Market Power

GlaxoSmithKline (GSK), the world’s largest producer of AIDS drugs, owns the patent on Combivir. A patent is a government grant that gives the owner the exclusive rights to make, use, or sell the patented product. GlaxoSmithKline, for example, is the only legal seller of Combivir. Even though the formula to manufacture it is well-known and easily duplicated, competitors who try to make Combivir or its equivalent will be jailed, at least in the United States and other countries where the patent is enforced.

Market power is the power to raise price above marginal cost without fear that other firms will enter the market.

GSK’s patent on Combivir gives GSK market power, the power to raise price above marginal cost without fear that other competitors will enter the market. A monopoly is simply a firm with market power.

A monopoly is a firm with market power.

India does not recognize the Combivir patent, so in that country competition prevails and an equivalent drug sells for just 50 cents per pill.5 Thus, economics correctly predicts that competition will drive price down to marginal cost; it’s just that GSK’s patent prevents competition from operating.

Patents are not the only source of market power. Government regulations other than patents, as well as economies of scale, exclusive access to an important input, and technological innovation can all create firms with market power. We discuss the sources of market power and appropriate responses at greater length later on in this chapter. For now, we want to ask how a firm will use its market power to maximize profit.