More writing samples from me that I never knew existed:
RJC2000PRELIMQ4
“The Internet’s early communalist enthusiasm for open-source software-which is free, unpatented and uncopyrighted- has now given way to a land-grab. Internet companies are rushing to patent their ideas.” The Economist, July 2000
- a. Explain the likely market structure which economic theory suggests would exist in industries where patents are prevalent. [12]
- b. To what extent is the above trend bad for the consumer? [13]
Part a
Economic theory suggests that an oligopolistic market is likely to exist in industries where patents are prevalent. An oligopoly is a market structure that falls between a monopoly and a monopolistic market, and it refers to the situation where a market is dominated by a small number of large powerful firms.
Like in the case of internet companies rushing to patent their ideas, the oligopolistic market is characterised by barriers to entry as well as interdependence of firms. Barriers to entry may be natural or artificial. Patents are a form of barriers to entry as they create secrecy of knowledge characteristic of oligopolistic firms producing differentiated products. Patents offer legal protection.
Other barriers to entry include brand loyalty. For example, the established real player and winamp software have a large following and are hyperlinked to many other websites, and thus a new software may need great innovation and first impact to rival the number of downloads these famous names receive.
Also the extensive research and product development may raise already high start up costs in industries where patents are prevalent. For example, the software counter-strike allows internet gaming and LAN games, and has new betas published frequently, and thus other companies will need to have equal, if not better, variety and quality in their software to rival that.
Besides that, in an oligopolistic market structure, products are differentiated, and secrecy is generally maintained. Generally, non-price competition is adopted and supernormal profit is made. For example, internet companies like SingNet and Pacific Internet have long avoided price competition, until StarHub introduced free access. Pacific Internet decides to attract eyeball s to avoid direct price competition.
An important characteristic of an oligopoly, here patents are prevalent, is the interdependence of firms. This may well lead to the formation of a formal collusion (a cartel e.g. Organisation of petroleum exporting countries OPEC) or a tacit collusion. Firms tend to adopt similar pricing, advertising and marketing strategies. For instance, both winamp and real player offer a free download with the option of purchasing a better full version of its product online. Due to tacit collusion, firms are likely to base prices on barometric firm price leadership – following the most representative firm at a particular point in time, or base prices on dominant firm price leadership – i.e. a firm that has the greatest influence sets the price and all others follow.
In an oligopoly there exists price stickiness, which may be explained by a kinked demand curve, showing that if a firm raises its prices, then other firms are not likely to follow but if prices fall then other firms are likely to follow suit. However, this does not explain why the kink occurs or why the initial price was determined such. The costs of updating the WebPages etc. and other menu costs incurred may explain price stickiness.
Part b
To some extent, the evolution of the internet into an oligopolistic market is bad for the consumer. First, an oligopolistic market relies heavily on advertising in a bid to avoid non-price competition. Advertising in itself may be a form of directly unproductive activity, and therefore is a misallocation of resources. Furthermore, advertising may be a form of irritant to consumers. For instance, pop-up advertisements that appear when one accesses a certain website. Advertising costs may be passed on to consumers indirectly too.
Second, the rise of oligopolies in an internet market where patents are prevalent may lead to the presence of X-inefficiency such as a breakdowns in a Hotmail account etc. X-inefficiency arises when the firm gets bigger.
Third, this above trend may increase the difficulty of new firms breaking into the market due to the higher fixed costs, the patented designs and so on. For instance, a young entrepreneur may find it expensive to start a new internet firm and patent his designs, when his competitors may include Netscape and Microsoft. Thus, innovation is limited and consumers may lose new choices.
However, this trend of moving towards an oligopolistic internet market may not be entirely bad, for instance, large oligopolistic firms earning supernormal profits will have funds for research and development to upgrade their existing products, and these improvements in product quality will be passed on to consumers.
Also, oligopolies provide a range of differentiated products for consumers to choose from. For example, one may choose a Netscape or Internet Explorer browser and equip it with a variety of other supporting software such as macromedia etc.
Third, oligopolies earn supernormal profits and the copyrights and popularity of existing firms may encourage entrepreneurial spirit t break into these contestable markets. For example, the establishment of meshworkz was encouraged by the boom of internet gaming and the underutilisation of internet gaming capabilities. Such new firms will benefit consumers by providing them with greater variety of choices.
However, considering that the oligopolistic market is potentially allocatively inefficient as price may exceed marginal cost, thus creaming off consumer surplus and leading to welfare loss, it may be seen that the trend of internet companies rushing to patent their ideas is no perfect blessing. An oligopolistic market, like any other market structure, has its good and bad.
Huang Kailin
A03A
19/25
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