How Do Patents Create Monopoly Power?

Intellectual property protection is a source of monopoly power.

Government legal restrictions, such as intellectual property law, are one source of monopoly power. Patents limit the production of a new invention or use of a new production process to its creator, giving the creator a monopoly over her new product for the duration of the patent.

What Is Monopoly Power?

Monopoly firms set prices to maximize profits.

A monopoly is a market structure in which only one seller produces and sells a good or service. Unlike firms in a competitive market, monopolies are able to determine their own prices in order to maximize their profit. This price-making ability, unique to monopolies, is known as monopoly power. Monopoly power arises due to barriers to entry--conditions that make it difficult for other businesses to enter a market and compete with a monopoly firm.

Patents

Patents are a type of intellectual property law that provide a set of exclusive rights to an inventor for a limited period in exchange for public disclosure of his invention. The government gives the patent holder the right to exclude others from using his invention, effectively creating a barrier to entry in the market. The patent, therefore, gives the holder a monopoly on his creation for the duration of the patent, which is 17 years in the United States.

Effects

Innovation creates profits with patent protection.

While the price-setting power that monopolies have can often create inefficiencies in a market, in some cases government regulation will create monopolies because of other positive effects monopolies may create. Governments permit creation of monopoly power through patents because this tends to foster more innovation. Because research and development is a costly process with no guarantee of success, firms will only innovate if their new creations can provide enough profit to cover the cost of development. With patent protection, firms have an incentive to innovate because they will be able to make profits on any inventions they develop for the duration of the patent.

When Patents Expire

The monopoly power created by a patent is only temporary. When the patent expires, the holder can no longer exclude other firms from producing or using her invention, and new competitors will enter the market. This can be seen in the pharmaceuticals industry, where cheaper, generic versions of brand-name drugs proliferate once the patent on the brand-name drug expires.

Considerations

An interesting case of patent protection and monopoly power arises in the markets where network effects are present. Network effects occur when a good increases in value as more people use it. This is common in the software industry, where the software becomes more useful as more users adopt it and can collaborate and share files and information with one another. Monopoly power may extend beyond the patent's expiration if network effects are so strong that competitors entering the market several years after the invention of the product have difficulty attracting enough users to compete with the network effects associated with the original, formerly patented product.

References

• "Principles of Microeconomics, 5th ed."; N. Gregory Mankiw; 2008
• "Principles of Economics"; The Nature of Monopoly"; Libby Rittenberg and Timothy Tregarthen
• United States Patent and Trademark Office: General Information Concerning Patents

Resources

• Economic and Game Theory: Against Intellectual Monopoly
• The Progress & Freedom Foundation: Intellectual Property as Monopoly