Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't

to produce more and increases society’s total wealth. This is especially true for monopolies that make large investments in research and development or in infrastructure; if they are not allowed to price discriminate, the firms will simply have to charge a uniform high price in order to recoup their R&D costs. This would place their product out of reach for the poor or others who can’t pay the high price.
Take pharmaceuticals again. Producers are given temporary monopolies in order to launch new drugs. Medicines are very costly to develop, test, and get approved, but cheap to manufacture. And once a drug is put on the market, it’s easy for other firms to reproduce it. If any company were allowed to copy another firm’s drugs, the original manufacturer would never recoup its R&D costs. Without the profits they can gain from their temporary monopolies on new drugs, companies would not be able to invest millions of dollars to develop new ones. So without monopolies, we would no longer get many new drugs, including the most vital, life-saving medicines.15
Let’s look at Reyataz and Emtriva. These drugs stop HIV from replicating and thus help to prolong HIV victims’ lives—often for many years. Many Americans can afford to pay a lot for these drugs; indeed, rich HIV sufferers would probably be willing to pay almost anything for them. But poor Americans and much poorer Africans can only pay very little for the drug, while others can probably afford some mid-level price. When manufacturers lower the drugs’ price for poorer HIV victims, they are engaging in price discrimination. Although it might not seem “fair” to charge different customers various prices for the same drug, price discrimination is clearly a good thing here; poor victims can get their drugs, while the companies can still make a profit by charging higher prices to wealthier sufferers.
The inherent problem with price discrimination, however, is that customers buying a product at a cheap price can profit by reselling it to those being charged a higher price. This is a problem faced by manufacturers of the aforementioned HIV drugs, which are sold cheaply in Africa but then sometimes resold in Europe, the U.S., or other countries where the drugs are sold for more. This is an important downside of lowering prices for poor consumers; drug companies risk creating competitors from among their own customers and thus reducing their profits on new drugs.
Other industries in which monopoly situations are created through the use of patents or copyrights face similar problems—monopolies are simply difficult to sustain, even when firms’ monopoly positions are legally protected. The publishing industry is a case in point. This industry functions similar to drug manufacturing—publishers must pay much more for the development of a book (the writing, editing, and marketing) than they do for the printing of each book, which may only cost a few dollars per copy. Although a book, once on the market, would be easy for a competitor to reproduce, publishers are protected from this competition through copyrights.
Ever wonder why a hardcover book is so much more expensive than its later paperback edition? It’s not the difference in printing costs, which is minimal. Part of the answer is that those most keen on buying a book will want it as soon as it is released, and will be willing to pay a higher price for it. But another, less apparent factor is that by the time a paperback edition comes out, there is already a secondary market in the resale of the hardcover edition. Readers who want the book are already paying less than the bookstore price by buying it secondhand. So the publisher must lower the price of its later editions in order to compete with the new market created by its own customers. Thus, even monopolies face competition.
Such secondary markets are particularly evident on university campuses. Any college student knows how easy it is to avoid paying monopoly prices for textbooks. You may see a lot of new copies when a textbook is first assigned, but by its second semester in use, many—if not most—of the books in use will be resold ones from the previous semester. While it might be pleasant to imagine students keeping textbooks their entire lives and eagerly refreshing their knowledge every few years, this seldom is the case; the vast majority of students resell their books as soon as their course ends. This creates large, extremely well-organized markets for secondhand books that sell well below the original price. And these secondary markets have really exploded in recent years thanks to Amazon.com and myriad other websites that create national—and even international—marketplaces for these transactions.
Monopolies are often forced to compete with these secondary markets, but sometimes the firms find ways around them. Take a totally different example. Allerca is a small California biotech company that has developed a hypoallergenic cat—that is, a feline genetically designed not to produce the protein that makes some people itch and sneeze. These cats cost $3,950 (plus a hefty $900 for shipping). In order to forestall the creation of a secondary market by customers who buy the cats and then breed them themselves, Allerca simply neuters all the cats it sells. Like pharmaceuticals, given the high cost of developing these cats, competition from a secondary market would eliminate the incentive to develop animals like these in the future.16
Although monopolies and price discrimination can both have beneficial effects, differences in prices don’t always—or even normally—indicate that either of these situations is occurring; price differences are frequently attributable to differences in quality or costs that may be invisible to consumers.
Not long ago, some neighbors of mine contracted to have their driveway repaved. A few days before the job, the paving company owner came to the neighborhood to see if he could line up more business. He offered to do my driveway for $2,000, but I wasn’t interested. The neighbors across the street agreed to pay $2,100. Then, on the day of the paving, the paver unexpectedly