
The average cost for the one
firm that's in the market is

279
00:10:32,230 --> 00:10:34,490
already always going to be below
the average cost for any

280
00:10:34,490 --> 00:10:36,670
new entrant.

281
00:10:36,670 --> 00:10:40,580
And that is going to be true
in markets with very large

282
00:10:40,580 --> 00:10:45,140
fixed costs and very small
marginal costs.

283
00:10:45,140 --> 00:10:48,440
A natural monopoly will occur
when there's very large fixed

284
00:10:48,440 --> 00:10:54,340
cost and very small marginal
cost. In that case, what we'll

285
00:10:54,340 --> 00:10:59,650
see is average cost is
always declining.

286
00:10:59,650 --> 00:11:02,160
Natural monopolies arise
when average

287
00:11:02,160 --> 00:11:03,680
cost is always declining.

288
00:11:03,680 --> 00:11:05,990
If average cost is always
declining, it's never going to

289
00:11:05,990 --> 00:11:10,330
make sense for another entrant
to come in the market.

290
00:11:10,330 --> 00:11:13,400
And an example we
could think of--

291
00:11:13,400 --> 00:11:16,400
The best example I could think
is like a water utility, the

292
00:11:16,400 --> 00:11:19,210
folks who deliver water
to our houses.

293
00:11:19,210 --> 00:11:21,570
The fixed costs of delivering
water are enormous.

294
00:11:21,570 --> 00:11:24,490
You've got to lay the pipe
to deliver the water

295
00:11:24,490 --> 00:11:25,790
all through the town.

296
00:11:25,790 --> 00:11:27,890
Those are enormous
fixed costs.

297
00:11:27,890 --> 00:11:28,965
The marginal costs
are trivial.

298
00:11:28,965 --> 00:11:29,930
I mean, water is cheap.

299
00:11:29,930 --> 00:11:30,440
You get the water.

300
00:11:30,440 --> 00:11:32,380
You send it through the pipes.

301
00:11:32,380 --> 00:11:33,280
OK?

302
00:11:33,280 --> 00:11:36,360
It would never make sense to
have two companies deliver

303
00:11:36,360 --> 00:11:37,896
water throughout the town.

304
00:11:37,896 --> 00:11:40,900
It wouldn't make sense to have
another company come in, rip

305
00:11:40,900 --> 00:11:43,750
up the roads, lay a competing
set of pipes all through the

306
00:11:43,750 --> 00:11:46,840
town to compete.

307
00:11:46,840 --> 00:11:49,040
It just wouldn't make sense
because those fixed costs are

308
00:11:49,040 --> 00:11:50,990
so huge relative to the
marginal costs.

309
00:11:50,990 --> 00:11:52,350
They could never make money.

310
00:11:52,350 --> 00:11:53,700
That first company--

311
00:11:53,700 --> 00:11:56,390
If a second company came in and
threatened to do that, the

312
00:11:56,390 --> 00:11:59,100
first company could always keep
the price low enough that

313
00:11:59,100 --> 00:12:00,350
that second company could never

314
00:12:00,350 --> 00:12:02,510
recover their fixed costs.

315
00:12:02,510 --> 00:12:04,740
Because the first company has
already paid the fixed cost,

316
00:12:04,740 --> 00:12:06,350
they're already in.

317
00:12:06,350 --> 00:12:07,980
A second company could
never come in and

318
00:12:07,980 --> 00:12:09,280
cover those fixed costs.

319
00:12:09,280 --> 00:12:13,380
So if we see figure 15-1.

320
00:12:13,380 --> 00:12:18,380
Here's an example of a firm,
of a water utility, low

321
00:12:18,380 --> 00:12:21,180
marginal cost. There was a
high fixed cost. So the

322
00:12:21,180 --> 00:12:23,410
initial average costs
are very high.

323
00:12:23,410 --> 00:12:25,930
But the average costs are
declining constantly because

324
00:12:25,930 --> 00:12:29,020
the marginal costs are low,
relative to fixed costs.

325
00:12:29,020 --> 00:12:30,950
OK?

326
00:12:30,950 --> 00:12:35,340
So if demand for the good goes
up, over some relevant range--

327
00:12:35,340 --> 00:12:37,840
If demand gets to be infinite,
it may make sense to lay

328
00:12:37,840 --> 00:12:38,830
another set of pipes.

329
00:12:38,830 --> 00:12:41,350
You know, the first set of pipes
may get overwhelmed.

330
00:12:41,350 --> 00:12:43,760
But as long as demand can be met
by the set of pipes that's

331
00:12:43,760 --> 00:12:49,070
been laid, there's absolutely no
reason for another firm to

332
00:12:49,070 --> 00:12:50,510
enter this market.

333
00:12:50,510 --> 00:12:53,000
If another firm ever threatened
to do so, the first

334
00:12:53,000 --> 00:12:55,236
firm would just lower price and
say, look, you're going to

335
00:12:55,236 --> 00:12:58,010
have to spend so much money
putting that set of pipes in

336
00:12:58,010 --> 00:13:00,590
through town you'll never
be able to make it up.

337
00:13:00,590 --> 00:13:02,500
Because having laid those
set of pipes--

338
00:13:02,500 --> 00:13:05,730
Remember what the shut
down condition is.

339
00:13:05,730 --> 00:13:08,320
As long as that first firm can
charge price greater than

340
00:13:08,320 --> 00:13:11,060
marginal, can charge price above
average variable cost,

341
00:13:11,060 --> 00:13:13,460
which is marginal cost
in this case.

342
00:13:13,460 --> 00:13:15,060
As long as that firm can charge
price above marginal

343
00:13:15,060 --> 00:13:17,760
cost, it will always
stay in business.

344
00:13:17,760 --> 00:13:20,560
And that second firm can't make
any money at a price near

345
00:13:20,560 --> 00:13:23,100
the marginal cost because they
can't cover their fixed cost.

346
00:13:23,100 --> 00:13:25,470
So they'll essentially
chase them out.

347
00:13:25,470 --> 00:13:27,920
So essentially, the fact that
they've had that set of pipes

348
00:13:27,920 --> 00:13:32,910
already laid down gives them a
threat, a credible threat,

349
00:13:32,910 --> 00:13:37,270
that that second firm
cannot enter.

350
00:13:37,270 --> 00:13:40,380
Thus, we call natural monopolies
are places where

351
00:13:40,380 --> 00:13:43,920
other firms face barriers
to entry.

352
00:13:43,920 --> 00:13:46,630
Natural monopolies are where
there are barriers to entry,

353
00:13:46,630 --> 00:13:50,630
where other firms cannot enter
because they'd have to pay

354
00:13:50,630 --> 00:13:51,930
those enormous fixed costs.

355
00:13:51,930 --> 00:13:56,180
And it would never make economic
sense to do so.

356
00:13:56,180 --> 00:13:56,660
OK.

357
00:13:56,660 --> 00:14:00,050
And in that case, you're going
to get a monopoly.

358
00:14:00,050 --> 00:14:02,840
And we call it a natural
monopoly because, in some

359
00:14:02,840 --> 00:14:04,910
sense, the monopoly is the
right thing to do.

360
00:14:04,910 --> 00:14:08,660
It is actually economically
efficient for there to be only

361
00:14:08,660 --> 00:14:11,260
one provider of water
in the town.

362
00:14:11,260 --> 00:14:12,380
That's the economically
efficient outcome.

363
00:14:12,380 --> 00:14:16,020
It is economically inefficient
to pay a second set of those

364
00:14:16,020 --> 00:14:17,930
enormous fixed costs.

365
00:14:17,930 --> 00:14:21,410
Now, then you say, well what
about the fact that monopolist

366
00:14:21,410 --> 00:14:23,220
will under produce water,
charge too much.

367
00:14:23,220 --> 00:14:25,360
We'll get to that in a minute.

368
00:14:25,360 --> 00:14:29,090
But when there's natural
monopolies, the goods should

369
00:14:29,090 --> 00:14:30,080
be delivered by a monopoly.

370
00:14:30,080 --> 00:14:32,050
That's the right thing to do.

371
00:14:32,050 --> 00:14:36,330
But there's a second reason why
monopolies arise, which is

372
00:14:36,330 --> 00:14:39,040
a little more pernicious, which
is government actions.

373
00:14:44,830 --> 00:14:48,680
Sometimes monopolies are
unnatural and created by the

374
00:14:48,680 --> 00:14:50,940
government.

375
00:14:50,940 --> 00:14:54,510
So a classic example is when
governments actually decide

376
00:14:54,510 --> 00:14:56,350
that they're going to deliver
a good and only they'll

377
00:14:56,350 --> 00:14:59,980
deliver the good, like
the postal service.

378
00:14:59,980 --> 00:15:03,040
When a government decides look,
we are just going to

379
00:15:03,040 --> 00:15:04,040
deliver this good.

380
00:15:04,040 --> 00:15:05,040
We're just going to have
the postal service.

381
00:15:05,040 --> 00:15:09,450
And for many, many years, if you
wanted to send a package

382
00:15:09,450 --> 00:15:11,000
from one place to another, you
had to do it through the

383
00:15:11,000 --> 00:15:12,980
postal service.

384
00:15:12,980 --> 00:15:14,160
Well, it turned out
of course, that

385
00:15:14,160 --> 00:15:15,870
wasn't a natural monopoly.

386
00:15:15,870 --> 00:15:19,220
As we know through the growth of
FedEx and others, there was

387
00:15:19,220 --> 00:15:21,820
actually quite a good distance
to compete in that market.

388
00:15:21,820 --> 00:15:24,290
And eventually, those other
folks delivering packages came

389
00:15:24,290 --> 00:15:27,420
in and competed in
that market.

390
00:15:27,420 --> 00:15:32,470
And in fact, in the US, it's
very rare to have a government

391
00:15:32,470 --> 00:15:35,630
provided good, a purely
government provided good.

392
00:15:35,630 --> 00:15:37,900
It's very rare.

393
00:15:37,900 --> 00:15:39,300
Historically, it wasn't.

394
00:15:39,300 --> 00:15:41,100
And in many other parts of
the world, it's not.

395
00:15:41,100 --> 00:15:42,790
In many other parts of the
world, governments run the

396
00:15:42,790 --> 00:15:46,860
banks, the airlines,
all utilities.

397
00:15:46,860 --> 00:15:48,560
So in many other parts of the
world, governments will

398
00:15:48,560 --> 00:15:50,830
actually set up these
monopolies

399
00:15:50,830 --> 00:15:53,180
through government action.

400
00:15:53,180 --> 00:15:56,350
And basically, that is something
which is not done

401
00:15:56,350 --> 00:15:59,080
much in the US but
done elsewhere.

402
00:15:59,080 --> 00:16:02,520
Now however, one place we do set
up monopolies in the US,

403
00:16:02,520 --> 00:16:04,210
which is pretty important,
is through

404
00:16:04,210 --> 00:16:05,663
the issuing of patents.

405
00:16:09,570 --> 00:16:16,220
If you invent, say a new drug,
and you patent it.

406
00:16:16,220 --> 00:16:18,760
You then have the exclusive
right to sell that chemical

407
00:16:18,760 --> 00:16:22,110
compound for 17 years.

408
00:16:22,110 --> 00:16:24,860
So if you come up with some new
chemical compound to treat

409
00:16:24,860 --> 00:16:29,380
whatever, you have the exclusive
right to market that

410
00:16:29,380 --> 00:16:32,830
chemical compound
for 17 years.

411
00:16:32,830 --> 00:16:35,430
That is a government sanctioned
monopoly.

412
00:16:39,240 --> 00:16:43,480
Now, is that a good thing
or a bad thing?

413
00:16:43,480 --> 00:16:44,610
Are patents--

414
00:16:44,610 --> 00:16:46,820
The government has just
created a monopoly.

415
00:16:46,820 --> 00:16:49,020
Could someone tell me why that
might be actually a good thing

416
00:16:49,020 --> 00:16:50,400
for the government to do?

417
00:16:50,400 --> 00:16:50,600
Yeah.

418
00:16:50,600 --> 00:16:53,025
AUDIENCE: Schumpeter talks about
how it's a way to cause

419
00:16:53,025 --> 00:16:53,246
innovation.

420
00:16:53,246 --> 00:16:54,916
Because no one would put that
many dollars into drug

421
00:16:54,916 --> 00:16:56,392
research, if they weren't
going to be

422
00:16:56,392 --> 00:16:57,130
able to make money.

423
00:16:57,130 --> 00:17:00,082
Because the marginal cost was
so low that other people--

424
00:17:00,082 --> 00:17:02,050
The cost of establishing a
pharmaceutical company

425
00:17:02,050 --> 00:17:04,018
[UNINTELLIGIBLE]
is really low.

426
00:17:04,018 --> 00:17:06,314
So other people would come
and cut out all their

427
00:17:06,314 --> 00:17:06,970
profits that they had.

428
00:17:06,970 --> 00:17:09,829
PROFESSOR: Exactly, if you put
all these resources into

429
00:17:09,829 --> 00:17:12,550
inventing a drug, it's not
like laying pipes.

430
00:17:12,550 --> 00:17:14,670
Once you invented it, someone
could just copy it the next

431
00:17:14,670 --> 00:17:17,069
day and produce it at the
same cost you can.

432
00:17:17,069 --> 00:17:18,930
So why would you ever do that?

433
00:17:18,930 --> 00:17:21,660
Why would you, as someone who,
even if you cared about the

434
00:17:21,660 --> 00:17:23,819
benefits to the world, still
want to make some money.

435
00:17:23,819 --> 00:17:26,170
Why would you spend billions
and millions of dollars

436
00:17:26,170 --> 00:17:27,230
inventing these new drugs?

437
00:17:27,230 --> 00:17:28,760
If the next day, someone
else can just say,

438
00:17:28,760 --> 00:17:29,260
that's a great idea.

439
00:17:29,260 --> 00:17:32,190
I'll produce that for $0.47 a
pill, just like you will.

440
00:17:32,190 --> 00:17:33,300
And you won't make
any money off it.

441
00:17:33,300 --> 00:17:35,550
And you'll have lost all this
money you invested.

442
00:17:35,550 --> 00:17:39,060
So the argument for patents is
you want an incentive for

443
00:17:39,060 --> 00:17:42,040
innovation, which suggests
there's a trade-off here.

444
00:17:42,040 --> 00:17:45,170
On the one hand, you want an
incentive for innovation.

445
00:17:45,170 --> 00:17:48,210
On the other hand, once you
create this monopoly, they can

446
00:17:48,210 --> 00:17:50,510
charge outrageous prices.

447
00:17:50,510 --> 00:17:51,480
There is a drug.

448
00:17:51,480 --> 00:17:52,270
There are drugs.

449
00:17:52,270 --> 00:17:55,290
Genzyme is very big company
started here in Massachusetts.

450
00:17:55,290 --> 00:17:59,510
And the whole reason they exist
is to create drugs for

451
00:17:59,510 --> 00:18:01,250
very, very rare diseases.

452
00:18:01,250 --> 00:18:02,950
Diseases that strike like
100,000 people a

453
00:18:02,950 --> 00:18:05,410
year but are deadly.

454
00:18:05,410 --> 00:18:08,100
Like Gaucher's disease is a
famous example of this one.

455
00:18:08,100 --> 00:18:09,270
So they create these drugs.

456
00:18:09,270 --> 00:18:11,190
They put billions of dollars
into research,

457
00:18:11,190 --> 00:18:12,960
create these drugs.

458
00:18:12,960 --> 00:18:15,100
And then, having created them
and gotten a patent, charge

459
00:18:15,100 --> 00:18:18,350
like $100,000 a year
to use the drugs.

460
00:18:18,350 --> 00:18:22,310
Drugs that cost, you know,
$500 a year to produce.

461
00:18:22,310 --> 00:18:25,770
Now on the one hand, if these
drugs didn't exist,

462
00:18:25,770 --> 00:18:26,930
people would die.

463
00:18:26,930 --> 00:18:29,060
These are literally
lifesaving drugs.

464
00:18:29,060 --> 00:18:31,930
These are people who used to
die, who now live because of

465
00:18:31,930 --> 00:18:34,060
these drugs.

466
00:18:34,060 --> 00:18:36,710
And these drugs never would have
been invented if Genzyme

467
00:18:36,710 --> 00:18:38,660
couldn't have made some
money off them.

468
00:18:38,660 --> 00:18:40,910
On the other hand, you've got
a product which costs $500 a

469
00:18:40,910 --> 00:18:44,500
year to make, and they're
charging $100,000 a year to

470
00:18:44,500 --> 00:18:46,200
people to use.

471
00:18:46,200 --> 00:18:48,100
And in particular, when it
comes to drugs like for

472
00:18:48,100 --> 00:18:52,250
treating AIDS in the developed
world where people cannot--

473
00:18:52,250 --> 00:18:54,240
There's no way they can afford
that kind of money.

474
00:18:54,240 --> 00:18:55,030
That's a problem.

475
00:18:55,030 --> 00:18:55,529
Yeah.

476
00:18:55,529 --> 00:18:58,148
AUDIENCE: But aren't you not
only paying for them to

477
00:18:58,148 --> 00:18:59,521
produce the drug but
paying for all the

478
00:18:59,521 --> 00:19:01,180
research that went into--

479
00:19:01,180 --> 00:19:02,860
PROFESSOR: Exactly,
that's right.

480
00:19:02,860 --> 00:19:03,690
You're paying for all
the research.

481
00:19:03,690 --> 00:19:04,570
That's why they never
would have

482
00:19:04,570 --> 00:19:05,760
invented it if they couldn't.

483
00:19:05,760 --> 00:19:07,350
So you're paying for
the research.

484
00:19:07,350 --> 00:19:09,460
They also take home a nice,
hefty profit at

485
00:19:09,460 --> 00:19:10,350
the end of the day.

486
00:19:10,350 --> 00:19:11,480
But that is true.

487
00:19:11,480 --> 00:19:13,390
You are also paying for the
research that goes into that.

488
00:19:13,390 --> 00:19:15,120
And people wouldn't put
that money up front.

489
00:19:15,120 --> 00:19:17,090
That research is funded
by investors.

490
00:19:17,090 --> 00:19:19,303
And investors would not invest
in Genzyme and give them money

491
00:19:19,303 --> 00:19:21,590
to do research if they weren't
going to get a return.

492
00:19:21,590 --> 00:19:22,660
So if Genzyme--

493
00:19:22,660 --> 00:19:26,920
Of that $99,500 Genzyme makes
on that Gaucher's disease

494
00:19:26,920 --> 00:19:30,260
drug, most of it is going back
to pay the people who funded

495
00:19:30,260 --> 00:19:31,040
the research.

496
00:19:31,040 --> 00:19:32,170
But a healthy chunk is not.

497
00:19:32,170 --> 00:19:35,750
A healthy chunk is market
power monopoly profit.

498
00:19:35,750 --> 00:19:36,070
Yeah.

499
00:19:36,070 --> 00:19:39,320
AUDIENCE: Could the government
then have subsidies for some

500
00:19:39,320 --> 00:19:42,570
types of licensing to ensure
that the consumers are not

501
00:19:42,570 --> 00:19:44,902
affected because everyone
cannot afford the

502
00:19:44,902 --> 00:19:45,570
drug without it.

503
00:19:45,570 --> 00:19:48,500
PROFESSOR: I'm going to come
to that in a second.

504
00:19:48,500 --> 00:19:50,770
Now actually, let me just hold
that thought for a second

505
00:19:50,770 --> 00:19:52,710
because I want to actually show
you how we think about

506
00:19:52,710 --> 00:19:54,490
whether patent is a
good idea or not.

507
00:19:54,490 --> 00:19:56,320
So let's go to figure 15-2.

508
00:19:56,320 --> 00:19:59,400
I just want to, sort of, show
you how what you guys seem to

509
00:19:59,400 --> 00:20:01,980
understand intuitively, we can
illustrate in the kind of

510
00:20:01,980 --> 00:20:03,850
graphs we've been using.

511
00:20:03,850 --> 00:20:05,580
Once again, we want to think
about going back and forth

512
00:20:05,580 --> 00:20:08,230
between the intuition and the
graphical and mathematical

513
00:20:08,230 --> 00:20:10,050
aspects of this stuff.

514
00:20:10,050 --> 00:20:15,120
So here we have a monopolist.
Imagine that you have a good

515
00:20:15,120 --> 00:20:18,700
where the original demand
curve is D1.

516
00:20:18,700 --> 00:20:21,470
A good where the original demand
curve is D1 and the

517
00:20:21,470 --> 00:20:26,490
original consumer surplus is
that dotted area C plus 1 plus

518
00:20:26,490 --> 00:20:27,990
that slashed triangle.

519
00:20:27,990 --> 00:20:31,960
So it's based on the area above
the competitive price PC

520
00:20:31,960 --> 00:20:33,900
under the demand curve D1.

521
00:20:33,900 --> 00:20:35,050
So you have a good.

522
00:20:35,050 --> 00:20:37,480
It's some drug, which
people like.

523
00:20:37,480 --> 00:20:38,910
And there's some
demand for it.

524
00:20:38,910 --> 00:20:41,890
And it's produced competitively
at a price PC

525
00:20:41,890 --> 00:20:44,340
with the consumer surplus
of that triangle.

526
00:20:44,340 --> 00:20:47,730
Now, let's say a monopolist
comes along and says, we can

527
00:20:47,730 --> 00:20:50,290
make this drug way better.

528
00:20:50,290 --> 00:20:52,070
We could make a much better
drug, but we're going to need

529
00:20:52,070 --> 00:20:53,260
a patent for it.

530
00:20:53,260 --> 00:20:54,510
Well, two things happen.

531
00:20:54,510 --> 00:20:58,530
On the one hand, the demand
curve shifts way out.

532
00:20:58,530 --> 00:21:01,360
Now you've got something which
people value a lot more.

533
00:21:01,360 --> 00:21:04,430
They're much more willing to
pay for this better drug.

534
00:21:04,430 --> 00:21:05,240
OK?

535
00:21:05,240 --> 00:21:06,540
And that's the benefit.

536
00:21:06,540 --> 00:21:10,100
That's the innovation
effect on demand.

537
00:21:10,100 --> 00:21:12,370
On the other hand, the
price goes up to the

538
00:21:12,370 --> 00:21:14,930
monopolist's price.

539
00:21:14,930 --> 00:21:17,386
Where marginal revenue equals
marginal cost, they're going

540
00:21:17,386 --> 00:21:21,930
to produce at Q sub m and charge
a higher price P sub m.

541
00:21:21,930 --> 00:21:23,770
Whereas, if this is a perfectly
competitive firm,

542
00:21:23,770 --> 00:21:27,930
they produce much more, where D2
hits the marginal cost and

543
00:21:27,930 --> 00:21:31,260
consumer surplus would
be much larger.

544
00:21:31,260 --> 00:21:35,830
So the trade off is, on the
one hand, you end up here.

545
00:21:35,830 --> 00:21:38,750
In this case I've drawn, you end
up with a larger consumer

546
00:21:38,750 --> 00:21:41,890
surplus, even with monopoly.

547
00:21:41,890 --> 00:21:45,300
But you could imagine drawing
the same graph, in the case

548
00:21:45,300 --> 00:21:47,110
where consumer surplus falls.

549
00:21:47,110 --> 00:21:49,540
You can imagine demand doesn't
go up that much.

550
00:21:49,540 --> 00:21:52,380
But the monopolist gets
the monopoly price.

551
00:21:52,380 --> 00:21:54,390
And you could imagine drawing
this triangle such that the

552
00:21:54,390 --> 00:21:56,330
new consumer surplus triangle
is smaller than the old

553
00:21:56,330 --> 00:21:58,010
consumer surplus triangle.

554
00:21:58,010 --> 00:21:59,080
OK?

555
00:21:59,080 --> 00:22:00,790
So it's not obvious which
way this goes.

556
00:22:00,790 --> 00:22:01,580
You have two effects.

557
00:22:01,580 --> 00:22:04,900
On the one hand, you have the
effect that demand shifts out.

558
00:22:04,900 --> 00:22:08,110
That creates a potential for
more social surplus.

559
00:22:08,110 --> 00:22:10,400
On the other hand, you have the
case that the monopolist

560
00:22:10,400 --> 00:22:12,500
artificially prices too high.

561
00:22:12,500 --> 00:22:14,670
That causes a reduction
in social surplus.

562
00:22:14,670 --> 00:22:17,120
In this case, the former
dominated the latter.

563
00:22:17,120 --> 00:22:19,170
But I hope you can see you can
draw this in cases where that

564
00:22:19,170 --> 00:22:20,750
wouldn't be true.

565
00:22:20,750 --> 00:22:23,520
And that's the tricky
thing with patents.

566
00:22:23,520 --> 00:22:24,800
It's going to depend.

567
00:22:24,800 --> 00:22:27,230
If you're patenting something
which is really demand

568
00:22:27,230 --> 00:22:28,480
increasing, that's great.

569
00:22:28,480 --> 00:22:30,070
But if you're patenting
something which is just a

570
00:22:30,070 --> 00:22:33,090
copycat of something that exists
and all you're doing is

571
00:22:33,090 --> 00:22:34,130
turning a competitive market--

572
00:22:34,130 --> 00:22:36,430
In the limit, imagine I
somehow snookered the

573
00:22:36,430 --> 00:22:39,570
government into giving me a
patent for something which

574
00:22:39,570 --> 00:22:42,690
literally does no more
than what's existed.

575
00:22:42,690 --> 00:22:44,830
But somehow I could fool--

576
00:22:44,830 --> 00:22:46,840
In that case, have to do a
little more or people wouldn't

577
00:22:46,840 --> 00:22:48,945
buy it, just a little more
than what existed.

578
00:22:48,945 --> 00:22:50,350
It wouldn't increase
demand much.

579
00:22:50,350 --> 00:22:57,830
But I would then have these
monopoly rents.

580
00:22:57,830 --> 00:22:58,430
OK?

581
00:22:58,430 --> 00:23:02,250
So that's basically the trade
off with patents.

582
00:23:02,250 --> 00:23:05,430
All right, question
about that.

583
00:23:05,430 --> 00:23:07,830
Now, let me move on then
and talk about--

584
00:23:07,830 --> 00:23:09,030
The question was
raised about--

585
00:23:09,030 --> 00:23:12,090
Well, couldn't the government
do something about this, in

586
00:23:12,090 --> 00:23:13,520
terms of trying to address
this problem.

587
00:23:13,520 --> 00:23:16,100
And we just talked about the
government as bad guy in

588
00:23:16,100 --> 00:23:16,960
creating this problem.

589
00:23:16,960 --> 00:23:18,170
Although, it's not necessarily
a problem

590
00:23:18,170 --> 00:23:19,740
in the case of patents.

591
00:23:19,740 --> 00:23:21,890
But there's also the role of
government as potential good

592
00:23:21,890 --> 00:23:25,990
guy, which is can the government
help in this case

593
00:23:25,990 --> 00:23:27,480
of natural monopoly?

594
00:23:27,480 --> 00:23:30,780
So natural monopoly, we've got
this awkward situation where

595
00:23:30,780 --> 00:23:32,150
clearly a monopoly
makes sense.

596
00:23:32,150 --> 00:23:33,980
It doesn't make sense to have
competitive people delivering

597
00:23:33,980 --> 00:23:35,330
water in town.

598
00:23:35,330 --> 00:23:37,990
But once you've got one person
delivering water, they'll

599
00:23:37,990 --> 00:23:41,400
charge you a fortune for it,
well above marginal cost. And

600
00:23:41,400 --> 00:23:42,090
that's inefficient.

601
00:23:42,090 --> 00:23:45,700
That lowers social surplus
relative to the optimal level

602
00:23:45,700 --> 00:23:47,650
of provision.

603
00:23:47,650 --> 00:23:50,600
So can the government
solve this problem?

604
00:23:50,600 --> 00:23:54,730
Could the government, for
example, come in and say look,

605
00:23:54,730 --> 00:23:56,340
we recognize there's
a natural monopoly.

606
00:23:56,340 --> 00:23:59,410
We recognize that you, Rubrico,
are the only company

607
00:23:59,410 --> 00:24:00,690
that makes sense to
deliver water.

608
00:24:00,690 --> 00:24:05,210
But we are going to regulate you
in a way to maximize the

609
00:24:05,210 --> 00:24:07,890
social surplus, given that
natural monopoly.

610
00:24:07,890 --> 00:24:09,450
So to see that, let's
go to the highly

611
00:24:09,450 --> 00:24:11,510
complicated figure 15-3.

612
00:24:11,510 --> 00:24:12,870
OK, we'll have to walk
through this slowly.

613
00:24:12,870 --> 00:24:15,040
It's a lot of stuff going
on here at once.

614
00:24:15,040 --> 00:24:17,340
OK?

615
00:24:17,340 --> 00:24:17,800
15-3.

616
00:24:17,800 --> 00:24:20,750
We're back to the usual curves
we were using last time.

617
00:24:20,750 --> 00:24:24,080
The demand curve is P
equals 24 minus Q.

618
00:24:24,080 --> 00:24:27,510
The cost curve is 12
plus Q squared.

619
00:24:27,510 --> 00:24:30,160
So the marginal cost
is just 2Q.

620
00:24:30,160 --> 00:24:33,980
The competitive outcome was
to produce eight units

621
00:24:33,980 --> 00:24:37,170
at a price of 16.

622
00:24:37,170 --> 00:24:39,450
The monopoly outcome was
to produce six units

623
00:24:39,450 --> 00:24:42,210
at a price of 18.

624
00:24:42,210 --> 00:24:43,210
OK?

625
00:24:43,210 --> 00:24:47,130
And you ended up with the
monopolist causing a

626
00:24:47,130 --> 00:24:51,670
deadweight loss of C plus E.
That was where we were last

627
00:24:51,670 --> 00:24:53,362
time in this example.

628
00:24:53,362 --> 00:24:55,980
And let's say this was
a natural monopoly.

629
00:24:55,980 --> 00:24:58,610
So that's why there's
a monopolist there.

630
00:24:58,610 --> 00:25:04,460
Now, what if the government came
in and mandated that the

631
00:25:04,460 --> 00:25:09,540
monopolist can charge no more
than the competitive price?

632
00:25:09,540 --> 00:25:10,550
Let's say the government
knew what the

633
00:25:10,550 --> 00:25:11,300
competitive price was.

634
00:25:11,300 --> 00:25:13,490
The government says,
look, I took 14.01.

635
00:25:13,490 --> 00:25:14,320
I see this graph.

636
00:25:14,320 --> 00:25:16,560
I know the competitive
price is 16.

637
00:25:16,560 --> 00:25:18,000
So I'm going to say,
monopolist--

638
00:25:18,000 --> 00:25:19,390
You're the monopolist.
You go ahead.

639
00:25:19,390 --> 00:25:21,180
And no one else can
deliver water.

640
00:25:21,180 --> 00:25:22,350
It makes sense for
you to do it.

641
00:25:22,350 --> 00:25:26,510
But I'm going to regulate that
you cannot charge consumers a

642
00:25:26,510 --> 00:25:29,670
price above 16.

643
00:25:29,670 --> 00:25:33,730
What you can see in that case,
is the government will turn

644
00:25:33,730 --> 00:25:38,580
the monopolist from a price
maker to a price taker.

645
00:25:38,580 --> 00:25:41,620
And in doing so, the government
will undo the

646
00:25:41,620 --> 00:25:44,810
poisoning effect we talked about
last time and cause the

647
00:25:44,810 --> 00:25:48,720
monopolist to behave as if it
was a competitive firm.

648
00:25:48,720 --> 00:25:52,860
So to see that, we have to ask,
well what's the marginal

649
00:25:52,860 --> 00:25:57,310
revenue curve now for the
monopolist, given this

650
00:25:57,310 --> 00:26:01,930
government mandate that it can
charge no more than 16?

651
00:26:01,930 --> 00:26:06,650
Well, the marginal revenue
curve, up to the point it

652
00:26:06,650 --> 00:26:09,790
sells six, is the old marginal
revenue curve.

653
00:26:09,790 --> 00:26:11,570
So we're working down this
marginal revenue curve.

654
00:26:11,570 --> 00:26:13,540
And up to that point, where
marginal revenue intersects

655
00:26:13,540 --> 00:26:17,910
marginal cost, that's the
marginal revenue curve.

656
00:26:17,910 --> 00:26:21,480
And that's where the monopolist
would stop.

657
00:26:21,480 --> 00:26:23,980
But the problem is the
monopolist isn't actually able

658
00:26:23,980 --> 00:26:26,290
to charge more than 16.

659
00:26:26,290 --> 00:26:29,570
So now, if it's charging 16,
now it asks itself well,

660
00:26:29,570 --> 00:26:32,130
should I produce that
seventh unit.

661
00:26:32,130 --> 00:26:34,210
Remember last time
we did the math.

662
00:26:34,210 --> 00:26:36,770
The monopolist should not
produce the seventh unit.

663
00:26:36,770 --> 00:26:38,590
Because last time we showed
that, because of that

664
00:26:38,590 --> 00:26:41,785
poisoning effect, profits would
fall if it produced that

665
00:26:41,785 --> 00:26:42,840
seventh unit.

666
00:26:42,840 --> 00:26:46,910
But now it's not true because
now it's only charging 16.

667
00:26:46,910 --> 00:26:50,300
So if it's charging 16, and if
it produces that seventh unit,

668
00:26:50,300 --> 00:26:52,380
it's still going to charge 16.

669
00:26:52,380 --> 00:26:55,270
The poisoning effect
has gone away.

670
00:26:55,270 --> 00:26:56,620
There's no more poisoning
effect.

671
00:26:56,620 --> 00:26:58,990
There's no loss to producing the
seventh unit because the

672
00:26:58,990 --> 00:27:00,040
most it can get is 16.

673
00:27:00,040 --> 00:27:01,240
It would like to price
it much higher.

674
00:27:01,240 --> 00:27:02,470
It can't.

675
00:27:02,470 --> 00:27:11,780
Since the most it can price at
is 16 he says, well gee, then

676
00:27:11,780 --> 00:27:12,640
there's no poisoning effect.

677
00:27:12,640 --> 00:27:17,390
I might as well produce at
the competitive level.

678
00:27:17,390 --> 00:27:19,900
And basically, what you can
see is if you tell the

679
00:27:19,900 --> 00:27:22,130
monopolist they can't charge
more than the competitive

680
00:27:22,130 --> 00:27:25,810
price, then they will produce
at the competitive level.

681
00:27:25,810 --> 00:27:28,820
And you'll end up at that
competitive outcome, even with

682
00:27:28,820 --> 00:27:31,240
a monopolist, because that will
be the profit maximizing

683
00:27:31,240 --> 00:27:34,770
thing for the monopolist
to do.

684
00:27:34,770 --> 00:27:38,130
So sounds like we've got a
pretty good solution here.

685
00:27:38,130 --> 00:27:38,720
Right?

686
00:27:38,720 --> 00:27:42,020
If there's a natural monopoly,
we just come in and say you

687
00:27:42,020 --> 00:27:45,470
can't charge more than the
competitive price.

688
00:27:45,470 --> 00:27:47,520
So in theory, government
can fix this.

689
00:27:47,520 --> 00:27:49,250
We've been talking about
government as a bad guy.

690
00:27:49,250 --> 00:27:50,590
Here's government
as a good guy.

691
00:27:50,590 --> 00:27:52,160
Government can come
in and fix this.

692
00:27:52,160 --> 00:27:54,180
What's the problem with that?

693
00:27:54,180 --> 00:27:55,890
What's the problem, in practice,
with carrying out

694
00:27:55,890 --> 00:27:58,588
what I just laid out
here in theory?

695
00:27:58,588 --> 00:27:59,084
Yeah.

696
00:27:59,084 --> 00:28:00,696
AUDIENCE: How does the
government know what the

697
00:28:00,696 --> 00:28:01,068
competitive price is?

698
00:28:01,068 --> 00:28:02,458
PROFESSOR: How does the
government know what the

699
00:28:02,458 --> 00:28:03,170
competitive price is?

700
00:28:03,170 --> 00:28:06,590
How does the government know
what these curves look like?

701
00:28:06,590 --> 00:28:08,590
Now, let's think about
both curves.

702
00:28:08,590 --> 00:28:10,170
OK, first the government
needs to know--

703
00:28:10,170 --> 00:28:11,630
If it wants to know the
competitive price, it's got to

704
00:28:11,630 --> 00:28:14,260
know the demand curve and
the supply curve.

705
00:28:14,260 --> 00:28:16,910
Well the demand curve, in
principle, the government

706
00:28:16,910 --> 00:28:17,370
could learn.

707
00:28:17,370 --> 00:28:20,010
The government could go out and
survey people and get a

708
00:28:20,010 --> 00:28:22,820
sense of kind of, could collect
some data, could run

709
00:28:22,820 --> 00:28:24,670
some experiments and try to
find out from people.

710
00:28:24,670 --> 00:28:27,200
Gee, how much are you willing
to pay for another unit,

711
00:28:27,200 --> 00:28:28,460
another unit, another unit?

712
00:28:28,460 --> 00:28:30,250
So in principle, the government
could actually

713
00:28:30,250 --> 00:28:33,160
measure demand curve by
doing market research.

714
00:28:33,160 --> 00:28:36,020
Although in practice,
this is quite hard.

715
00:28:36,020 --> 00:28:38,100
It turns out in practice--

716
00:28:38,100 --> 00:28:41,580
The first rule of economics is
believe what people do, not

717
00:28:41,580 --> 00:28:42,670
what they say.

718
00:28:42,670 --> 00:28:44,760
Turns out, if you ask people
what they're willing to pay,

719
00:28:44,760 --> 00:28:47,640
you get very silly answers,
relative to actually do it.

720
00:28:47,640 --> 00:28:50,470
So for example, this comes up
a lot in when the government

721
00:28:50,470 --> 00:28:52,930
needs to value environmental
damage.

722
00:28:52,930 --> 00:28:57,590
So if we need to ask how much
should we charge BP for the

723
00:28:57,590 --> 00:29:01,830
damage they did to the Gulf, we
need to value how sad are

724
00:29:01,830 --> 00:29:04,820
people that the wetlands
are ruined.

725
00:29:04,820 --> 00:29:07,100
Well, the only thing to
do is to ask people.

726
00:29:07,100 --> 00:29:07,930
And it turns out when
you do that, you get

727
00:29:07,930 --> 00:29:09,510
incredibly silly answers.

728
00:29:09,510 --> 00:29:11,815
Things like, for example, if you
ask people how sorry are

729
00:29:11,815 --> 00:29:14,820
you if 10 ducks died, they'll
say I'm this sad.

730
00:29:14,820 --> 00:29:16,560
Say how sad are you if
a million ducks died?

731
00:29:16,560 --> 00:29:18,290
They'll say, I'm the
same amount sad.

732
00:29:18,290 --> 00:29:19,820
OK, that doesn't make sense.

733
00:29:19,820 --> 00:29:23,240
You ask people what's it
worth to save a duck

734
00:29:23,240 --> 00:29:25,790
versus saving a whale.

735
00:29:25,790 --> 00:29:27,660
And you ask in that order,
they'll say saving a duck is

736
00:29:27,660 --> 00:29:30,460
worth $100, saving a whale
is worth $100.

737
00:29:30,460 --> 00:29:31,830
Or it's worth $150.

738
00:29:31,830 --> 00:29:32,650
You ask the other order.

739
00:29:32,650 --> 00:29:33,870
You say, how much is
it worth to save a

740
00:29:33,870 --> 00:29:34,940
whale and then a duck.

741
00:29:34,940 --> 00:29:36,310
Well then, saving a whale
is worth $300.

742
00:29:36,310 --> 00:29:38,690
And a duck's only worth
$50, same question

743
00:29:38,690 --> 00:29:40,640
just a different order.

744
00:29:40,640 --> 00:29:42,900
People do not give sensible
answers when you ask them what

745
00:29:42,900 --> 00:29:43,760
things are worth.

746
00:29:43,760 --> 00:29:46,640
The best way to know is to
actually vary the price, is to

747
00:29:46,640 --> 00:29:50,770
actually run experiments where
you actually say, OK, we have

748
00:29:50,770 --> 00:29:52,580
to actually give people
different prices and see how

749
00:29:52,580 --> 00:29:56,460
they behave, actually trace
out the demand curve.

750
00:29:56,460 --> 00:29:59,210
That turns out to be very hard
to do, especially for things

751
00:29:59,210 --> 00:30:00,960
like valuing damage
to wetlands.

752
00:30:00,960 --> 00:30:03,380
But even for things like valuing
prescription drugs,

753
00:30:03,380 --> 00:30:04,550
you've got to literally--

754
00:30:04,550 --> 00:30:07,480
It's hard to run the experiment
where, literally, I

755
00:30:07,480 --> 00:30:08,710
give you a different price
than you for a

756
00:30:08,710 --> 00:30:09,890
prescription drug.

757
00:30:09,890 --> 00:30:10,900
That's a little bit tricky.

758
00:30:10,900 --> 00:30:12,080
So it's hard to get
the demand curve.

759
00:30:12,080 --> 00:30:13,870
So that's the first problem
the government faces.

760
00:30:13,870 --> 00:30:17,740
But in some sense, that's the
less difficult problem.

761
00:30:17,740 --> 00:30:19,230
It is tracing out the
demand curve.

762
00:30:19,230 --> 00:30:20,720
In principle, there
are ways to do it.

763
00:30:20,720 --> 00:30:22,450
In principle, you could run
experiments where you vary the

764
00:30:22,450 --> 00:30:25,620
price and you get that
demand curve.

765
00:30:25,620 --> 00:30:29,860
In practice, the difficulty
is firm supply

766
00:30:29,860 --> 00:30:31,060
curves are much harder.

767
00:30:31,060 --> 00:30:32,520
And why is that?

768
00:30:32,520 --> 00:30:34,195
Because let's say the government
comes to you and

769
00:30:34,195 --> 00:30:35,300
says, look I'm doing great.

770
00:30:35,300 --> 00:30:36,570
I've nailed down the
demand curve.

771
00:30:36,570 --> 00:30:38,340
I just need to know your supply
curve, so I can set

772
00:30:38,340 --> 00:30:39,210
your price.

773
00:30:39,210 --> 00:30:41,290
What's your supply
curve again?

774
00:30:41,290 --> 00:30:42,055
OK, what are you going to say?

775
00:30:42,055 --> 00:30:43,262
AUDIENCE: [INAUDIBLE]

776
00:30:43,262 --> 00:30:45,490
PROFESSOR: Aw, this stuff
costs a fortune to make.

777
00:30:45,490 --> 00:30:48,550
You would not believe what it
costs this stuff to make.

778
00:30:48,550 --> 00:30:49,450
My supply curve--

779
00:30:49,450 --> 00:30:50,360
12 plus Q squared?

780
00:30:50,360 --> 00:30:50,850
Ha!

781
00:30:50,850 --> 00:30:51,280
That's a joke.

782
00:30:51,280 --> 00:30:53,480
It's 30 plus 18Q squared.

783
00:30:53,480 --> 00:30:54,050
Are you kidding?

784
00:30:54,050 --> 00:30:56,720
My supply curve is crazy high.

785
00:30:56,720 --> 00:31:00,340
And the problem is, the
government doesn't know.

786
00:31:00,340 --> 00:31:02,950
Because with consumers, at least
I can run experiments to

787
00:31:02,950 --> 00:31:03,480
get the demand.

788
00:31:03,480 --> 00:31:05,800
With the firm, I can't get
inside their books.

789
00:31:05,800 --> 00:31:06,650
I can't really know.

790
00:31:06,650 --> 00:31:08,840
And if I get inside the books,
they can cook their books and

791
00:31:08,840 --> 00:31:10,240
make it look like stuff
costs more.

792
00:31:10,240 --> 00:31:11,010
How can I really know?

793
00:31:11,010 --> 00:31:13,340
Just like it's difficult for
the board of directors to

794
00:31:13,340 --> 00:31:16,900
figure out whether the CEO of a
company needs his own plane,

795
00:31:16,900 --> 00:31:18,640
it's very difficult for
government regulators to

796
00:31:18,640 --> 00:31:21,845
figure out what it actually
costs to produce these drugs.

797
00:31:21,845 --> 00:31:26,570
And as a result, it's very
hard to get this right.

798
00:31:26,570 --> 00:31:31,700
And the problem is if the
government gets it wrong, it

799
00:31:31,700 --> 00:31:35,200
can make it worse than not
regulating at all.

800
00:31:35,200 --> 00:31:40,180
So for example, if the
government came in, and let's

801
00:31:40,180 --> 00:31:42,750
say, the government said look,
I can't believe this firm.

802
00:31:42,750 --> 00:31:45,370
12 plus Q squared sounds way
too high for cost. I think

803
00:31:45,370 --> 00:31:46,930
marginal costs are much
lower than that.

804
00:31:46,930 --> 00:31:50,060
And I think the competitive
price should be 10 because I

805
00:31:50,060 --> 00:31:51,470
know the firm is going
to lie to me.

806
00:31:51,470 --> 00:31:52,740
I know they're going to tell
me numbers too big.

807
00:31:52,740 --> 00:31:54,795
So I'm going to say that
equilibrium should be

808
00:31:54,795 --> 00:31:57,740
competitive, should
be a price of 10.

809
00:31:57,740 --> 00:32:01,500
And at a price of 10, the firm
is now operating off the

810
00:32:01,500 --> 00:32:04,130
marginal revenue curve
at that low price

811
00:32:04,130 --> 00:32:05,940
because it's below 16.

812
00:32:05,940 --> 00:32:09,660
So at a price of 10, the firm
is going to set marginal

813
00:32:09,660 --> 00:32:14,790
revenue equal to marginal cost.
Well, marginal revenue

814
00:32:14,790 --> 00:32:17,560
at a price of 10 is the price.

815
00:32:17,560 --> 00:32:19,490
That's all they can
charge is 10.

816
00:32:19,490 --> 00:32:22,450
So they're going to set price
equal to marginal cost. The

817
00:32:22,450 --> 00:32:27,040
marginal cost with a
production of 10--

818
00:32:27,040 --> 00:32:29,010
The marginal cost is 2Q.

819
00:32:29,010 --> 00:32:31,090
So set price equal to 2Q.

820
00:32:31,090 --> 00:32:33,490
Or 10 equals 2Q.

821
00:32:33,490 --> 00:32:35,280
Or Q equals five.

822
00:32:35,280 --> 00:32:37,230
They'll produce five units.

823
00:32:37,230 --> 00:32:38,520
They'll say look, if you're only
going to let me charge

824
00:32:38,520 --> 00:32:41,020
10, I'm only going to
produce five units.

825
00:32:41,020 --> 00:32:41,750
That's what I'll produce.

826
00:32:41,750 --> 00:32:46,450
That's what's optimal for
me at a price of 10.

827
00:32:46,450 --> 00:32:48,030
What you see is--

828
00:32:48,030 --> 00:32:50,240
Now if you look at this graph
and you look at the firm

829
00:32:50,240 --> 00:32:53,585
producing five units.

830
00:32:53,585 --> 00:32:56,540
What you see is the firm
produces five units.

831
00:32:56,540 --> 00:32:59,540
Now, the total surplus
has fallen.

832
00:32:59,540 --> 00:33:04,670
It's just A plus B plus D. The
consumer surplus is very high.

833
00:33:04,670 --> 00:33:06,320
We don't have the horizontal
line of 10 here.

834
00:33:06,320 --> 00:33:09,360
But draw yourself that
horizontal line of 10, which

835
00:33:09,360 --> 00:33:12,120
is where the dashed line of five
intersects the marginal

836
00:33:12,120 --> 00:33:13,870
cost curve.

837
00:33:13,870 --> 00:33:15,430
You could see there's a
big consumer surplus.

838
00:33:15,430 --> 00:33:18,980
It's A plus B plus half of D and
a little producer surplus,

839
00:33:18,980 --> 00:33:21,800
which is that triangle that's
the lower half of D. But look

840
00:33:21,800 --> 00:33:23,550
what's happened to
social surplus.

841
00:33:23,550 --> 00:33:26,550
Before the government got
involved, the deadweight loss

842
00:33:26,550 --> 00:33:30,190
was just C plus E. Now the
government, by misregulating

843
00:33:30,190 --> 00:33:33,210
the price, has created
deadweight losses of C plus E

844
00:33:33,210 --> 00:33:36,840
plus F plus G plus H. The
government has just increased

845
00:33:36,840 --> 00:33:41,240
the deadweight loss a lot,
by getting involved and

846
00:33:41,240 --> 00:33:43,710
misregulating.

847
00:33:43,710 --> 00:33:47,150
And in particular, that area
that increases it--

848
00:33:47,150 --> 00:33:49,150
Here's the interesting thing.

849
00:33:49,150 --> 00:33:52,490
Falling from eight to six caused
that little triangle.

850
00:33:52,490 --> 00:33:55,650
Falling from six to five, just
one more unit, causes a

851
00:33:55,650 --> 00:33:59,280
trapezoid, which is probably
bigger than that triangle.

852
00:33:59,280 --> 00:34:00,250
Why?

853
00:34:00,250 --> 00:34:01,770
Because we're moving
farther and farther

854
00:34:01,770 --> 00:34:03,170
away from the optimum.

855
00:34:03,170 --> 00:34:05,890
We're losing more and more
trades that were socially

856
00:34:05,890 --> 00:34:08,199
beneficial.

857
00:34:08,199 --> 00:34:10,929
Remember at the optimum,
deadweight loss is very small.

858
00:34:10,929 --> 00:34:13,190
But as you move farther and
farther away, that deadweight

859
00:34:13,190 --> 00:34:14,190
loss gets bigger and bigger.

860
00:34:14,190 --> 00:34:17,760
So this government
misregulation, instead of

861
00:34:17,760 --> 00:34:23,280
moving us to what's optimal,
by just moving us one below

862
00:34:23,280 --> 00:34:25,870
where we were as a monopolist
has caused all this huge extra

863
00:34:25,870 --> 00:34:29,120
deadweight loss and
made things worse.

864
00:34:29,120 --> 00:34:31,280
Indeed, it could be worse.

865
00:34:31,280 --> 00:34:33,630
Imagine the government chose a
price so low the firm just

866
00:34:33,630 --> 00:34:34,100
said, forget it.

867
00:34:34,100 --> 00:34:36,000
I'm going to shut down.

868
00:34:36,000 --> 00:34:37,699
You could lose all surplus
in this market.

869
00:34:37,699 --> 00:34:39,360
If the government came
in and said, no, we

870
00:34:39,360 --> 00:34:39,880
don't believe you.

871
00:34:39,880 --> 00:34:41,130
The price should be whatever.

872
00:34:41,130 --> 00:34:43,300
It wouldn't be, in this case,
because in this case, price is

873
00:34:43,300 --> 00:34:45,580
always greater than
marginal cost.

874
00:34:45,580 --> 00:34:47,445
But let's say the government
came in another case and set a

875
00:34:47,445 --> 00:34:48,239
price that was too low.

876
00:34:48,239 --> 00:34:49,650
It could just cause the
firm to shut down.

877
00:34:49,650 --> 00:34:53,090
Then all social surplus in the
market would disappear.

878
00:34:53,090 --> 00:34:54,190
OK?

879
00:34:54,190 --> 00:34:56,540
So basically, there's these
difficulties with the

880
00:34:56,540 --> 00:34:59,720
regulation, which is it's hard
to know how to set the price.

881
00:34:59,720 --> 00:35:02,620
Now in practice, of course, what
happens is governments

882
00:35:02,620 --> 00:35:04,570
set the price too high.

883
00:35:04,570 --> 00:35:08,740
In practice, the government
would much rather err on the

884
00:35:08,740 --> 00:35:11,160
side of letting monopolists make
a little money than err

885
00:35:11,160 --> 00:35:13,720
on the side of there being
too little of the good.

886
00:35:13,720 --> 00:35:15,170
So government, facing
uncertainty about what the

887
00:35:15,170 --> 00:35:18,410
right level to set is, will
typically end up erring on the

888
00:35:18,410 --> 00:35:20,460
side of monopolists, partly
because of the way of the

889
00:35:20,460 --> 00:35:21,990
nature of regulation.

890
00:35:21,990 --> 00:35:26,700
So let's say you are
president whatever.

891
00:35:26,700 --> 00:35:28,310
And you want to regulate
this new good.

892
00:35:28,310 --> 00:35:30,660
OK, somebody made the new good
and you want to regulate it.

893
00:35:30,660 --> 00:35:33,630
Well who are you going to hire
to be the regulator?

894
00:35:33,630 --> 00:35:34,700
Well clearly, someone who knows

895
00:35:34,700 --> 00:35:36,740
something about the market.

896
00:35:36,740 --> 00:35:38,930
So there's a new good.

897
00:35:38,930 --> 00:35:41,020
My favorite example
of an outdated

898
00:35:41,020 --> 00:35:42,420
technology is the umbrella.

899
00:35:42,420 --> 00:35:43,490
I really think we've
got to figure out a

900
00:35:43,490 --> 00:35:44,360
better way to do umbrellas.

901
00:35:44,360 --> 00:35:45,030
They suck.

902
00:35:45,030 --> 00:35:46,410
In the wind, they blow up.

903
00:35:46,410 --> 00:35:47,110
They're useless, right.

904
00:35:47,110 --> 00:35:48,490
There's got to be a better
umbrella out there.

905
00:35:48,490 --> 00:35:52,050
Let's say somebody finally
figures out a better umbrella.

906
00:35:52,050 --> 00:35:54,150
But they've got a
patent on it.

907
00:35:54,150 --> 00:35:54,720
And so you want to
regulate it.

908
00:35:54,720 --> 00:35:56,480
It's got some natural monopoly
producing it.

909
00:35:56,480 --> 00:35:57,950
It uses unobtanium.

910
00:35:57,950 --> 00:35:59,750
And the only can find it
in one place, Pandora.

911
00:35:59,750 --> 00:36:01,090
So they've got to--

912
00:36:01,090 --> 00:36:02,835
They're the only guys--

913
00:36:02,835 --> 00:36:04,640
Isn't that the stupidest name
ever for a material?

914
00:36:04,640 --> 00:36:06,300
How could they have not come
up with a better name than

915
00:36:06,300 --> 00:36:07,250
unobtanium?

916
00:36:07,250 --> 00:36:09,570
Anyway, so it uses unobtanium.

917
00:36:09,570 --> 00:36:11,320
And basically they have
this natural monopoly.

918
00:36:11,320 --> 00:36:12,950
So you want to regulate it

919
00:36:12,950 --> 00:36:14,770
Well, who are you going to
find to regulate it?

920
00:36:14,770 --> 00:36:16,540
Well you know, once there was an
expert in making umbrellas

921
00:36:16,540 --> 00:36:18,510
with unobtanium.

922
00:36:18,510 --> 00:36:20,220
That person who you're
going to hire.

923
00:36:20,220 --> 00:36:21,370
That's the right
person to hire.

924
00:36:21,370 --> 00:36:22,630
Unfortunately, that probably
means they're probably

925
00:36:22,630 --> 00:36:24,270
friendly with all the guys
that make umbrellas with

926
00:36:24,270 --> 00:36:25,900
unobtanium.

927
00:36:25,900 --> 00:36:26,790
And they're not going
to want to be too

928
00:36:26,790 --> 00:36:29,100
tough on their buddies.

929
00:36:29,100 --> 00:36:31,110
So the natural person who's
going to regulate, by their

930
00:36:31,110 --> 00:36:35,560
nature, is going to tend to be
someone who's going to think

931
00:36:35,560 --> 00:36:37,070
sort of on the industry's
side.

932
00:36:37,070 --> 00:36:38,970
Moreover, what are they going to
do after they're done being

933
00:36:38,970 --> 00:36:40,050
the regulator?

934
00:36:40,050 --> 00:36:41,190
They're going to go back into
the business of making

935
00:36:41,190 --> 00:36:42,440
umbrellas with unobtanium.

936
00:36:42,440 --> 00:36:43,910
So they're not going to want to
be too mean to the business

937
00:36:43,910 --> 00:36:45,000
because they're going to
be making money off

938
00:36:45,000 --> 00:36:46,550
it five years hence.

939
00:36:46,550 --> 00:36:49,340
So you've got this problem that
regulators are going to

940
00:36:49,340 --> 00:36:51,390
have a natural tendency to be
sort of friendly towards

941
00:36:51,390 --> 00:36:52,700
industry they're regulating.

942
00:36:52,700 --> 00:36:55,280
And that's going to lead
to an upward bias.

943
00:36:55,280 --> 00:36:59,970
The question is, how much is
that upward bias in the price

944
00:36:59,970 --> 00:37:02,160
relative to what the monopolist
would actually do.

945
00:37:02,160 --> 00:37:03,860
And much like a patent,
it depends.

946
00:37:03,860 --> 00:37:05,850
You can draw examples where
the government regulation

947
00:37:05,850 --> 00:37:08,180
would improve things and
examples where the government

948
00:37:08,180 --> 00:37:09,730
regulation would make
things worse.

949
00:37:09,730 --> 00:37:11,490
You can do examples
either way.

950
00:37:11,490 --> 00:37:14,170
And what, at least, is
interesting here is this is

951
00:37:14,170 --> 00:37:15,623
the first example we've seen
or one of the few examples

952
00:37:15,623 --> 00:37:16,670
we've seen where the government,
at least, could

953
00:37:16,670 --> 00:37:18,270
possibly make things better.

954
00:37:18,270 --> 00:37:19,730
Even though it's not
clear they will.

955
00:37:19,730 --> 00:37:21,600
At least, they could possibly
make things better.

956
00:37:21,600 --> 00:37:22,710
And that's because--

957
00:37:22,710 --> 00:37:23,365
Why is that?

958
00:37:23,365 --> 00:37:24,910
This is a very important
insight.

959
00:37:24,910 --> 00:37:25,740
Why is that?

960
00:37:25,740 --> 00:37:27,530
That's because everything we've
dealt with so far, the

961
00:37:27,530 --> 00:37:29,710
market does everything well.

962
00:37:29,710 --> 00:37:31,280
We haven't needed
a government.

963
00:37:31,280 --> 00:37:34,290
What natural monopolies do is
they say, wow, here's a case

964
00:37:34,290 --> 00:37:36,970
of what we call a
market failure.

965
00:37:36,970 --> 00:37:40,480
The market has failed to
maximize social surplus.

966
00:37:40,480 --> 00:37:44,860
And that opens the door for
potential gains for government

967
00:37:44,860 --> 00:37:46,220
intervention.

968
00:37:46,220 --> 00:37:49,130
Basically, as long as markets
are functioning well in a

969
00:37:49,130 --> 00:37:52,650
competitive manner, there's no
door open for the government

970
00:37:52,650 --> 00:37:53,270
to make things better.

971
00:37:53,270 --> 00:37:55,590
The government can just
make things worse.

972
00:37:55,590 --> 00:37:58,640
It's only when there's market
failures, of which natural

973
00:37:58,640 --> 00:38:02,720
monopoly is one example, can
the government come in and

974
00:38:02,720 --> 00:38:03,730
potentially make
things better.

975
00:38:03,730 --> 00:38:06,170
It won't necessarily do so.

976
00:38:06,170 --> 00:38:09,210
But at least there's a door
open to doing so.

977
00:38:09,210 --> 00:38:11,840
Questions about that--

978
00:38:11,840 --> 00:38:14,990
OK, the last thing I want to
talk about, today, is an

979
00:38:14,990 --> 00:38:20,160
example that's in between a
natural monopoly and no

980
00:38:20,160 --> 00:38:22,200
natural monopoly, which
is what we call

981
00:38:22,200 --> 00:38:23,460
a contestable market.

982
00:38:29,890 --> 00:38:31,610
A contestable market--

983
00:38:31,610 --> 00:38:36,080
A contestable market is one
which says that there is a

984
00:38:36,080 --> 00:38:41,180
natural monopoly, but it's not
so big that someone couldn't

985
00:38:41,180 --> 00:38:44,860
come in and compete if the
profits got too large.

986
00:38:44,860 --> 00:38:47,960
Or another way of saying this
is, just because there's a

987
00:38:47,960 --> 00:38:52,020
monopoly doesn't mean there's
a whole lot of market power.

988
00:38:52,020 --> 00:38:53,800
Just because there's a monopoly
doesn't mean there's

989
00:38:53,800 --> 00:38:55,750
a whole lot of market power.

990
00:38:55,750 --> 00:38:58,740
So imagine a natural monopoly
market with a very modest

991
00:38:58,740 --> 00:39:02,030
fixed cost, a fixed cost
that's, you know,

992
00:39:02,030 --> 00:39:05,440
real but not enormous.

993
00:39:05,440 --> 00:39:08,700
As long that monopolist who
gets in first keeps their

994
00:39:08,700 --> 00:39:12,940
price near marginal cost,
no will ever enter.

995
00:39:12,940 --> 00:39:14,770
As long as they get their price
near marginal cost, no

996
00:39:14,770 --> 00:39:16,700
one will enter, even if they're
making a small profit.

997
00:39:16,700 --> 00:39:21,090
No one will enter because no one
could ever make money then

998
00:39:21,090 --> 00:39:21,690
and pay the fixed.

999
00:39:21,690 --> 00:39:23,340
No one could ever come in,
pay the fixed cost,

1000
00:39:23,340 --> 00:39:24,940
and still make money.

1001
00:39:24,940 --> 00:39:26,720
So no one's ever
going to enter.

1002
00:39:26,720 --> 00:39:30,370
But if that price ever got too
far above marginal cost, then

1003
00:39:30,370 --> 00:39:32,210
someone would say, ah, there's
so much profit to be made.

1004
00:39:32,210 --> 00:39:33,210
That'll cover my fixed costs.

1005
00:39:33,210 --> 00:39:34,960
I'm coming in.

1006
00:39:34,960 --> 00:39:37,260
That's what we mean by
contestable market, a market

1007
00:39:37,260 --> 00:39:41,010
which can exist with a monopoly
and can exist with

1008
00:39:41,010 --> 00:39:41,880
someone making money.

1009
00:39:41,880 --> 00:39:47,630
And yet ultimately, there's
sufficiently easy entry that,

1010
00:39:47,630 --> 00:39:52,100
basically, the monopolist is
forced to behave almost like a

1011
00:39:52,100 --> 00:39:53,250
competitive firm.

1012
00:39:53,250 --> 00:39:56,410
So it's sort of like market
pressure on monopolists.

1013
00:39:56,410 --> 00:39:59,080
It's a weird outcome where you
get a monopoly market but

1014
00:39:59,080 --> 00:40:01,670
pricing close to competitive
levels because of

1015
00:40:01,670 --> 00:40:04,290
this threat of entry.

1016
00:40:04,290 --> 00:40:07,910
Now the most famous example
of this is in airlines and

1017
00:40:07,910 --> 00:40:10,620
airline deregulation.

1018
00:40:10,620 --> 00:40:14,900
Until the 1970s, the way
airlines worked in the US is

1019
00:40:14,900 --> 00:40:16,400
there were private airline
companies.

1020
00:40:16,400 --> 00:40:18,750
Many of them don't exist
anymore, Eastern, Pan Am.

1021
00:40:18,750 --> 00:40:21,290
Ones you don't know about,
don't exist anymore.

1022
00:40:21,290 --> 00:40:24,010
And they were regulated.

1023
00:40:24,010 --> 00:40:25,650
It was a regulated oligopoly.

1024
00:40:25,650 --> 00:40:26,940
We haven't really talked
about oligopolies yet.

1025
00:40:26,940 --> 00:40:28,150
It was a few firms competing.

1026
00:40:28,150 --> 00:40:29,490
But think of it as a monopoly.

1027
00:40:29,490 --> 00:40:31,540
It's basically regulated
monopoly.

1028
00:40:31,540 --> 00:40:33,380
In particular, they
had monopolies

1029
00:40:33,380 --> 00:40:34,570
on different routes.

1030
00:40:34,570 --> 00:40:35,630
So what happened is the
government would

1031
00:40:35,630 --> 00:40:38,120
say New York to Boston.

1032
00:40:38,120 --> 00:40:41,740
That is the route that Eastern
Airlines owns.

1033
00:40:41,740 --> 00:40:44,930
And they fly that without
competition.

1034
00:40:44,930 --> 00:40:46,940
But in order to make sure they
don't rip off the consumer,

1035
00:40:46,940 --> 00:40:49,200
we're going to regulate
their prices.

1036
00:40:49,200 --> 00:40:50,950
So Eastern Airlines, you fly
this without competition.

1037
00:40:50,950 --> 00:40:52,260
But we're going to
regulate what you

1038
00:40:52,260 --> 00:40:54,750
can charge the consumer.

1039
00:40:54,750 --> 00:40:57,350
And this was because the
government viewed airlines as

1040
00:40:57,350 --> 00:40:58,050
a natural monopoly.

1041
00:40:58,050 --> 00:41:01,750
It said, look, airplanes are
really big and expensive.

1042
00:41:01,750 --> 00:41:04,720
There's huge fixed cost to
becoming an airline.

1043
00:41:04,720 --> 00:41:05,990
So we think this is a
natural monopoly.

1044
00:41:05,990 --> 00:41:08,650
And we're going to
regulate it.

1045
00:41:08,650 --> 00:41:10,750
However, economists started
pointing out, and experts

1046
00:41:10,750 --> 00:41:14,580
started pointing out that no,
in fact, this was actually a

1047
00:41:14,580 --> 00:41:16,150
very contestable market.

1048
00:41:16,150 --> 00:41:17,400
That it turned out
it wasn't that

1049
00:41:17,400 --> 00:41:18,360
expensive to produce airplanes.

1050
00:41:18,360 --> 00:41:20,610
There were a lot of older
airplanes you could

1051
00:41:20,610 --> 00:41:22,960
refurbish, et cetera.

1052
00:41:22,960 --> 00:41:24,620
And that basically this is
a market where, if the

1053
00:41:24,620 --> 00:41:27,120
government opened it up to
competition, you could

1054
00:41:27,120 --> 00:41:28,680
actually get some--

1055
00:41:28,680 --> 00:41:29,720
That threat of entry
eventually could

1056
00:41:29,720 --> 00:41:32,620
drive prices down.

1057
00:41:32,620 --> 00:41:34,535
And so basically, after a lot of
debate, the government, in

1058
00:41:34,535 --> 00:41:37,960
the late 1970s, did deregulate
airlines.

1059
00:41:37,960 --> 00:41:39,965
One of the most important
changes in government policy

1060
00:41:39,965 --> 00:41:42,880
in the 1970s was they
deregulated airlines.

1061
00:41:42,880 --> 00:41:44,390
And what happened?

1062
00:41:44,390 --> 00:41:46,270
Well, three things happened.

1063
00:41:46,270 --> 00:41:49,520
First of all, prices
fell enormously.

1064
00:41:49,520 --> 00:41:51,790
Prices fell by about a third.

1065
00:41:51,790 --> 00:41:53,980
Flying from point A to point B
fell by a third, other places

1066
00:41:53,980 --> 00:41:55,050
more extreme.

1067
00:41:55,050 --> 00:41:59,040
When I was an undergraduate at
MIT, I could fly from Boston

1068
00:41:59,040 --> 00:42:02,000
to Newark for $19 each way.

1069
00:42:02,000 --> 00:42:04,490
There was this airline called
People's Express that was

1070
00:42:04,490 --> 00:42:06,880
introduced in the wave of
deregulation in the 1980s.

1071
00:42:06,880 --> 00:42:07,590
People's Express--

1072
00:42:07,590 --> 00:42:08,680
It was fascinating.

1073
00:42:08,680 --> 00:42:11,440
I don't know what their planes
were held together by.

1074
00:42:11,440 --> 00:42:14,510
And the thing was, you didn't
even buy a ticket.

1075
00:42:14,510 --> 00:42:15,920
You just went and
waited on line.

1076
00:42:15,920 --> 00:42:16,830
They let you on the plane.

1077
00:42:16,830 --> 00:42:18,240
And when the plane was
full, they took off.

1078
00:42:18,240 --> 00:42:20,350
And they made you pay
on the plane.

1079
00:42:20,350 --> 00:42:21,740
I still, to this day, don't
know what happened if you

1080
00:42:21,740 --> 00:42:23,350
didn't have the money, if they
like threw you off, get

1081
00:42:23,350 --> 00:42:24,070
parachutes or something.

1082
00:42:24,070 --> 00:42:25,320
I don't know what they did.

1083
00:42:25,320 --> 00:42:26,880
But literally, they'd come down
the middle of the aisle

1084
00:42:26,880 --> 00:42:28,720
with a little credit
card thing.

1085
00:42:28,720 --> 00:42:30,030
And they'd make you
pay on the plane.

1086
00:42:30,030 --> 00:42:33,065
I mean literally, it was cheaper
than taking a bus.

1087
00:42:33,065 --> 00:42:37,400
It was incredible,
$19 each way.

1088
00:42:37,400 --> 00:42:40,240
So prices came way, way down.

1089
00:42:40,240 --> 00:42:42,640
The second effect was
many more routes

1090
00:42:42,640 --> 00:42:44,200
were offered to consumers.

1091
00:42:44,200 --> 00:42:47,040
Suddenly, routes which the
government had said, no that's

1092
00:42:47,040 --> 00:42:47,740
not profitable.

1093
00:42:47,740 --> 00:42:49,140
You shouldn't fly that.

1094
00:42:49,140 --> 00:42:50,910
New entrants said, no, in
fact, it is profitable,

1095
00:42:50,910 --> 00:42:51,220
government.

1096
00:42:51,220 --> 00:42:53,040
You just had the cost
structure wrong.

1097
00:42:53,040 --> 00:42:57,070
And it is profitable to fly from
Pittsburgh to Akron, or

1098
00:42:57,070 --> 00:43:00,670
whatever, wherever
they now fly.

1099
00:43:00,670 --> 00:43:03,140
There are hundreds more places
you can fly now than you could

1100
00:43:03,140 --> 00:43:04,520
in the 1970s.

1101
00:43:04,520 --> 00:43:07,220
Hundreds and hundreds of routes
that just didn't exist

1102
00:43:07,220 --> 00:43:08,350
because the government
regulators assumed they

1103
00:43:08,350 --> 00:43:09,250
weren't profitable.

1104
00:43:09,250 --> 00:43:10,210
But in fact, they were.

1105
00:43:10,210 --> 00:43:13,180
Once there was competition in
these contestable markets,

1106
00:43:13,180 --> 00:43:14,430
they did turn out to
be profitable.

1107
00:43:16,660 --> 00:43:20,200
And the final thing that
happened was that quality of

1108
00:43:20,200 --> 00:43:23,870
airline travel deteriorated
massively.

1109
00:43:23,870 --> 00:43:25,920
When I was a kid, and
you flew on planes.

1110
00:43:25,920 --> 00:43:27,580
It was really nice.

1111
00:43:27,580 --> 00:43:29,420
I mean there was tons
of leg room.

1112
00:43:29,420 --> 00:43:33,820
You got tons of free food,
free movies, free drinks.

1113
00:43:33,820 --> 00:43:34,690
And I didn't do that
when I was a kid.

1114
00:43:34,690 --> 00:43:35,640
My parents did.

1115
00:43:35,640 --> 00:43:39,120
Basically, it was an
unbelievably nice experience.

1116
00:43:39,120 --> 00:43:40,490
It's not so nice now.

1117
00:43:40,490 --> 00:43:42,680
I think as any of you who have
flown will attest to.

1118
00:43:42,680 --> 00:43:43,920
Now they're charging
you for everything.

1119
00:43:43,920 --> 00:43:47,650
And you can barely fit your legs
in if you're over 5'2".

1120
00:43:47,650 --> 00:43:51,490
Now, why did this happen?

1121
00:43:51,490 --> 00:43:52,100
Somebody tell me.

1122
00:43:52,100 --> 00:43:53,080
Why did this happen?

1123
00:43:53,080 --> 00:43:56,260
Why did deregulation lead from
a world where flights were

1124
00:43:56,260 --> 00:44:00,890
unbelievably comfy to a world
where flights are uncomfy?

1125
00:44:00,890 --> 00:44:01,155
Yeah.

1126
00:44:01,155 --> 00:44:04,408
AUDIENCE: It's more profitable
to have more people taking it.

1127
00:44:04,408 --> 00:44:04,906
And--

1128
00:44:04,906 --> 00:44:06,490
PROFESSOR: Sure, but that
was always true.

1129
00:44:06,490 --> 00:44:07,800
It was always more profitable
to have

1130
00:44:07,800 --> 00:44:08,650
more people on a plane.

1131
00:44:08,650 --> 00:44:11,070
It was always more profitable
to not give them nice stuff.

1132
00:44:11,070 --> 00:44:12,080
That hasn't changed.

1133
00:44:12,080 --> 00:44:13,000
What has changed?

1134
00:44:13,000 --> 00:44:13,340
Yeah.

1135
00:44:13,340 --> 00:44:14,663
AUDIENCE: You have-- there's
competition.

1136
00:44:14,663 --> 00:44:16,380
So they need to reduce
their cost more.

1137
00:44:16,380 --> 00:44:17,253
PROFESSOR: What's that?

1138
00:44:17,253 --> 00:44:18,702
AUDIENCE: There's more
competition.

1139
00:44:18,702 --> 00:44:21,120
So they need to reduce
their cost.

1140
00:44:21,120 --> 00:44:22,300
PROFESSOR: There is
more competition.

1141
00:44:22,300 --> 00:44:24,620
But there was some competition
before.

1142
00:44:24,620 --> 00:44:25,470
But you're right.

1143
00:44:25,470 --> 00:44:26,440
Your about halfway there.

1144
00:44:26,440 --> 00:44:27,063
What else?

1145
00:44:27,063 --> 00:44:29,485
AUDIENCE: Consumers aren't
willing to pay for leg room

1146
00:44:29,485 --> 00:44:29,970
and all that stuff.

1147
00:44:29,970 --> 00:44:33,260
PROFESSOR: Basically before, if
there was a route with two

1148
00:44:33,260 --> 00:44:34,730
airlines on it--

1149
00:44:34,730 --> 00:44:35,970
A lot of them, I said there's
two airlines.

1150
00:44:35,970 --> 00:44:37,320
And you wanted to compete.

1151
00:44:37,320 --> 00:44:38,490
How did you compete?

1152
00:44:38,490 --> 00:44:40,210
You couldn't compete on price.

1153
00:44:40,210 --> 00:44:41,285
Right?

1154
00:44:41,285 --> 00:44:44,660
If Eastern and Pan Am were
flying New York to Boston,

1155
00:44:44,660 --> 00:44:45,900
they couldn't compete
on price.

1156
00:44:45,900 --> 00:44:46,720
The price was regulated.

1157
00:44:46,720 --> 00:44:48,960
So how did they compete, by
being as nice as possible on

1158
00:44:48,960 --> 00:44:51,600
everything else, even though
consumers didn't

1159
00:44:51,600 --> 00:44:53,170
really value it.

1160
00:44:53,170 --> 00:44:55,080
Well, once they competed on
price, they said, look,

1161
00:44:55,080 --> 00:44:56,650
consumers don't really care
so much about this

1162
00:44:56,650 --> 00:44:58,650
crappy airline food.

1163
00:44:58,650 --> 00:45:01,380
We're going to get rid of
it and charge 20% less.

1164
00:45:01,380 --> 00:45:03,960
And lo and behold, they did.

1165
00:45:03,960 --> 00:45:06,180
What's ironic, of course, is
everyone bitches about how bad

1166
00:45:06,180 --> 00:45:08,050
airlines are.

1167
00:45:08,050 --> 00:45:10,800
But they don't bitch about
how cheap they are.

1168
00:45:10,800 --> 00:45:13,990
It is so cheap to fly now,
compared to when I was a kid.

1169
00:45:13,990 --> 00:45:16,080
Based on what happened is they
went from competing on

1170
00:45:16,080 --> 00:45:19,240
non-price factors to
competing on price.

1171
00:45:19,240 --> 00:45:21,570
There's always competitive
pressure.

1172
00:45:21,570 --> 00:45:22,760
There's always competitive
pressure.

1173
00:45:22,760 --> 00:45:24,610
It's just before, the
competition had to be on

1174
00:45:24,610 --> 00:45:26,160
things which consumers
didn't like.

1175
00:45:26,160 --> 00:45:28,030
But they liked it enough
that you might as

1176
00:45:28,030 --> 00:45:28,770
well compete on it.

1177
00:45:28,770 --> 00:45:30,130
Because it was not that
consumers didn't like it all.

1178
00:45:30,130 --> 00:45:31,050
Obviously they liked
it some, or they

1179
00:45:31,050 --> 00:45:32,750
wouldn't have bothered.

1180
00:45:32,750 --> 00:45:35,250
Now they've moved to a more
efficient form of competition,

1181
00:45:35,250 --> 00:45:38,770
which is to compete on price
rather than on quantity.

1182
00:45:38,770 --> 00:45:39,251
Yeah.

1183
00:45:39,251 --> 00:45:41,014
AUDIENCE: When you said the
government regulated the

1184
00:45:41,014 --> 00:45:43,580
price, only wasn't that just
on the upper level

1185
00:45:43,580 --> 00:45:44,542
that you got that?

1186
00:45:44,542 --> 00:45:45,790
PROFESSOR: No.

1187
00:45:45,790 --> 00:45:48,560
The government just regulated
the price.

1188
00:45:48,560 --> 00:45:51,680
Now, so this is a big victory
for economists.

1189
00:45:51,680 --> 00:45:53,370
Yay for economists--

1190
00:45:53,370 --> 00:45:54,220
We did a great job.

1191
00:45:54,220 --> 00:45:57,430
But we whiffed on one thing.

1192
00:45:57,430 --> 00:46:01,130
We whiffed on one thing, which
we did not foresee, which has

1193
00:46:01,130 --> 00:46:03,620
led deregulation to be much
less beneficial than we

1194
00:46:03,620 --> 00:46:05,150
thought it was going to be.

1195
00:46:05,150 --> 00:46:08,990
What we whiffed on was the
hub and spoke system.

1196
00:46:08,990 --> 00:46:12,780
We whiffed on the fact that,
while building airplanes is

1197
00:46:12,780 --> 00:46:18,200
contestable, building slots
at airports is not.

1198
00:46:18,200 --> 00:46:20,190
That there's a limited number
of slots at airports.

1199
00:46:20,190 --> 00:46:23,020
And it's incredibly hard to
build a new airport because of

1200
00:46:23,020 --> 00:46:25,320
environmental regulations
and other things.

1201
00:46:25,320 --> 00:46:28,770
What that meant was there is
still a natural monopoly in

1202
00:46:28,770 --> 00:46:30,780
airport slots, even if
there's not much of a

1203
00:46:30,780 --> 00:46:32,970
natural monopoly in planes.

1204
00:46:32,970 --> 00:46:36,920
The result is that now what
airlines do is funnel everyone

1205
00:46:36,920 --> 00:46:41,570
through their hub and then
out to the spokes.

1206
00:46:41,570 --> 00:46:44,990
And as a result, because of that
they have developed new

1207
00:46:44,990 --> 00:46:46,440
quasi monopolies.

1208
00:46:46,440 --> 00:46:48,820
So to fly from point A to point
B, for many A's and B's,

1209
00:46:48,820 --> 00:46:50,150
only one airline flies it.

1210
00:46:50,150 --> 00:46:51,670
Because it's economical
for them because

1211
00:46:51,670 --> 00:46:53,210
point A is their hub.

1212
00:46:53,210 --> 00:46:55,460
But airline B can't
get into that hub.

1213
00:46:55,460 --> 00:46:57,830
They can't get a gate
at that hub.

1214
00:46:57,830 --> 00:47:01,060
So as a result, they can't
effectively fly from A to B.

1215
00:47:01,060 --> 00:47:02,940
So my wife is from
Minneapolis.

1216
00:47:02,940 --> 00:47:03,960
We had to go to Minneapolis.

1217
00:47:03,960 --> 00:47:06,420
Northwest had a monopoly on
going to Minneapolis.

1218
00:47:06,420 --> 00:47:09,890
So I could fly from Boston to
LA for half the price of

1219
00:47:09,890 --> 00:47:12,410
Boston to Minneapolis.

1220
00:47:12,410 --> 00:47:15,680
Why, because Northwest
controlled all the gate slots

1221
00:47:15,680 --> 00:47:16,560
in Minneapolis.

1222
00:47:16,560 --> 00:47:18,790
They had a natural monopoly
on that resource.

1223
00:47:18,790 --> 00:47:20,160
And that's what economists
missed.

1224
00:47:20,160 --> 00:47:23,170
So deregulation worked in some
markets with a lot of

1225
00:47:23,170 --> 00:47:23,550
competition.

1226
00:47:23,550 --> 00:47:27,180
Like the New York to LA market
is very competitive.

1227
00:47:27,180 --> 00:47:29,740
It did not work in other
markets, where there was this

1228
00:47:29,740 --> 00:47:31,030
natural hub.

1229
00:47:31,030 --> 00:47:35,590
And so one airline
could dominate.

1230
00:47:35,590 --> 00:47:37,040
Or a few airlines
could dominate.

1231
00:47:37,040 --> 00:47:38,660
And that's why you could
see some crazy pricing

1232
00:47:38,660 --> 00:47:40,180
differentials.

1233
00:47:40,180 --> 00:47:41,490
That's why, for example,
I could fly to

1234
00:47:41,490 --> 00:47:43,510
Baltimore for $127.

1235
00:47:43,510 --> 00:47:48,480
But to DC, it cost me $500, even
though they're less than

1236
00:47:48,480 --> 00:47:50,640
an hour apart by car.

1237
00:47:50,640 --> 00:47:55,800
This is because the constraint
on slots has limited the

1238
00:47:55,800 --> 00:47:58,420
amount of competition
that can go on.

1239
00:47:58,420 --> 00:48:00,730
And so that's sort of an example
of where competition

1240
00:48:00,730 --> 00:48:03,040
can work and where it can't to
try to deal with these natural

1241
00:48:03,040 --> 00:48:04,460
monopoly problems.

1242
00:48:04,460 --> 00:48:06,670
All right, let me stop there.

1243
00:48:06,670 --> 00:48:08,690
And we'll come back
on Wednesday

1244
00:48:08,690 --> 00:48:09,930
and talk about oligopoly.

1245
00:48:09,930 --> 00:48:12,550
Good luck tomorrow night
on the exam.

1246
00:48:12,550 --> 00:48:13,400
It's tomorrow night?

1247
00:48:13,400 --> 00:48:14,430
Yeah, tomorrow night.

1248
00:48:14,430 --> 00:48:15,150
Good luck.

1249
00:48:15,150 --> 00:48:17,030
Everyone looked confused
for a second.

1250
00:48:17,030 --> 00:48:18,100
Next week--

1251
00:48:18,100 --> 00:48:20,750
Oh--

1252
00:48:20,750 --> 00:48:23,570
OK, just joking, April fools,
Halloween fools.

1253
00:48:23,570 --> 00:48:24,820
Good luck next week
on the exam.