1
00:00:00,000 --> 00:00:01,960
[SQUEAKING]

2
00:00:01,960 --> 00:00:03,920
[RUSTLING]

3
00:00:03,920 --> 00:00:06,370
[CLICKING]

4
00:00:12,270 --> 00:00:15,342
JONATHAN GRUBER: OK,
so let's continue

5
00:00:15,342 --> 00:00:16,550
our discussion of monopolies.

6
00:00:16,550 --> 00:00:18,740
Last time, we talked
about monopolies

7
00:00:18,740 --> 00:00:22,670
and talked about how they're
another extreme of the market

8
00:00:22,670 --> 00:00:23,750
structure spectrum.

9
00:00:23,750 --> 00:00:25,850
We have perfectly
competitive firms,

10
00:00:25,850 --> 00:00:29,150
where there's facing a
perfectly elastic demand curve,

11
00:00:29,150 --> 00:00:31,910
and competing with essentially
infinite number of other firms

12
00:00:31,910 --> 00:00:35,960
and taking prices, versus a
monopolist who owns the market

13
00:00:35,960 --> 00:00:38,000
and sets the price,
but therefore,

14
00:00:38,000 --> 00:00:40,790
faces this poisoning
effect, which

15
00:00:40,790 --> 00:00:44,583
leads them to under-produce
and creates deadweight loss.

16
00:00:44,583 --> 00:00:47,000
So today, we want to continue
our discussion of monopolies

17
00:00:47,000 --> 00:00:49,610
with three sort of
separate topics.

18
00:00:49,610 --> 00:00:51,380
OK, the first topic
I want to cover

19
00:00:51,380 --> 00:00:54,260
is, where do
monopolies come from?

20
00:00:54,260 --> 00:00:57,140
So the stork does
not bring monopolies.

21
00:00:57,140 --> 00:01:00,200
They come from somewhere else.

22
00:01:00,200 --> 00:01:02,000
So sort of, how do
monopolies arise?

23
00:01:08,330 --> 00:01:10,490
And there's really two
sources of monopoly

24
00:01:10,490 --> 00:01:12,480
that I want to focus on today.

25
00:01:12,480 --> 00:01:17,030
The first is
monopolies that arise

26
00:01:17,030 --> 00:01:23,940
from cost advantages,
the monopolies that

27
00:01:23,940 --> 00:01:25,940
arise from cost advantages.

28
00:01:25,940 --> 00:01:29,080
So some markets come with
a natural built-in cost

29
00:01:29,080 --> 00:01:31,738
advantage for one participant.

30
00:01:31,738 --> 00:01:34,030
So it could be there's an
essential input, like there's

31
00:01:34,030 --> 00:01:36,690
one rock quarry in town.

32
00:01:36,690 --> 00:01:38,380
And whoever controls
the rock quarry,

33
00:01:38,380 --> 00:01:42,220
they supply the rocks
for the whole area.

34
00:01:42,220 --> 00:01:45,700
In that case, we say
that this is an example

35
00:01:45,700 --> 00:01:48,550
of a natural monopoly.

36
00:01:54,130 --> 00:01:59,620
A natural monopoly
is a market where,

37
00:01:59,620 --> 00:02:05,370
for all relevant quantities,
one firm can always

38
00:02:05,370 --> 00:02:10,840
produce at a lower average
cost than another firm can.

39
00:02:10,840 --> 00:02:13,870
So for all relevant
quantities, one firm

40
00:02:13,870 --> 00:02:16,120
can always produce
at a lower average

41
00:02:16,120 --> 00:02:19,650
cost than can other firms.

42
00:02:19,650 --> 00:02:23,530
OK, this basically
is the same as saying

43
00:02:23,530 --> 00:02:27,580
that it's a market where average
cost is everywhere declining,

44
00:02:27,580 --> 00:02:30,520
at least in the relevant
production range.

45
00:02:30,520 --> 00:02:32,860
You can imagine where, so
for some crazy quantities,

46
00:02:32,860 --> 00:02:34,300
average cost increases.

47
00:02:34,300 --> 00:02:37,820
But where average costs
is everywhere declining

48
00:02:37,820 --> 00:02:40,557
is a market with a
natural monopoly.

49
00:02:40,557 --> 00:02:41,640
So why would this be true?

50
00:02:41,640 --> 00:02:43,682
Let's consider what I
think is the simplest case.

51
00:02:43,682 --> 00:02:45,170
Let's think about
a water utility,

52
00:02:45,170 --> 00:02:46,760
delivering water
to people's houses

53
00:02:46,760 --> 00:02:49,400
through pipes underground.

54
00:02:49,400 --> 00:02:55,980
Once those pipes are laid, it
is that the giant fixed costs

55
00:02:55,980 --> 00:02:58,330
are paid, and the marginal
costs are trivial.

56
00:02:58,330 --> 00:03:00,120
It's the cost of the water.

57
00:03:00,120 --> 00:03:05,310
The fixed costs are so large
relative to the marginal costs

58
00:03:05,310 --> 00:03:07,842
that average cost
always declines.

59
00:03:07,842 --> 00:03:09,300
In our typical
production function,

60
00:03:09,300 --> 00:03:12,060
remember, average cost first
declines, then goes back up.

61
00:03:12,060 --> 00:03:14,460
It first declines, you
pay off the fixed costs,

62
00:03:14,460 --> 00:03:16,920
then back up as the rising
marginal costs start

63
00:03:16,920 --> 00:03:17,638
to dominate.

64
00:03:17,638 --> 00:03:19,680
This is a market where
that second purchase never

65
00:03:19,680 --> 00:03:24,690
gets big enough, say
where, essentially,

66
00:03:24,690 --> 00:03:26,700
marginal productivity
is close to flat,

67
00:03:26,700 --> 00:03:30,060
so the marginal cost curve
isn't rising that fast, and/or

68
00:03:30,060 --> 00:03:33,600
the fixed costs are enormous.

69
00:03:33,600 --> 00:03:36,780
So we could see
that in figure 12.1.

70
00:03:36,780 --> 00:03:42,065
Imagine a water utility, which
has roughly flat marginal cost.

71
00:03:42,065 --> 00:03:44,190
That is, the marginal cost
is the cost of procuring

72
00:03:44,190 --> 00:03:45,780
another gallon of water.

73
00:03:45,780 --> 00:03:47,850
Now once again, at
some point, if you

74
00:03:47,850 --> 00:03:49,350
want to give every
person in America

75
00:03:49,350 --> 00:03:51,840
one million gallons of
water, marginal costs

76
00:03:51,840 --> 00:03:53,040
would start to rise.

77
00:03:53,040 --> 00:03:56,140
But for the relevant
range, it's roughly flat.

78
00:03:56,140 --> 00:03:57,700
And yet there's
enormous fixed costs.

79
00:03:57,700 --> 00:04:00,290
You got to lay
those water pipes.

80
00:04:00,290 --> 00:04:05,780
So in that world, average
cost is everywhere declining.

81
00:04:05,780 --> 00:04:07,850
It's approaching marginal
cost, but it never

82
00:04:07,850 --> 00:04:09,140
crosses marginal cost.

83
00:04:12,060 --> 00:04:15,300
In such a world,
once one firm has

84
00:04:15,300 --> 00:04:17,459
laid the pipes that's
providing water,

85
00:04:17,459 --> 00:04:21,279
it never makes sense for
another firm to enter.

86
00:04:21,279 --> 00:04:22,750
Entry never makes sense.

87
00:04:22,750 --> 00:04:23,680
Why is that?

88
00:04:23,680 --> 00:04:26,690
Because if another firm
thinks about entering,

89
00:04:26,690 --> 00:04:29,120
they can say, oh, look this
water utility is making all

90
00:04:29,120 --> 00:04:31,412
this money, this is a great
market to enter-- remember,

91
00:04:31,412 --> 00:04:33,170
we talked about
unlimited entry and exit

92
00:04:33,170 --> 00:04:35,340
and perfect competition
that drives profits away.

93
00:04:35,340 --> 00:04:37,840
Well, let's say another firm
says, look at all this profits,

94
00:04:37,840 --> 00:04:38,840
I want into this market.

95
00:04:38,840 --> 00:04:40,215
The first firm
will say, I'm just

96
00:04:40,215 --> 00:04:42,690
going to tell you right now,
if you enter this market,

97
00:04:42,690 --> 00:04:47,330
I will price at marginal
cost until you leave.

98
00:04:47,330 --> 00:04:48,788
For the first firm,
they've already

99
00:04:48,788 --> 00:04:50,372
paid to lay down the
pipes, so as long

100
00:04:50,372 --> 00:04:53,000
as they're pricing at marginal
cost, they're not losing money.

101
00:04:53,000 --> 00:04:57,720
But for the second firm,
they will lose money

102
00:04:57,720 --> 00:04:59,310
if the firm stays
at marginal cost.

103
00:04:59,310 --> 00:05:01,140
So they'll just never enter.

104
00:05:01,140 --> 00:05:05,250
Because they know the first
firm has a barrier to entry.

105
00:05:05,250 --> 00:05:08,990
They have a natural monopoly,
having laid down those pipes.

106
00:05:08,990 --> 00:05:13,140
Having already paid that
fixed cost, that sunk,

107
00:05:13,140 --> 00:05:14,730
they will win any battle.

108
00:05:14,730 --> 00:05:17,130
They'll just price at
or near marginal cost

109
00:05:17,130 --> 00:05:20,550
and drive any competitors
out of the market.

110
00:05:20,550 --> 00:05:24,840
So these kinds of essentially
natural monopolies

111
00:05:24,840 --> 00:05:31,300
arise when enormous fixed
costs create a barrier to entry

112
00:05:31,300 --> 00:05:34,130
when enormous fixed costs
create a barrier to entry.

113
00:05:34,130 --> 00:05:37,480
You can see natural monopoly.

114
00:05:37,480 --> 00:05:41,310
And that's one common way
monopolies arise in the world.

115
00:05:41,310 --> 00:05:42,740
Think of utilities.

116
00:05:42,740 --> 00:05:45,820
Delivering water is a
classic example of that.

117
00:05:45,820 --> 00:05:47,680
That's one way we
get monopolies.

118
00:05:47,680 --> 00:05:52,030
The second way we get monopolies
is through government action.

119
00:05:55,380 --> 00:05:59,190
Governments also create
monopolies remember,

120
00:05:59,190 --> 00:06:02,010
today I told you we talk about
governments as good guys.

121
00:06:02,010 --> 00:06:06,390
But still governments
can do things which

122
00:06:06,390 --> 00:06:09,270
can create deadweight loss.

123
00:06:09,270 --> 00:06:12,030
And now sometimes,
governments do

124
00:06:12,030 --> 00:06:15,060
this for a good reason, like
a natural monopoly reason,

125
00:06:15,060 --> 00:06:17,340
like the postal
service for example.

126
00:06:17,340 --> 00:06:21,938
Local postal delivery,
delivering letters locally,

127
00:06:21,938 --> 00:06:23,730
has all the features
of a natural monopoly.

128
00:06:23,730 --> 00:06:25,920
It's a huge fixed cost
of building all the post

129
00:06:25,920 --> 00:06:28,740
offices and a small marginal
cost of transmitting letters

130
00:06:28,740 --> 00:06:31,470
from place to place.

131
00:06:31,470 --> 00:06:35,030
Now however, in other cases,
this is not necessarily true.

132
00:06:35,030 --> 00:06:38,353
In the US, we have very few
government-created monopolies.

133
00:06:38,353 --> 00:06:40,520
The rest of the world,
especially in the developing,

134
00:06:40,520 --> 00:06:41,860
it's much more common.

135
00:06:41,860 --> 00:06:43,610
Many countries have
the government control

136
00:06:43,610 --> 00:06:47,690
the production of steel,
the airlines are controlled

137
00:06:47,690 --> 00:06:50,240
by the government ,
banking is often controlled

138
00:06:50,240 --> 00:06:51,360
by the government.

139
00:06:51,360 --> 00:06:53,490
These are places where
probably evidence suggests

140
00:06:53,490 --> 00:06:55,340
it would be more efficient to
not have the government control

141
00:06:55,340 --> 00:06:55,940
this.

142
00:06:55,940 --> 00:06:58,930
There is no real natural
monopoly in banking.

143
00:06:58,930 --> 00:07:01,700
But it's more for political
reasons that they're created.

144
00:07:01,700 --> 00:07:03,970
But that's not really
that relevant in the US.

145
00:07:03,970 --> 00:07:05,950
Even the post office
isn't a monopoly anymore,

146
00:07:05,950 --> 00:07:09,370
with FedEx and UPS and stuff.

147
00:07:09,370 --> 00:07:12,580
So it's not really
relevant in the US.

148
00:07:12,580 --> 00:07:16,630
The more relevant for the US,
way that the government creates

149
00:07:16,630 --> 00:07:20,290
monopoly is by creating
barriers to entry.

150
00:07:20,290 --> 00:07:21,790
The government could
create barriers

151
00:07:21,790 --> 00:07:24,685
to entry, the most prominent
of which is patents.

152
00:07:27,808 --> 00:07:32,550
The most prominent barrier
to entry is a patent.

153
00:07:32,550 --> 00:07:34,470
This is the case where
the fixed cost here

154
00:07:34,470 --> 00:07:35,770
isn't building a pipe.

155
00:07:35,770 --> 00:07:38,610
It's coming up with an idea.

156
00:07:38,610 --> 00:07:41,340
And that basically
the government

157
00:07:41,340 --> 00:07:45,030
has a law which says that,
if you have a new idea

158
00:07:45,030 --> 00:07:49,010
and you patent it, you
are granted a monopoly

159
00:07:49,010 --> 00:07:51,290
to sell the
resulting good for 20

160
00:07:51,290 --> 00:07:54,630
years from the date of patent.

161
00:07:54,630 --> 00:07:57,610
So when you patent
a good, you're

162
00:07:57,610 --> 00:08:01,380
granted the right to a monopoly
over that market for 20 years.

163
00:08:01,380 --> 00:08:03,720
Essentially, the government
is creating a monopoly.

164
00:08:03,720 --> 00:08:06,180
It's saying, once
you've patented that--

165
00:08:06,180 --> 00:08:08,250
now remember, very
importantly-- especially

166
00:08:08,250 --> 00:08:10,425
for drug development--
it's not the date at which

167
00:08:10,425 --> 00:08:11,820
the good comes to market.

168
00:08:11,820 --> 00:08:13,800
It's the data at which you file.

169
00:08:13,800 --> 00:08:15,990
So if you file for a
patent and it takes you

170
00:08:15,990 --> 00:08:17,910
19 years to develop the
product, then you only

171
00:08:17,910 --> 00:08:19,930
get one year monopoly
in the market.

172
00:08:19,930 --> 00:08:20,810
So it's the sum.

173
00:08:20,810 --> 00:08:23,352
20 years is both the development
period and the sales period.

174
00:08:23,352 --> 00:08:26,310
You get 20 years from
the date you file.

175
00:08:26,310 --> 00:08:29,550
Now, patents are quite
interesting because the welfare

176
00:08:29,550 --> 00:08:32,470
implications are kind of mixed.

177
00:08:32,470 --> 00:08:37,919
On the one hand, a patent,
by creating monopoly,

178
00:08:37,919 --> 00:08:39,990
creates deadweight loss.

179
00:08:39,990 --> 00:08:43,770
For potentially up
to 20 years, you've

180
00:08:43,770 --> 00:08:45,715
got deadweight loss
in that market,

181
00:08:45,715 --> 00:08:47,340
because one firm has
the monopoly right

182
00:08:47,340 --> 00:08:49,860
to sell the good.

183
00:08:49,860 --> 00:08:54,360
On the other hand, why might
patents be a good idea.

184
00:08:54,360 --> 00:08:55,023
Yeah.

185
00:08:55,023 --> 00:08:57,405
AUDIENCE: [INAUDIBLE]
for developing drugs,

186
00:08:57,405 --> 00:08:59,905
the company that can't
ever make any money off

187
00:08:59,905 --> 00:09:01,820
of its research and
development costs

188
00:09:01,820 --> 00:09:05,262
will never be incentivized
to develop it [INAUDIBLE]..

189
00:09:05,262 --> 00:09:06,220
JONATHAN GRUBER: Right.

190
00:09:06,220 --> 00:09:11,050
Because research and development
is a huge fixed cost.

191
00:09:11,050 --> 00:09:12,550
And if you pay that
huge fixed cost,

192
00:09:12,550 --> 00:09:15,160
and the minute you develop it
someone else can just copy you,

193
00:09:15,160 --> 00:09:17,320
then you'd never invest
those fixed costs.

194
00:09:21,370 --> 00:09:23,860
We'll talk later in the
course about externalities.

195
00:09:23,860 --> 00:09:27,700
But you think of this as
sort of a positive spillover

196
00:09:27,700 --> 00:09:34,700
from R&D. When firms do R&D,
when a firm invents something,

197
00:09:34,700 --> 00:09:38,970
it benefits everybody who
might produce that good.

198
00:09:38,970 --> 00:09:41,540
So if I invent something,
then everybody could copy me,

199
00:09:41,540 --> 00:09:42,770
could benefit.

200
00:09:42,770 --> 00:09:45,215
So I will not invest
in R&D unless I

201
00:09:45,215 --> 00:09:47,090
can be sure I might get
some money out of it.

202
00:09:47,090 --> 00:09:49,130
And that's what the patent does.

203
00:09:49,130 --> 00:09:51,920
It reduces those
spillovers by saying, OK,

204
00:09:51,920 --> 00:09:54,620
you get to own this for 20
years and make some money on it.

205
00:09:54,620 --> 00:09:56,870
Therefore, go ahead and invest.

206
00:09:56,870 --> 00:09:59,210
In other words,
what a patent does

207
00:09:59,210 --> 00:10:02,500
is, essentially, the
government's saying,

208
00:10:02,500 --> 00:10:05,460
you're going to get a reward
for being first to market.

209
00:10:05,460 --> 00:10:08,780
And that reward is 20
years of privilege of being

210
00:10:08,780 --> 00:10:09,917
a monopolist in a market.

211
00:10:09,917 --> 00:10:12,250
Therefore, that's an incentive
for you to go and invent.

212
00:10:12,250 --> 00:10:12,900
Yeah.

213
00:10:12,900 --> 00:10:15,400
AUDIENCE: What's the process
like for extending your patent?

214
00:10:15,400 --> 00:10:16,977
Because I know
Disney, for example,

215
00:10:16,977 --> 00:10:20,050
has [INAUDIBLE]
which is giving them

216
00:10:20,050 --> 00:10:22,040
more years than what they had?

217
00:10:22,040 --> 00:10:23,095
JONATHAN GRUBER: That's
a very detailed concept

218
00:10:23,095 --> 00:10:24,560
that I don't have
enough time to get into,

219
00:10:24,560 --> 00:10:26,910
but there's a whole bunch of
legal battles around that.

220
00:10:26,910 --> 00:10:30,440
But the bottom line is,
there's a patent tradeoff here.

221
00:10:30,440 --> 00:10:34,100
The tradeoff is,
on the one hand,

222
00:10:34,100 --> 00:10:36,700
it's what we call a static
versus dynamic tradeoff, sort

223
00:10:36,700 --> 00:10:38,350
of today versus the future.

224
00:10:38,350 --> 00:10:41,650
At any point in time, there's
a ton of deadweight loss

225
00:10:41,650 --> 00:10:44,080
out there, because
monopolists who have patents

226
00:10:44,080 --> 00:10:46,830
are under-producing.

227
00:10:46,830 --> 00:10:50,700
At the same time,
over time, we're

228
00:10:50,700 --> 00:10:53,290
getting cool new products
because of patents.

229
00:10:53,290 --> 00:10:55,950
And that's the tradeoff.

230
00:10:55,950 --> 00:10:57,870
How did 20 years get picked?

231
00:10:57,870 --> 00:10:59,700
Ideally, you'd have
some optimal period

232
00:10:59,700 --> 00:11:02,520
to resolve that tradeoff, the
ultimate result of a tradeoff

233
00:11:02,520 --> 00:11:05,448
long enough to get creation,
but short enough so

234
00:11:05,448 --> 00:11:06,990
that the gains on
that creation don't

235
00:11:06,990 --> 00:11:10,140
exceed the deadweight
loss from monopoly.

236
00:11:10,140 --> 00:11:11,910
And that's an example
how a monopoly can

237
00:11:11,910 --> 00:11:13,680
arise from a government action.

238
00:11:13,680 --> 00:11:17,700
And the point is that, for both
natural monopolies and patents,

239
00:11:17,700 --> 00:11:20,890
there are legitimate reasons
for monopolies to arise.

240
00:11:20,890 --> 00:11:24,240
So what I want to say is,
monopolies are not bad.

241
00:11:24,240 --> 00:11:29,200
They're not necessarily an
inherent flaw in the system.

242
00:11:29,200 --> 00:11:31,200
There are legitimate
reasons to have monopolies,

243
00:11:31,200 --> 00:11:34,470
both because of natural
monopoly and because of patent.

244
00:11:34,470 --> 00:11:38,960
But they do, at any point in
time, create deadweight loss.

245
00:11:38,960 --> 00:11:39,830
Yeah.

246
00:11:39,830 --> 00:11:43,580
AUDIENCE: Is there
a way to measure

247
00:11:43,580 --> 00:11:48,475
how the impact of [INAUDIBLE]
something that receives patent,

248
00:11:48,475 --> 00:11:51,580
like how [INAUDIBLE] that
relates to the deadweight loss

249
00:11:51,580 --> 00:11:52,080
[INAUDIBLE]?

250
00:11:52,080 --> 00:11:52,960
JONATHAN GRUBER: It's
a great question.

251
00:11:52,960 --> 00:11:55,350
There are people who do
spend their lives doing that.

252
00:11:55,350 --> 00:11:59,760
And basically, the
way you would do

253
00:11:59,760 --> 00:12:02,190
it is you would essentially
measure the consumer

254
00:12:02,190 --> 00:12:04,950
surplus created from the
new good, versus-- it

255
00:12:04,950 --> 00:12:06,120
would be the triangle sizes.

256
00:12:06,120 --> 00:12:07,345
It would be, how much
consumer surplus would

257
00:12:07,345 --> 00:12:08,730
you get from the new good
versus deadweight loss

258
00:12:08,730 --> 00:12:10,500
from that good sales
being restricted.

259
00:12:10,500 --> 00:12:11,917
Now obviously, if
it's a good that

260
00:12:11,917 --> 00:12:14,160
never would have existed
otherwise, by definition,

261
00:12:14,160 --> 00:12:15,445
the patent's a good thing.

262
00:12:15,445 --> 00:12:17,070
Because who cares
about deadweight loss

263
00:12:17,070 --> 00:12:19,153
if you never would have
had it in the first place.

264
00:12:19,153 --> 00:12:21,390
The question really is
about the substitutability.

265
00:12:21,390 --> 00:12:23,010
If you're patenting
something which

266
00:12:23,010 --> 00:12:26,650
is only incrementally better,
then maybe it's not worth it.

267
00:12:26,650 --> 00:12:29,470
So that's sort of the tradeoff.

268
00:12:29,470 --> 00:12:31,770
Other questions?

269
00:12:31,770 --> 00:12:39,610
OK, so now let's talk about
addressing or regulating

270
00:12:39,610 --> 00:12:40,360
monopolies.

271
00:12:43,540 --> 00:12:46,450
Let's go back to think about
our natural monopoly case.

272
00:12:50,410 --> 00:12:52,960
Let's think about our
natural monopoly case.

273
00:12:54,787 --> 00:12:57,120
Actually, I'm going to call
this section not regulating.

274
00:12:57,120 --> 00:12:59,380
I'm going to call this
addressing monopolies,

275
00:12:59,380 --> 00:13:02,400
addressing monopolies.

276
00:13:02,400 --> 00:13:05,520
There are different ways that
we can address monopolies.

277
00:13:05,520 --> 00:13:09,310
And we'll go back to our natural
monopoly case to make it easy.

278
00:13:09,310 --> 00:13:11,680
The first way we
can address monopoly

279
00:13:11,680 --> 00:13:15,740
is through government
regulation.

280
00:13:15,740 --> 00:13:16,760
So let's step back here.

281
00:13:16,760 --> 00:13:19,680
The bottom line is, we have
a monopoly that should exist,

282
00:13:19,680 --> 00:13:22,021
say a natural monopoly.

283
00:13:22,021 --> 00:13:23,620
It exists naturally.

284
00:13:23,620 --> 00:13:27,250
At the same time, that is
creating a deadweight loss.

285
00:13:27,250 --> 00:13:29,390
It's creating inefficiency.

286
00:13:29,390 --> 00:13:31,640
So the brilliance,
the insight of

287
00:13:31,640 --> 00:13:33,950
the first fundamental
theorem of all for economics

288
00:13:33,950 --> 00:13:36,317
was, the competition
through entry and exit

289
00:13:36,317 --> 00:13:38,150
will bring us the
efficient production level

290
00:13:38,150 --> 00:13:40,560
and reduce deadweight loss.

291
00:13:40,560 --> 00:13:42,840
Here with a natural
monopoly, that doesn't work.

292
00:13:42,840 --> 00:13:45,010
Competition can't
work, therefore,

293
00:13:45,010 --> 00:13:46,770
we end up with a
deadweight loss,

294
00:13:46,770 --> 00:13:49,420
because the firm that owns
the market is under-producing.

295
00:13:52,120 --> 00:13:54,880
This is the first case, as I
mentioned last time, of what we

296
00:13:54,880 --> 00:13:57,660
call a market failure.

297
00:13:57,660 --> 00:14:01,520
The market outcome
is not delivering

298
00:14:01,520 --> 00:14:05,810
the welfare-maximizing
result. And once there's

299
00:14:05,810 --> 00:14:08,540
a market failure, there is
a potential beneficial role

300
00:14:08,540 --> 00:14:09,610
for government.

301
00:14:09,610 --> 00:14:11,360
I said last time, with
no market failures,

302
00:14:11,360 --> 00:14:13,280
government's just the bad guy.

303
00:14:13,280 --> 00:14:18,350
With no market failures,
all government can do,

304
00:14:18,350 --> 00:14:19,960
it can help with
the redistribution.

305
00:14:19,960 --> 00:14:21,290
But from an efficiency
perspective,

306
00:14:21,290 --> 00:14:23,290
all the government can
do is muck up the market.

307
00:14:23,290 --> 00:14:25,160
But once there's
a market failure,

308
00:14:25,160 --> 00:14:28,700
there's a potential role for
the government addressing it.

309
00:14:28,700 --> 00:14:31,370
So to see that, let's return
to our monopoly example

310
00:14:31,370 --> 00:14:36,320
from last time in figure 12.2.

311
00:14:36,320 --> 00:14:39,840
Figure 12.2 is our monopoly
example from last time.

312
00:14:39,840 --> 00:14:42,690
Remember, we had
demand curve that

313
00:14:42,690 --> 00:14:47,170
was Q equals 24 minus
P. We had a cost

314
00:14:47,170 --> 00:14:52,290
curve that delivered the
marginal cost of MC equals 2Q.

315
00:14:52,290 --> 00:14:55,320
And that's graphed here.

316
00:14:55,320 --> 00:14:59,340
And we said last time
that the monopoly outcome

317
00:14:59,340 --> 00:15:02,610
would be at E sub M. The
monopolist would sell

318
00:15:02,610 --> 00:15:04,710
6 units at the price
of 18, creating

319
00:15:04,710 --> 00:15:08,500
a deadweight loss of C plus E.

320
00:15:08,500 --> 00:15:13,780
Now, what if the government
came along and simply mandated

321
00:15:13,780 --> 00:15:18,797
that the monopolist was not
allowed to charge more than 16?

322
00:15:18,797 --> 00:15:21,130
The government says, look, I
understand it's a monopoly.

323
00:15:21,130 --> 00:15:22,570
I'm not going to try to
break up the monopoly.

324
00:15:22,570 --> 00:15:24,040
It's a natural
monopoly, whatever.

325
00:15:24,040 --> 00:15:26,900
Simple rule-- price
ceiling of 16.

326
00:15:26,900 --> 00:15:29,440
Now, when I mentioned pricing
a couple of lectures ago,

327
00:15:29,440 --> 00:15:30,940
you should have
learned to say, boo,

328
00:15:30,940 --> 00:15:33,940
price ceilings, bad, increase
deadweight loss, terrible.

329
00:15:33,940 --> 00:15:36,790
But now, suddenly
a price ceiling

330
00:15:36,790 --> 00:15:39,290
can actually get rid
of deadweight loss.

331
00:15:39,290 --> 00:15:40,390
How's that possible?

332
00:15:40,390 --> 00:15:41,140
Let's take a look.

333
00:15:43,830 --> 00:15:48,510
In this case, the monopolist
knew marginal revenue curve

334
00:15:48,510 --> 00:15:51,660
is a bit different.

335
00:15:51,660 --> 00:15:55,380
The new marginal revenue curve
is the old marginal revenue

336
00:15:55,380 --> 00:16:00,700
curve, until you
get to the point

337
00:16:00,700 --> 00:16:04,750
where the first dashed line
intersects marginal revenue.

338
00:16:04,750 --> 00:16:07,180
It's the old marginal
revenue curve,

339
00:16:07,180 --> 00:16:11,900
until you get where the marginal
cost crosses marginal revenue.

340
00:16:11,900 --> 00:16:15,830
Then it jumps to
the flat line at 16.

341
00:16:23,300 --> 00:16:25,880
Essentially, the new
marginal revenue curve

342
00:16:25,880 --> 00:16:28,057
is downward sloping
till the point

343
00:16:28,057 --> 00:16:29,890
where marginal cost
equals marginal revenue.

344
00:16:29,890 --> 00:16:33,890
Then it jumps back
up to the flat part

345
00:16:33,890 --> 00:16:37,130
that goes from 6 to 8.

346
00:16:37,130 --> 00:16:39,020
Now the exact shape
doesn't matter.

347
00:16:39,020 --> 00:16:40,820
It's the intuition that matters.

348
00:16:40,820 --> 00:16:42,410
The point is the following.

349
00:16:42,410 --> 00:16:44,870
Think about the
monopolist's decision.

350
00:16:44,870 --> 00:16:48,170
He decides, based on the
logic of the last time,

351
00:16:48,170 --> 00:16:49,400
to sell six units.

352
00:16:49,400 --> 00:16:50,900
That's the point
where the poisoning

353
00:16:50,900 --> 00:16:53,867
effect offsets the benefits
of selling another unit.

354
00:16:53,867 --> 00:16:55,700
Now let's say the
government comes and says,

355
00:16:55,700 --> 00:16:58,952
monopolists, you can't
charge more than 16.

356
00:16:58,952 --> 00:17:01,760
Well, once a monopolist
is forced to charge 16,

357
00:17:01,760 --> 00:17:06,530
now think about her decision
to sell the seventh unit.

358
00:17:06,530 --> 00:17:08,849
Well, before she didn't want
to sell the seventh unit,

359
00:17:08,849 --> 00:17:10,819
because selling the
seventh unit meant she

360
00:17:10,819 --> 00:17:13,400
had to lower the price to 17.

361
00:17:13,400 --> 00:17:16,130
Well now she has to lower
the price to 16 already,

362
00:17:16,130 --> 00:17:18,140
so why not sell
the seventh unit?

363
00:17:18,140 --> 00:17:21,700
Indeed, why not sell
the eighth unit?

364
00:17:21,700 --> 00:17:24,369
We've essentially gotten
rid of the poisoning effect

365
00:17:24,369 --> 00:17:26,890
by pre-poisoning them, by
already telling them, look,

366
00:17:26,890 --> 00:17:29,020
you can't charge more than 16.

367
00:17:29,020 --> 00:17:30,920
There's no way to
charge more than that,

368
00:17:30,920 --> 00:17:34,960
so you might as well
sell eight units.

369
00:17:34,960 --> 00:17:36,970
So by telling the
monopolist they

370
00:17:36,970 --> 00:17:39,130
have to charge a
competitive price,

371
00:17:39,130 --> 00:17:42,190
you will force them to sell
the competitive quantity

372
00:17:42,190 --> 00:17:44,450
and you get rid of
deadweight loss.

373
00:17:44,450 --> 00:17:47,080
That's our first example
of how the government has

374
00:17:47,080 --> 00:17:48,773
improved things.

375
00:17:48,773 --> 00:17:50,940
The government has gotten
rid of the deadweight loss

376
00:17:50,940 --> 00:17:52,830
by setting a price ceiling.

377
00:17:52,830 --> 00:17:55,560
Price ceiling, in a perfect
market, is only bad,

378
00:17:55,560 --> 00:18:00,830
but a price ceiling here
can actually improve things.

379
00:18:00,830 --> 00:18:03,560
So that actually
sounds pretty good.

380
00:18:03,560 --> 00:18:04,677
So what's the problem?

381
00:18:04,677 --> 00:18:06,260
Why not, in reality,
just say, hey, we

382
00:18:06,260 --> 00:18:07,718
can solve all our
monopoly problems

383
00:18:07,718 --> 00:18:09,770
by just having the
government regulate the price

384
00:18:09,770 --> 00:18:11,785
at the competitive level?

385
00:18:11,785 --> 00:18:13,910
What's the problem, in
reality, with that solution?

386
00:18:13,910 --> 00:18:14,050
Yeah.

387
00:18:14,050 --> 00:18:15,364
AUDIENCE: How would
the government

388
00:18:15,364 --> 00:18:16,420
know the competitive level?

389
00:18:16,420 --> 00:18:17,200
JONATHAN GRUBER: How the
hell does the government

390
00:18:17,200 --> 00:18:18,117
the competitive level?

391
00:18:18,117 --> 00:18:19,610
It's great with this chart.

392
00:18:19,610 --> 00:18:21,225
But in reality, the
government doesn't

393
00:18:21,225 --> 00:18:23,350
know where the competitive
level is because there's

394
00:18:23,350 --> 00:18:24,225
two difficult points.

395
00:18:24,225 --> 00:18:25,933
What does the government
need to collect?

396
00:18:25,933 --> 00:18:27,640
First of all, the
government needs

397
00:18:27,640 --> 00:18:30,435
to know what the
demand curve is.

398
00:18:30,435 --> 00:18:31,810
Well, it turns
out demand curve's

399
00:18:31,810 --> 00:18:37,720
aren't written on our foreheads
or out there on the dark web.

400
00:18:37,720 --> 00:18:40,360
Demand curves are something
which you have to estimate.

401
00:18:40,360 --> 00:18:42,460
You have to gather
information from people.

402
00:18:42,460 --> 00:18:45,070
And it turns out that
it's pretty hard.

403
00:18:45,070 --> 00:18:47,680
Because if you want
to gather information

404
00:18:47,680 --> 00:18:50,050
on what people are
willing to pay for apples,

405
00:18:50,050 --> 00:18:52,383
you can just go to stores and
look at the prices charged

406
00:18:52,383 --> 00:18:53,090
for apples.

407
00:18:53,090 --> 00:18:54,610
But if you want to gather
information on the willingness

408
00:18:54,610 --> 00:18:56,770
to pay for getting water
delivered to your house,

409
00:18:56,770 --> 00:18:59,500
there's no market to turn to.

410
00:18:59,500 --> 00:19:02,110
It turns out to be
pretty hard to figure out

411
00:19:02,110 --> 00:19:05,740
how you value a lot of goods,
which is natural monopolies.

412
00:19:05,740 --> 00:19:08,183
Now, you might say,
well, why do you just ask

413
00:19:08,183 --> 00:19:09,475
people what it's worth to them?

414
00:19:09,475 --> 00:19:12,160
You just say to people, look,
tell me you demand for water.

415
00:19:12,160 --> 00:19:14,368
It turns out that's really
hard because people aren't

416
00:19:14,368 --> 00:19:17,080
very good at thinking
about how to assign prices

417
00:19:17,080 --> 00:19:18,370
to things they don't shop for.

418
00:19:22,310 --> 00:19:24,050
If I say to you,
what's an apple worth,

419
00:19:24,050 --> 00:19:24,920
the first thing in
your head is, you

420
00:19:24,920 --> 00:19:26,390
think about being in a
supermarket looking at apples

421
00:19:26,390 --> 00:19:27,480
and what they cost.

422
00:19:27,480 --> 00:19:29,147
You don't think about
the inherent value

423
00:19:29,147 --> 00:19:32,240
to you of consuming an apple.

424
00:19:32,240 --> 00:19:34,525
But when you think about
what water is worth,

425
00:19:34,525 --> 00:19:36,650
you have to think about
sort of the inherent value.

426
00:19:36,650 --> 00:19:38,930
And so you have to
rely on something

427
00:19:38,930 --> 00:19:44,570
that we call contingent
valuation, which

428
00:19:44,570 --> 00:19:46,670
is the economist's fancy
word for just asking

429
00:19:46,670 --> 00:19:47,962
people what it's worth to them.

430
00:19:50,635 --> 00:19:52,760
The problem is, people
aren't very good about that.

431
00:19:52,760 --> 00:19:55,060
So for example, a
classic case was the rise

432
00:19:55,060 --> 00:19:57,180
in environmental issues.

433
00:19:57,180 --> 00:19:59,270
How much is it worth
to have clean air?

434
00:19:59,270 --> 00:20:02,580
How much is it worth to
save the Grand Canyon?

435
00:20:02,580 --> 00:20:04,770
So it turns out people
give sort of crazy answers

436
00:20:04,770 --> 00:20:08,935
that violate all the rules we
set up in the first lecture

437
00:20:08,935 --> 00:20:09,810
by utility functions.

438
00:20:09,810 --> 00:20:12,215
Like for example,
if you asked folks

439
00:20:12,215 --> 00:20:13,590
what it's worth
to save the Grand

440
00:20:13,590 --> 00:20:16,740
Canyon as a single question,
and then you ask them

441
00:20:16,740 --> 00:20:20,520
as the third question on the
list, it's worth 1/5 as much

442
00:20:20,520 --> 00:20:23,150
to save the Grand Canyon was
the third question on the list,

443
00:20:23,150 --> 00:20:24,472
which doesn't make any sense.

444
00:20:24,472 --> 00:20:26,430
It doesn't matter what
the other questions are.

445
00:20:26,430 --> 00:20:28,770
If you ask people,
how much they would

446
00:20:28,770 --> 00:20:32,600
pay to save seals and
whales, in that order,

447
00:20:32,600 --> 00:20:40,410
they'd say saving seals is
worth $142 and whales $195.

448
00:20:40,410 --> 00:20:42,140
So whales and seals
are about the same.

449
00:20:42,140 --> 00:20:44,040
But when you reverse
the order, whales

450
00:20:44,040 --> 00:20:46,260
are worth about twice
what seals are worth, just

451
00:20:46,260 --> 00:20:47,950
by reversing the order.

452
00:20:47,950 --> 00:20:49,560
Well, more
relevantly, if you ask

453
00:20:49,560 --> 00:20:51,990
people what it's worth to
save a bird or 10 birds

454
00:20:51,990 --> 00:20:53,530
or 1,000 birds or
a million birds,

455
00:20:53,530 --> 00:20:55,890
they give you pretty
much the same answer,

456
00:20:55,890 --> 00:20:57,730
which doesn't make any sense.

457
00:20:57,730 --> 00:21:00,330
So basically, the problem is
these contingent valuation

458
00:21:00,330 --> 00:21:03,060
methods don't really
give sensible answers.

459
00:21:03,060 --> 00:21:05,328
And it's very hard to
get sensible answers.

460
00:21:05,328 --> 00:21:06,870
In my other course,
Public Economics,

461
00:21:06,870 --> 00:21:09,780
we talk about lots of
interesting clever methods

462
00:21:09,780 --> 00:21:11,970
for trying to get people
to reveal their preferences

463
00:21:11,970 --> 00:21:13,290
for these public goods.

464
00:21:13,290 --> 00:21:14,775
But it turns out to be hard.

465
00:21:14,775 --> 00:21:17,150
So that's one problem, is it's
hard to measure the demand

466
00:21:17,150 --> 00:21:18,240
curve.

467
00:21:18,240 --> 00:21:21,870
The other problem is, it's hard
to measure the supply curve.

468
00:21:21,870 --> 00:21:24,360
Because where does
supply curve come from?

469
00:21:24,360 --> 00:21:27,000
It's sort of a firm's
marginal cost function.

470
00:21:27,000 --> 00:21:31,170
You as the regulator do not
know what their marginal cost

471
00:21:31,170 --> 00:21:32,490
function is.

472
00:21:32,490 --> 00:21:33,510
So how do you find out?

473
00:21:33,510 --> 00:21:34,420
You ask them.

474
00:21:34,420 --> 00:21:37,170
You say, hey, business
I'm going to regulate,

475
00:21:37,170 --> 00:21:39,090
I'd like to know what
your marginal cost is.

476
00:21:39,090 --> 00:21:41,310
And by the way, the
lower you tell me

477
00:21:41,310 --> 00:21:44,032
it is, the lower price I'm
going to let you charge.

478
00:21:44,032 --> 00:21:45,240
So what's your marginal cost?

479
00:21:45,240 --> 00:21:47,325
Oh, god, our marginal
cost is horribly high.

480
00:21:47,325 --> 00:21:48,080
It terrible.

481
00:21:48,080 --> 00:21:50,078
You wouldn't believe
it, can't complain

482
00:21:50,078 --> 00:21:51,870
enough about how high
our marginal cost is.

483
00:21:51,870 --> 00:21:54,630
And basically, unless the
regulator perfectly knows

484
00:21:54,630 --> 00:21:56,460
the production function
and perfectly knows

485
00:21:56,460 --> 00:21:58,585
the input prices, none of
which are perfectly known

486
00:21:58,585 --> 00:22:00,183
by anybody but the
firm, they aren't

487
00:22:00,183 --> 00:22:02,100
going to know what the
supply curve looks like

488
00:22:02,100 --> 00:22:03,910
and what the marginal
cost looks like.

489
00:22:03,910 --> 00:22:05,481
Question.

490
00:22:05,481 --> 00:22:09,530
AUDIENCE: Couldn't they also,
say, in a public company,

491
00:22:09,530 --> 00:22:12,320
basically inspect their factory
and manufacturing [INAUDIBLE]??

492
00:22:12,320 --> 00:22:13,500
JONATHAN GRUBER: You
could absolutely do that

493
00:22:13,500 --> 00:22:15,150
and you can try to collect data.

494
00:22:15,150 --> 00:22:18,200
But ultimately, they could,
that day that you show up

495
00:22:18,200 --> 00:22:21,140
with the inspector, have a
really expensive-looking setup

496
00:22:21,140 --> 00:22:22,460
in their factory or whatever.

497
00:22:22,460 --> 00:22:26,120
It's basically very, very hard.

498
00:22:26,120 --> 00:22:31,292
So basically, the problem is
that regulation-- and this

499
00:22:31,292 --> 00:22:32,750
will generally be
a feature when we

500
00:22:32,750 --> 00:22:35,420
talk about the benefits of
government intervention.

501
00:22:35,420 --> 00:22:39,557
We'll say, market
failure makes it possible

502
00:22:39,557 --> 00:22:41,390
that government
intervention can make things

503
00:22:41,390 --> 00:22:43,682
better, but not definite.

504
00:22:43,682 --> 00:22:45,140
So the way to think
about the logic

505
00:22:45,140 --> 00:22:48,230
is, in a perfectly competitive
market with no market failure,

506
00:22:48,230 --> 00:22:51,210
government intervention only
makes things less efficient.

507
00:22:51,210 --> 00:22:52,850
We're leaving
redistribution aside.

508
00:22:52,850 --> 00:22:54,650
It only makes things
less efficient.

509
00:22:54,650 --> 00:22:56,720
When you move to
markets with failure,

510
00:22:56,720 --> 00:22:59,510
you open up the possibility
that government intervention

511
00:22:59,510 --> 00:23:02,850
can make things better, but
not for sure that it will.

512
00:23:02,850 --> 00:23:04,700
You open up the possibility.

513
00:23:04,700 --> 00:23:06,710
It's a necessary but not
a sufficient condition

514
00:23:06,710 --> 00:23:08,880
for saying the government
improves efficiency.

515
00:23:08,880 --> 00:23:13,400
So for example, imagine
that the government came in

516
00:23:13,400 --> 00:23:15,830
to this market
and said, we think

517
00:23:15,830 --> 00:23:19,640
the competitive price is 10.

518
00:23:19,640 --> 00:23:21,460
We think the
competitive price is 10.

519
00:23:21,460 --> 00:23:24,470
Well, if the government
set the price equal to 10,

520
00:23:24,470 --> 00:23:28,810
we know that firms
are going to produce

521
00:23:28,810 --> 00:23:31,533
where marginal revenue--

522
00:23:31,533 --> 00:23:32,950
which is now just
10, because it's

523
00:23:32,950 --> 00:23:39,310
regulated-- equals marginal
cost, so where 10 equals 2q.

524
00:23:39,310 --> 00:23:41,960
Little q and big Q are the
same because of the monopolist.

525
00:23:41,960 --> 00:23:45,910
Where 10 equals 2q,
or where q equals 5.

526
00:23:45,910 --> 00:23:47,590
So if the government
comes in and says,

527
00:23:47,590 --> 00:23:49,360
we're fixing your
price at 10, we

528
00:23:49,360 --> 00:23:51,976
know the firm
produced five units.

529
00:23:51,976 --> 00:23:55,468
Well, with five units, the
deadweight loss is even bigger.

530
00:23:55,468 --> 00:23:58,010
The key trick with deadweight
loss triangles, deadweight loss

531
00:23:58,010 --> 00:24:00,350
is essentially
proportional to how far you

532
00:24:00,350 --> 00:24:02,050
deviate from the optimal point.

533
00:24:02,050 --> 00:24:03,470
So the more you
move to the left,

534
00:24:03,470 --> 00:24:05,600
the bigger the deadweight
loss triangle is going to get.

535
00:24:05,600 --> 00:24:07,100
So deadweight loss
with 5 units sold

536
00:24:07,100 --> 00:24:09,520
is bigger than deadweight
loss with 6 units sold.

537
00:24:09,520 --> 00:24:12,590
So the government's
actually made things worse.

538
00:24:12,590 --> 00:24:14,460
By coming and setting
this price of 10,

539
00:24:14,460 --> 00:24:17,690
the government's
made things worse.

540
00:24:17,690 --> 00:24:19,340
Indeed, the government
could actually

541
00:24:19,340 --> 00:24:21,442
set the price so
low you shut down.

542
00:24:21,442 --> 00:24:23,900
The government could set the
price below the shutdown point

543
00:24:23,900 --> 00:24:26,970
and wipe the whole
business off the map.

544
00:24:26,970 --> 00:24:28,790
So here we have the tradeoff.

545
00:24:28,790 --> 00:24:30,290
The government can
potentially make

546
00:24:30,290 --> 00:24:32,473
the market more efficient
through price regulation,

547
00:24:32,473 --> 00:24:33,515
but it won't necessarily.

548
00:24:33,515 --> 00:24:35,217
It depends on its
level of information

549
00:24:35,217 --> 00:24:36,800
and how well it does
setting the price

550
00:24:36,800 --> 00:24:38,930
relative to the
competitive price.

551
00:24:41,960 --> 00:24:44,300
So basically, this
is a very sort

552
00:24:44,300 --> 00:24:50,780
of interesting and difficult
problem for the government.

553
00:24:50,780 --> 00:24:52,970
So one way is
through regulation.

554
00:24:52,970 --> 00:24:55,250
Questions about that?

555
00:24:55,250 --> 00:24:58,340
The other way to try to
address monopoly is by saying,

556
00:24:58,340 --> 00:25:02,930
is there some way to
introduce competition?

557
00:25:02,930 --> 00:25:06,740
That is, even in what feels
like a natural monopoly market,

558
00:25:06,740 --> 00:25:10,630
is there some way to
choose competition?

559
00:25:10,630 --> 00:25:15,560
So for example, think
about broadband delivery.

560
00:25:15,560 --> 00:25:16,670
Now we're still wired.

561
00:25:16,670 --> 00:25:17,660
In the future,
it's all wireless.

562
00:25:17,660 --> 00:25:18,410
This is different.

563
00:25:18,410 --> 00:25:20,085
But it's still wired.

564
00:25:20,085 --> 00:25:21,710
The way it works is,
broadband delivery

565
00:25:21,710 --> 00:25:24,350
has features of a
natural monopoly, which

566
00:25:24,350 --> 00:25:29,400
is, someone has to lay the wires
to your house to deliver it.

567
00:25:29,400 --> 00:25:31,680
At the same time, once
those wires are laid,

568
00:25:31,680 --> 00:25:36,090
it's a 0 marginal cost to allow
you to connect to the internet.

569
00:25:36,090 --> 00:25:40,970
So what governments do in other
countries, but not the US--

570
00:25:40,970 --> 00:25:42,920
in the US, we have competition.

571
00:25:42,920 --> 00:25:46,070
Everybody lays their
own lines down.

572
00:25:46,070 --> 00:25:48,460
In Europe, they recognize
that's inefficient.

573
00:25:48,460 --> 00:25:49,460
It's a natural monopoly.

574
00:25:49,460 --> 00:25:52,220
What they do is, they have one
set of publicly laid lines,

575
00:25:52,220 --> 00:25:56,330
and you compete to deliver
content over those lines.

576
00:25:56,330 --> 00:26:00,890
So there's competition where
the monopoly is not natural,

577
00:26:00,890 --> 00:26:03,542
which is over the
speed and the quality.

578
00:26:03,542 --> 00:26:05,000
It's the quality
of the connection.

579
00:26:05,000 --> 00:26:07,700
But the lines themselves, since
that's a giant fixed cost,

580
00:26:07,700 --> 00:26:10,035
they realize there can't
be competition over that.

581
00:26:10,035 --> 00:26:11,660
So that's one way
you could try to deal

582
00:26:11,660 --> 00:26:12,730
with a natural monopoly.

583
00:26:12,730 --> 00:26:13,670
In other words, the
government could

584
00:26:13,670 --> 00:26:15,753
control the pipes underground
delivering the water

585
00:26:15,753 --> 00:26:19,220
and have firms compete over
delivering the water to you.

586
00:26:19,220 --> 00:26:20,820
So that's one way
to deal with it.

587
00:26:20,820 --> 00:26:24,510
Another example is to think
about the public sector

588
00:26:24,510 --> 00:26:28,580
and think about education,
education delivery.

589
00:26:28,580 --> 00:26:36,110
Now, for those of you
who grew up in the US,

590
00:26:36,110 --> 00:26:40,060
you are evidence of the success
of the US educational system.

591
00:26:40,060 --> 00:26:42,750
But you are the
exception, not the rule.

592
00:26:42,750 --> 00:26:45,000
The US educational system,
by international standards,

593
00:26:45,000 --> 00:26:47,950
performs very badly.

594
00:26:47,950 --> 00:26:49,840
Probably out of the
top 30 countries,

595
00:26:49,840 --> 00:26:52,480
we're like 15th in terms
of things like math scores

596
00:26:52,480 --> 00:26:54,460
and other things like that.

597
00:26:54,460 --> 00:26:56,890
Yet, we spend more
money per pupil

598
00:26:56,890 --> 00:27:01,120
than any other
educational system

599
00:27:01,120 --> 00:27:03,910
in the world by a large amount.

600
00:27:03,910 --> 00:27:08,440
So if you look at figure
12-3, figure 12-3 shows,

601
00:27:08,440 --> 00:27:12,040
in the blue, primary
school spending per pupil,

602
00:27:12,040 --> 00:27:14,320
and in the red, eighth
grade math scores.

603
00:27:14,320 --> 00:27:17,030
And you can see the US spends
way more than other people,

604
00:27:17,030 --> 00:27:18,405
but our scores
aren't any better.

605
00:27:18,405 --> 00:27:19,905
Indeed, it doesn't
look like there's

606
00:27:19,905 --> 00:27:21,820
a very strong
relationship here at all

607
00:27:21,820 --> 00:27:26,650
between how much countries spend
and what you get in return.

608
00:27:26,650 --> 00:27:28,510
But at least it's
quite striking how low

609
00:27:28,510 --> 00:27:32,360
the US is given how
high our spending is.

610
00:27:32,360 --> 00:27:35,120
Now, why is that?

611
00:27:35,120 --> 00:27:42,630
One reason is because we have
given local schools a monopoly.

612
00:27:42,630 --> 00:27:45,183
We have said to
local schools, you

613
00:27:45,183 --> 00:27:47,850
have a monopoly where you get to
deliver the education to anyone

614
00:27:47,850 --> 00:27:49,892
who lives within a certain
radius of your school.

615
00:27:52,820 --> 00:27:55,190
We've created that
natural monopoly.

616
00:27:55,190 --> 00:27:57,300
And once we created
that natural monopoly,

617
00:27:57,300 --> 00:28:02,672
we reduce pressures on firms
to produce efficiently.

618
00:28:02,672 --> 00:28:04,880
We've essentially said to
firms, you have a monopoly.

619
00:28:04,880 --> 00:28:08,173
There's no reason you have
to produce efficiently.

620
00:28:08,173 --> 00:28:09,590
Because there's
no entry and exit,

621
00:28:09,590 --> 00:28:12,790
which can put those
pressures on you.

622
00:28:12,790 --> 00:28:15,480
So in some sense, that's a
government-created monopoly.

623
00:28:15,480 --> 00:28:20,060
Your local public school is a
government-created monopoly.

624
00:28:20,060 --> 00:28:21,775
So what can we do for that?

625
00:28:21,775 --> 00:28:22,400
What can we do?

626
00:28:22,400 --> 00:28:24,440
Well, we can actually
introduce competition.

627
00:28:24,440 --> 00:28:28,070
So for example, we can
have public school choice,

628
00:28:28,070 --> 00:28:31,170
which many cities now
have, where, in fact, you

629
00:28:31,170 --> 00:28:35,500
don't have to go to the
school in your neighborhood.

630
00:28:35,500 --> 00:28:38,110
You can try to go to any
school in the district.

631
00:28:38,110 --> 00:28:39,657
You can essentially
enter a lottery

632
00:28:39,657 --> 00:28:41,990
and try to move around to
other schools in the district.

633
00:28:41,990 --> 00:28:43,510
And that introduces competition.

634
00:28:43,510 --> 00:28:44,927
Because then the
schools that want

635
00:28:44,927 --> 00:28:47,770
kids will have to
be better and have

636
00:28:47,770 --> 00:28:49,176
to produce more efficiently.

637
00:28:52,610 --> 00:28:56,517
And then a further
mode of that is,

638
00:28:56,517 --> 00:28:57,725
you can have charter schools.

639
00:29:00,350 --> 00:29:06,270
Charter schools are publicly
funded, but not city provided.

640
00:29:06,270 --> 00:29:09,860
They're in between public
schools and private schools.

641
00:29:09,860 --> 00:29:12,560
Charter schools are
separate schools,

642
00:29:12,560 --> 00:29:15,290
which get funding
from the government.

643
00:29:15,290 --> 00:29:18,635
But they aren't under the
local government's control.

644
00:29:18,635 --> 00:29:20,510
Regulatory control, but
they aren't delivered

645
00:29:20,510 --> 00:29:22,550
by the city as education.

646
00:29:22,550 --> 00:29:26,570
And that provides more public
school choice for individuals.

647
00:29:26,570 --> 00:29:29,810
And there's a lot of evidence,
much of it by my colleagues

648
00:29:29,810 --> 00:29:32,000
here at MIT, which
shows that there's

649
00:29:32,000 --> 00:29:34,250
been enormous benefits
to these movements,

650
00:29:34,250 --> 00:29:36,835
that public school choice
and charter schools

651
00:29:36,835 --> 00:29:38,460
have delivered-- now
I know some of you

652
00:29:38,460 --> 00:29:40,250
might have seen the John Oliver
segment a couple of years

653
00:29:40,250 --> 00:29:41,875
ago where he ragged
on charter schools.

654
00:29:41,875 --> 00:29:44,400
I mean, I love him in general,
but he was wrong on that one.

655
00:29:44,400 --> 00:29:45,925
There's a couple of bad actors.

656
00:29:45,925 --> 00:29:47,300
But by and large,
charter schools

657
00:29:47,300 --> 00:29:49,550
have been an enormous benefit
to the education system

658
00:29:49,550 --> 00:29:54,080
by introducing competition
and allowing students

659
00:29:54,080 --> 00:29:59,070
an option to improve their
educational outcomes.

660
00:29:59,070 --> 00:30:01,970
Now, the furthest out
option, and something

661
00:30:01,970 --> 00:30:04,785
you'll hear a lot of
discussion of, is vouchers.

662
00:30:07,956 --> 00:30:10,890
The most radical option is
what we call public school

663
00:30:10,890 --> 00:30:13,605
vouchers, or just vouchers.

664
00:30:13,605 --> 00:30:14,730
Here's how this would work.

665
00:30:14,730 --> 00:30:16,897
This is a very popular idea
on the conservative side

666
00:30:16,897 --> 00:30:17,940
of the spectrum.

667
00:30:17,940 --> 00:30:19,150
Here's how this would work.

668
00:30:19,150 --> 00:30:21,030
So I live in Lexington.

669
00:30:21,030 --> 00:30:23,640
What that means is, if I
send my kid to a Lexington

670
00:30:23,640 --> 00:30:27,440
public school, it's free.

671
00:30:27,440 --> 00:30:29,360
But the minute I pull
my kid out and send him

672
00:30:29,360 --> 00:30:33,000
to a private school, it
costs me the entire amount.

673
00:30:33,000 --> 00:30:35,250
So imagine a Lexington public
school education's worth

674
00:30:35,250 --> 00:30:38,610
$10,000.

675
00:30:38,610 --> 00:30:42,660
I'm essentially getting
$10,000, conditional on sending

676
00:30:42,660 --> 00:30:44,100
my kids to a Lexington school.

677
00:30:44,100 --> 00:30:45,892
The minute I choose to
send them elsewhere,

678
00:30:45,892 --> 00:30:49,420
I literally give
up that $10,000.

679
00:30:49,420 --> 00:30:51,490
A voucher system would
say, the way it would work

680
00:30:51,490 --> 00:30:53,770
is, everyone in town
would get a check

681
00:30:53,770 --> 00:30:57,040
or would get a
voucher for $10,000

682
00:30:57,040 --> 00:30:59,218
to be used at any
school they want.

683
00:30:59,218 --> 00:31:01,510
So if you want to go in
Lexington, you just hand it in.

684
00:31:01,510 --> 00:31:03,190
Life's never changed.

685
00:31:03,190 --> 00:31:05,040
But now if you want to
go to private school,

686
00:31:05,040 --> 00:31:07,460
we're allowing you to
take your money elsewhere.

687
00:31:07,460 --> 00:31:09,110
That puts competitive
pressure not just

688
00:31:09,110 --> 00:31:12,488
on schools within the district
but on the whole district.

689
00:31:12,488 --> 00:31:14,280
The whole district now
says, wait a second,

690
00:31:14,280 --> 00:31:15,760
if we don't do a
good job, people

691
00:31:15,760 --> 00:31:17,906
are going to leave and
take their money elsewhere.

692
00:31:17,906 --> 00:31:21,630
So the idea is to actually
set up broader competition

693
00:31:21,630 --> 00:31:26,550
to put pressure on districts
to improve their performance.

694
00:31:26,550 --> 00:31:28,600
So this has been a
longtime attractive option

695
00:31:28,600 --> 00:31:30,630
to many economists.

696
00:31:30,630 --> 00:31:33,740
And I've spent a whole long time
talking about the pros and cons

697
00:31:33,740 --> 00:31:35,180
of this in my other class.

698
00:31:35,180 --> 00:31:38,330
But briefly speaking, the
pros are all the reasons

699
00:31:38,330 --> 00:31:40,420
we like competition in markets.

700
00:31:40,420 --> 00:31:42,920
It'll cause more
production efficiency

701
00:31:42,920 --> 00:31:45,140
because schools would
have to compete.

702
00:31:45,140 --> 00:31:47,150
The cons are numerous, though.

703
00:31:47,150 --> 00:31:51,357
One con is, you then have to
have the public sector that

704
00:31:51,357 --> 00:31:53,690
has a vested interest in
making sure private schools are

705
00:31:53,690 --> 00:31:57,000
delivering a public
quality education.

706
00:31:57,000 --> 00:32:02,000
So basically, you could set up
a private school that is just

707
00:32:02,000 --> 00:32:03,980
a football training academy.

708
00:32:03,980 --> 00:32:06,440
And suddenly, people could take
their voucher and go there,

709
00:32:06,440 --> 00:32:08,160
and suddenly they
wouldn't get education.

710
00:32:08,160 --> 00:32:09,950
That's one con.

711
00:32:09,950 --> 00:32:14,820
Another con of these systems
is that they're expensive.

712
00:32:14,820 --> 00:32:15,667
So take me.

713
00:32:15,667 --> 00:32:16,500
I live in Lexington.

714
00:32:16,500 --> 00:32:17,780
I'm a pretty rich guy.

715
00:32:17,780 --> 00:32:20,870
I sent my kids to
private school.

716
00:32:20,870 --> 00:32:22,130
I sent them and I paid.

717
00:32:22,130 --> 00:32:24,140
Now, imagine Lexington
had a voucher system

718
00:32:24,140 --> 00:32:27,050
and they give me a
check for $10,000.

719
00:32:27,050 --> 00:32:30,415
Why should Lexington give a
relatively rich guy $10,000?

720
00:32:30,415 --> 00:32:31,290
That's sort of silly.

721
00:32:31,290 --> 00:32:33,290
I was already sending my
kids to private school.

722
00:32:33,290 --> 00:32:35,600
So who would be the big winner
from a system like this?

723
00:32:35,600 --> 00:32:37,100
Well, some winners
would be kids who

724
00:32:37,100 --> 00:32:38,790
then get a better education.

725
00:32:38,790 --> 00:32:40,280
But a lot of winners would be
rich people who already sent

726
00:32:40,280 --> 00:32:41,060
their kids to private school.

727
00:32:41,060 --> 00:32:42,500
We'd just be
handing them checks.

728
00:32:42,500 --> 00:32:44,090
That's not a great outcome.

729
00:32:44,090 --> 00:32:47,810
So there are
definitely tradeoffs

730
00:32:47,810 --> 00:32:49,470
inherent in a system like this.

731
00:32:49,470 --> 00:32:50,762
I know there's a few questions.

732
00:32:50,762 --> 00:32:52,887
Let's do a couple of
questions, then we'll move on.

733
00:32:52,887 --> 00:32:53,880
Yeah, in the back.

734
00:32:53,880 --> 00:32:55,880
AUDIENCE: So say you
have these vouchers,

735
00:32:55,880 --> 00:32:58,760
and instead of going
to the public school,

736
00:32:58,760 --> 00:33:01,880
students are leaving to the
private school, and then

737
00:33:01,880 --> 00:33:04,370
the fixed cost of having
the infrastructure

738
00:33:04,370 --> 00:33:08,220
of a public school, that's then
spread out over less students.

739
00:33:08,220 --> 00:33:12,440
So how do you account for, the
price of teaching one student

740
00:33:12,440 --> 00:33:15,590
might go up if there are these
students that are leaving?

741
00:33:15,590 --> 00:33:17,570
JONATHAN GRUBER: That
is an awesome question.

742
00:33:17,570 --> 00:33:19,370
There's two elements to that.

743
00:33:19,370 --> 00:33:22,890
Question one is, there is an
actual natural monopoly feature

744
00:33:22,890 --> 00:33:24,590
to local public education.

745
00:33:24,590 --> 00:33:27,190
So remember, competition
doesn't make sense when

746
00:33:27,190 --> 00:33:28,575
it's a true natural monopoly.

747
00:33:28,575 --> 00:33:30,200
There is some natural
monopoly element.

748
00:33:30,200 --> 00:33:33,290
So as you shrink the
number, you suddenly

749
00:33:33,290 --> 00:33:34,850
are raising the average cost.

750
00:33:34,850 --> 00:33:36,350
And that is a potential problem.

751
00:33:36,350 --> 00:33:37,517
There's an efficiency issue.

752
00:33:37,517 --> 00:33:39,230
There's also an
equity issue, which

753
00:33:39,230 --> 00:33:41,410
is, who uses the
vouchers and leaves?

754
00:33:41,410 --> 00:33:43,815
The people with motivated
parents who are with it.

755
00:33:43,815 --> 00:33:44,690
Who gets left behind?

756
00:33:44,690 --> 00:33:46,730
People's parents who don't
give a shit about him.

757
00:33:46,730 --> 00:33:48,522
There's an equity issue,
too, of, suddenly,

758
00:33:48,522 --> 00:33:50,993
you're pulling all the smart
kids, all the motivated kids

759
00:33:50,993 --> 00:33:52,910
out of the public schools
and leaving the kids

760
00:33:52,910 --> 00:33:55,260
behind who aren't motivated or
whose parents aren't motivated.

761
00:33:55,260 --> 00:33:56,420
There's an equity
issue there, too,

762
00:33:56,420 --> 00:33:57,545
so that's another tradeoff.

763
00:33:57,545 --> 00:33:58,396
Yeah.

764
00:33:58,396 --> 00:33:59,890
AUDIENCE: You got
a good education.

765
00:33:59,890 --> 00:34:02,500
JONATHAN GRUBER: How do you tell
if people get a good education?

766
00:34:02,500 --> 00:34:03,440
Well, that's [INAUDIBLE].

767
00:34:03,440 --> 00:34:05,140
AUDIENCE: Well, if you're
going to get a good education.

768
00:34:05,140 --> 00:34:07,220
JONATHAN GRUBER: Well,
that's another problem.

769
00:34:07,220 --> 00:34:10,420
Which is, competition, one of
our fundamental assumptions

770
00:34:10,420 --> 00:34:13,909
of perfect competition
was perfect information.

771
00:34:13,909 --> 00:34:16,130
That's fine when you're
looking at apples or maybe

772
00:34:16,130 --> 00:34:17,870
even computers.

773
00:34:17,870 --> 00:34:19,760
It's not so easy
looking at schools.

774
00:34:19,760 --> 00:34:21,527
Now, schools
publish test scores.

775
00:34:21,527 --> 00:34:24,110
You can look at the test scores
of kids who go to that school.

776
00:34:24,110 --> 00:34:25,818
But once again, that's
not that reliable,

777
00:34:25,818 --> 00:34:27,735
because if smart kids
are going to the school,

778
00:34:27,735 --> 00:34:30,170
they'll have high test
scores, even if teachers suck.

779
00:34:30,170 --> 00:34:32,750
For example, Harvard--
sorry, I couldn't resist.

780
00:34:32,750 --> 00:34:34,880
[LAUGHTER]

781
00:34:34,880 --> 00:34:42,090
So basically, you
can't really tell that.

782
00:34:42,090 --> 00:34:45,469
In other words, there's
a number of failures

783
00:34:45,469 --> 00:34:48,739
of the private
education market, that

784
00:34:48,739 --> 00:34:51,568
are a problem with this
kind of voucher solution.

785
00:34:51,568 --> 00:34:52,860
But it doesn't mean it's wrong.

786
00:34:52,860 --> 00:34:54,810
It means it's interesting.

787
00:34:54,810 --> 00:34:55,699
There's a tradeoff.

788
00:34:55,699 --> 00:34:57,653
On the one hand, we'd
introduce competition,

789
00:34:57,653 --> 00:34:59,820
which would maybe increase
efficiency in the market.

790
00:34:59,820 --> 00:35:01,420
On the other hand, there's
a lot of market failures

791
00:35:01,420 --> 00:35:03,620
which might get in the way
of this functioning properly.

792
00:35:03,620 --> 00:35:05,670
Fascinating topic, and if
you want to learn more,

793
00:35:05,670 --> 00:35:06,920
I urge you take 1441.

794
00:35:06,920 --> 00:35:09,740
We spend a whole lecture
talking about it.

795
00:35:09,740 --> 00:35:13,790
So that was the second
topic I want to talk about.

796
00:35:13,790 --> 00:35:16,310
Once again, we've
started down the road

797
00:35:16,310 --> 00:35:22,380
of questioning the wisdom of the
market, so the road of market

798
00:35:22,380 --> 00:35:24,263
failures.

799
00:35:24,263 --> 00:35:25,680
The first market
fail is monopoly.

800
00:35:25,680 --> 00:35:28,260
We've talked about the
pros and cons of trying

801
00:35:28,260 --> 00:35:30,650
to deal with monopoly.

802
00:35:30,650 --> 00:35:33,110
But I want to talk
about one other topic

803
00:35:33,110 --> 00:35:34,820
before we leave
monopolies, which

804
00:35:34,820 --> 00:35:39,320
is this topic of what we call
contestable markets, which

805
00:35:39,320 --> 00:35:42,440
is sort of an informal term.

806
00:35:42,440 --> 00:35:43,988
But I really like
it as an intuition,

807
00:35:43,988 --> 00:35:45,530
so I'd like to spend
some time on it.

808
00:35:48,620 --> 00:35:53,440
Contestable markets are monopoly
markets without market power

809
00:35:53,440 --> 00:35:55,150
or without much market power.

810
00:35:55,150 --> 00:35:56,950
That is, we talked
about monopolists

811
00:35:56,950 --> 00:35:59,020
as having lots of market power.

812
00:35:59,020 --> 00:36:03,080
Remember, we said the markup
was essentially proportional.

813
00:36:03,080 --> 00:36:05,830
We said that monopolists
had a markup, price

814
00:36:05,830 --> 00:36:09,100
minus marginal cost over price,
which is equal to minus 1

815
00:36:09,100 --> 00:36:12,320
over the elasticity of demand.

816
00:36:12,320 --> 00:36:14,000
That was their markup.

817
00:36:14,000 --> 00:36:17,818
And so you know some markets,
different monopoly markets

818
00:36:17,818 --> 00:36:19,610
will have different
levels of market power.

819
00:36:19,610 --> 00:36:21,902
You can be a monopolist, but
not have much market power

820
00:36:21,902 --> 00:36:24,130
if consumers are very elastic.

821
00:36:24,130 --> 00:36:27,940
But there's another reason
why monopolists face pressure

822
00:36:27,940 --> 00:36:30,290
besides the
elasticity of demand,

823
00:36:30,290 --> 00:36:34,008
which is, in some sense, the
size of the barrier to entry.

824
00:36:34,008 --> 00:36:36,425
So one reason monopolists are
constrained in their pricing

825
00:36:36,425 --> 00:36:38,750
is because demand's elastic.

826
00:36:38,750 --> 00:36:41,180
Another reason is because
the barriers to entry

827
00:36:41,180 --> 00:36:44,080
might not be that large.

828
00:36:44,080 --> 00:36:45,670
So you could think
of it, roughly

829
00:36:45,670 --> 00:36:49,180
speaking, for a given
elasticity of demand,

830
00:36:49,180 --> 00:36:52,733
the larger the barrier to entry,
the more market power you have.

831
00:36:52,733 --> 00:36:54,400
Because the larger
the barrier to entry,

832
00:36:54,400 --> 00:36:56,650
the more you can be sure no
other firm's going to come in.

833
00:36:56,650 --> 00:36:58,330
Or in other words,
the amount to which

834
00:36:58,330 --> 00:37:02,530
you can charge above marginal
cost for a given elasticity

835
00:37:02,530 --> 00:37:07,500
is proportional to how severe
the barriers to entry are.

836
00:37:07,500 --> 00:37:10,950
If there's no way a second firm
can get in, then essentially,

837
00:37:10,950 --> 00:37:13,730
you get to just
obey this formula.

838
00:37:13,730 --> 00:37:16,073
But if a second firm
can get in easily,

839
00:37:16,073 --> 00:37:18,490
then you might not even be
able to have this big a markup.

840
00:37:18,490 --> 00:37:19,948
Because if you try,
someone's going

841
00:37:19,948 --> 00:37:22,600
to come in and
steal your profits.

842
00:37:22,600 --> 00:37:26,840
So in other words, there's
essentially an important issue,

843
00:37:26,840 --> 00:37:28,540
which is that the
market monopolists can

844
00:37:28,540 --> 00:37:31,232
get as a function both of
elastic demand and the size

845
00:37:31,232 --> 00:37:33,270
of their barriers to entry.

846
00:37:33,270 --> 00:37:36,170
This is an important
issue that came up

847
00:37:36,170 --> 00:37:41,120
in the area of airline
deregulation, which

848
00:37:41,120 --> 00:37:43,280
is what I want to talk
about for a few minutes.

849
00:37:43,280 --> 00:37:45,920
It's an important application
of the kind of stuff

850
00:37:45,920 --> 00:37:47,170
we've been talking about.

851
00:37:47,170 --> 00:37:53,220
Now, how many of you
have seen Mad Men.

852
00:37:53,220 --> 00:37:53,875
Jeez, really?

853
00:37:53,875 --> 00:37:55,250
Wow, OK, it's a
pretty good show.

854
00:37:55,250 --> 00:37:56,520
I mean, it's not outstanding.

855
00:37:56,520 --> 00:37:58,230
How many have seen Breaking Bad?

856
00:37:58,230 --> 00:37:59,007
OK, good.

857
00:37:59,007 --> 00:38:00,090
That, you have to all see.

858
00:38:00,090 --> 00:38:02,042
Mad Men's pretty good.

859
00:38:02,042 --> 00:38:03,750
But basically, what's
nice about Mad Men,

860
00:38:03,750 --> 00:38:06,880
it shows what flying was
like when I was a kid.

861
00:38:06,880 --> 00:38:11,220
When I was a kid, when you
flew, it was like luxurious.

862
00:38:11,220 --> 00:38:13,590
You went on, there was
plenty of leg room.

863
00:38:13,590 --> 00:38:16,440
You had free meals, free
movies, free drinks.

864
00:38:21,480 --> 00:38:23,970
And the reason was because--

865
00:38:23,970 --> 00:38:25,590
I sort of skipped
ahead in the story.

866
00:38:25,590 --> 00:38:28,530
When I was a kid,
airlines were regulated.

867
00:38:28,530 --> 00:38:33,330
What that meant was
that, essentially,

868
00:38:33,330 --> 00:38:36,870
the government viewed airlines
as a natural monopoly.

869
00:38:36,870 --> 00:38:39,790
They said, look, planes
are very expensive.

870
00:38:39,790 --> 00:38:42,722
There's a big fixed cost,
so it's a natural monopoly.

871
00:38:42,722 --> 00:38:44,680
We don't think competition
will work well here,

872
00:38:44,680 --> 00:38:46,962
so we're going to have
regulation of airlines.

873
00:38:46,962 --> 00:38:48,420
What that meant
was, the government

874
00:38:48,420 --> 00:38:51,300
set the price of every
flight and regulated

875
00:38:51,300 --> 00:38:53,040
where planes could go.

876
00:38:53,040 --> 00:38:54,720
So airlines every
year would submit

877
00:38:54,720 --> 00:38:57,390
a set of routes they wanted
to fly and a set of prices.

878
00:38:57,390 --> 00:38:59,970
And the government would
approve or turn them down.

879
00:38:59,970 --> 00:39:02,745
It was a regulated market.

880
00:39:02,745 --> 00:39:05,120
And it was generally viewed
that the government basically

881
00:39:05,120 --> 00:39:07,580
sort of screwed this up
and set the rates too high.

882
00:39:07,580 --> 00:39:08,600
That was sort of
the general view,

883
00:39:08,600 --> 00:39:10,825
that, basically, government,
because, essentially, they

884
00:39:10,825 --> 00:39:12,575
didn't really understand
the supply curve,

885
00:39:12,575 --> 00:39:14,583
they were being
fooled by the airlines

886
00:39:14,583 --> 00:39:17,000
to think costs were higher
than they were and were setting

887
00:39:17,000 --> 00:39:19,700
prices too high.

888
00:39:19,700 --> 00:39:24,380
But economists said, look,
this is not a natural monopoly.

889
00:39:24,380 --> 00:39:26,900
Because in fact,
it's not actually

890
00:39:26,900 --> 00:39:32,120
that cheap to get a used
plane and enter this business.

891
00:39:32,120 --> 00:39:35,240
Because these companies turn
over their planes all the time.

892
00:39:35,240 --> 00:39:37,612
And yes, buying a new
plane's expensive.

893
00:39:37,612 --> 00:39:39,320
But getting a
well-functioning used plane

894
00:39:39,320 --> 00:39:40,640
isn't that expensive.

895
00:39:40,640 --> 00:39:43,730
And you could easily create
competitors in this business.

896
00:39:43,730 --> 00:39:47,780
They said it was what we called
a contestable market, a market

897
00:39:47,780 --> 00:39:51,830
with very low barriers
to entry, that, in fact,

898
00:39:51,830 --> 00:39:54,800
if you allowed competition,
you would have a lot of entry

899
00:39:54,800 --> 00:39:55,907
into this market.

900
00:39:55,907 --> 00:39:58,490
And it would function fine, that
it wasn't a natural monopoly,

901
00:39:58,490 --> 00:40:01,535
it was a contestable market.

902
00:40:01,535 --> 00:40:03,910
And they argued, in fact, that
if you lacked competition,

903
00:40:03,910 --> 00:40:08,580
price would fall very
close to marginal cost.

904
00:40:08,580 --> 00:40:11,270
Price could fall very
close to marginal cost.

905
00:40:11,270 --> 00:40:13,980
So in fact, economists
carried the day.

906
00:40:13,980 --> 00:40:17,540
In the 1970s, we deregulated
the airline industry.

907
00:40:17,540 --> 00:40:20,570
The government stopped setting
prices and regulating routes.

908
00:40:20,570 --> 00:40:21,950
What happened?

909
00:40:21,950 --> 00:40:24,880
OK, three things happened.

910
00:40:24,880 --> 00:40:28,150
The first thing is,
price fell enormously.

911
00:40:28,150 --> 00:40:31,940
The cost of flying
fell by about 1/3.

912
00:40:31,940 --> 00:40:36,830
The best example was the airline
I took home from MIT in 1984

913
00:40:36,830 --> 00:40:38,760
called People Express.

914
00:40:38,760 --> 00:40:40,260
People Express
Airlines introduced--

915
00:40:40,260 --> 00:40:43,100
this was sort of shortly
after deregulation.

916
00:40:43,100 --> 00:40:49,100
I could fly from Boston
to Newark for $29.

917
00:40:49,100 --> 00:40:50,728
Now, how did that work?

918
00:40:50,728 --> 00:40:51,270
It was crazy.

919
00:40:51,270 --> 00:40:52,790
You showed up at the airport.

920
00:40:52,790 --> 00:40:53,873
There was no reservations.

921
00:40:53,873 --> 00:40:55,160
You just waited on line.

922
00:40:55,160 --> 00:40:56,580
They let people on until
the plane was full.

923
00:40:56,580 --> 00:40:58,040
Then you waited
for the next one.

924
00:40:58,040 --> 00:41:00,062
You paid on the plane
with a credit card.

925
00:41:00,062 --> 00:41:01,520
I still to this
day don't know what

926
00:41:01,520 --> 00:41:02,340
happened if you didn't pay.

927
00:41:02,340 --> 00:41:03,370
Did they throw you
out the window?

928
00:41:03,370 --> 00:41:04,170
I don't know.

929
00:41:04,170 --> 00:41:05,870
But you paid on the plane.

930
00:41:05,870 --> 00:41:07,550
And it was incredibly
competitive.

931
00:41:07,550 --> 00:41:08,633
And this is what happened.

932
00:41:08,633 --> 00:41:11,480
Flying got incredibly cheap.

933
00:41:11,480 --> 00:41:17,910
The second thing that happened
is you had many more routes.

934
00:41:17,910 --> 00:41:19,630
It turned out that
the government

935
00:41:19,630 --> 00:41:21,580
thought that flying
from point A to point B

936
00:41:21,580 --> 00:41:23,532
wasn't profitable
often when it was.

937
00:41:23,532 --> 00:41:25,990
So the government wouldn't let
airlines flight from point A

938
00:41:25,990 --> 00:41:27,730
to point B, when,
if fact, airlines

939
00:41:27,730 --> 00:41:29,850
could make plenty of
money doing that flight.

940
00:41:29,850 --> 00:41:34,570
So you had cheaper
flights and more routes.

941
00:41:34,570 --> 00:41:37,840
The third thing
is, flying sucks.

942
00:41:41,710 --> 00:41:44,050
When I was a kid,
flying was awesome--

943
00:41:44,050 --> 00:41:46,600
meals, booze, big seats.

944
00:41:46,600 --> 00:41:51,820
Now it's terrible-- no
meals, no booze, tiny seats.

945
00:41:51,820 --> 00:41:53,447
Why?

946
00:41:53,447 --> 00:41:54,280
Why did this happen?

947
00:41:56,352 --> 00:41:58,310
Flights got cheaper and
there are more of them,

948
00:41:58,310 --> 00:42:01,980
but why were they
suddenly crappier?

949
00:42:01,980 --> 00:42:02,660
Yeah.

950
00:42:02,660 --> 00:42:04,160
AUDIENCE: There was
more competition

951
00:42:04,160 --> 00:42:06,880
so they were trying to bring
down the marginal cost so bring

952
00:42:06,880 --> 00:42:07,990
prices lower.

953
00:42:07,990 --> 00:42:10,032
JONATHAN GRUBER: Right,
that's one way to put it.

954
00:42:10,032 --> 00:42:13,600
But the point is, what
this example points out

955
00:42:13,600 --> 00:42:15,350
is that there's
always competition.

956
00:42:15,350 --> 00:42:16,090
Yeah, what were
you going to say?

957
00:42:16,090 --> 00:42:17,350
AUDIENCE: I was going to
say price discrimination.

958
00:42:17,350 --> 00:42:19,720
They could discriminate based
on what people [INAUDIBLE]

959
00:42:19,720 --> 00:42:20,290
JONATHAN GRUBER:
It actually wasn't.

960
00:42:20,290 --> 00:42:21,070
They still price discriminate.

961
00:42:21,070 --> 00:42:22,360
It wasn't quite that.

962
00:42:22,360 --> 00:42:23,430
But yeah.

963
00:42:23,430 --> 00:42:26,670
AUDIENCE: People were
willing to fly [INAUDIBLE]

964
00:42:26,670 --> 00:42:28,420
JONATHAN GRUBER: They
were willing to fly.

965
00:42:28,420 --> 00:42:29,800
But what were they doing before?

966
00:42:29,800 --> 00:42:30,740
Yeah.

967
00:42:30,740 --> 00:42:33,520
AUDIENCE: If you couldn't
compete on price,

968
00:42:33,520 --> 00:42:35,592
you could compete
on luxuriousness.

969
00:42:35,592 --> 00:42:36,550
JONATHAN GRUBER: Right.

970
00:42:36,550 --> 00:42:38,020
So there were multiple
airlines before.

971
00:42:38,020 --> 00:42:40,020
The government said we'll
only compete on price.

972
00:42:40,020 --> 00:42:43,130
But they said, great, we'll
compete on other stuff.

973
00:42:43,130 --> 00:42:45,830
Remember, economic actors
want to be economic actors.

974
00:42:45,830 --> 00:42:47,937
They want to use economic tools.

975
00:42:47,937 --> 00:42:49,520
So if the government
says to airlines,

976
00:42:49,520 --> 00:42:50,900
we're not going to let
you charge a higher price,

977
00:42:50,900 --> 00:42:52,275
they're like great,
we'll compete

978
00:42:52,275 --> 00:42:56,420
by having better food,
better drinks, bigger seats.

979
00:42:56,420 --> 00:42:57,830
Once the government
said, now you

980
00:42:57,830 --> 00:43:00,320
have a new mode
of competing, they

981
00:43:00,320 --> 00:43:02,485
realized people
weren't willing to pay

982
00:43:02,485 --> 00:43:04,610
for better food and better
drinks and bigger seats.

983
00:43:04,610 --> 00:43:06,483
They'd rather fly cheaper.

984
00:43:06,483 --> 00:43:08,150
So they switched the
mode of competition

985
00:43:08,150 --> 00:43:12,050
from quality competition
to price competition.

986
00:43:12,050 --> 00:43:14,450
They used to use
quality competition.

987
00:43:14,450 --> 00:43:17,000
Now they use price competition.

988
00:43:17,000 --> 00:43:20,150
This means that all of us who
complain that flying sucks

989
00:43:20,150 --> 00:43:22,140
should just shut up.

990
00:43:22,140 --> 00:43:24,060
Because if we really
cared that much,

991
00:43:24,060 --> 00:43:27,370
then there'd be a good airline
that charged more and gave you

992
00:43:27,370 --> 00:43:28,083
better stuff.

993
00:43:28,083 --> 00:43:28,750
But there's not.

994
00:43:28,750 --> 00:43:30,350
I mean, JetBlue's
a little better.

995
00:43:30,350 --> 00:43:33,490
But by and large,
there's not airlines

996
00:43:33,490 --> 00:43:35,820
that charge more and
give you better stuff.

997
00:43:35,820 --> 00:43:37,570
And that's because,
at the end of the day,

998
00:43:37,570 --> 00:43:40,090
we would rather fly cheaper
than have this extra stuff.

999
00:43:40,090 --> 00:43:42,680
It wasn't worth the money
that we were paying for it.

1000
00:43:45,490 --> 00:43:49,180
Which really says that
regulation was failing here.

1001
00:43:49,180 --> 00:43:51,430
Regulation was forcing
airlines to compete

1002
00:43:51,430 --> 00:43:53,120
in an inefficient way.

1003
00:43:53,120 --> 00:43:56,320
They're competing by giving us
nice meals when we would rather

1004
00:43:56,320 --> 00:43:57,970
have the money.

1005
00:43:57,970 --> 00:44:02,350
So it was an example
that regulation failed.

1006
00:44:02,350 --> 00:44:04,610
So that's all really good news.

1007
00:44:04,610 --> 00:44:08,050
But there's one piece of bad
news, which is that, economists

1008
00:44:08,050 --> 00:44:09,670
aren't all-knowing.

1009
00:44:09,670 --> 00:44:13,690
And the economists, there's
a fourth outcome we missed,

1010
00:44:13,690 --> 00:44:16,090
which was the rise of
the hub and spoke system.

1011
00:44:18,850 --> 00:44:22,740
Which is that what we
missed is that airplanes

1012
00:44:22,740 --> 00:44:27,460
aren't a natural monopoly,
but airports are.

1013
00:44:27,460 --> 00:44:30,720
And what airlines started
doing is essentially

1014
00:44:30,720 --> 00:44:36,190
taking over airport
slots, and then saying,

1015
00:44:36,190 --> 00:44:37,760
we are going to have
all the flights.

1016
00:44:37,760 --> 00:44:39,593
So for example, my wife
is from Minneapolis.

1017
00:44:39,593 --> 00:44:42,440
We used to go to Minneapolis,
the only option was Northwest.

1018
00:44:42,440 --> 00:44:45,200
Northwest owned all the slots
in the Minneapolis airport.

1019
00:44:45,200 --> 00:44:47,450
And they'd say, if you ever
fly anywhere on Northwest,

1020
00:44:47,450 --> 00:44:51,025
we're going to route you from
Minneapolis to wherever you go.

1021
00:44:51,025 --> 00:44:52,650
It was called the
hub and spoke system.

1022
00:44:52,650 --> 00:44:54,650
You always went to a
central point and went out.

1023
00:44:54,650 --> 00:44:56,220
So US Air had Pittsburgh.

1024
00:44:56,220 --> 00:44:58,960
Northwest had Minneapolis.

1025
00:44:58,960 --> 00:45:00,290
American had Dallas, et cetera.

1026
00:45:00,290 --> 00:45:02,040
They had these hubs
that you'd go through.

1027
00:45:02,040 --> 00:45:03,720
What that meant was,
they essentially

1028
00:45:03,720 --> 00:45:06,480
got a monopoly on the
route into the hubs,

1029
00:45:06,480 --> 00:45:10,457
because they had monopoly
on the slots in the airport.

1030
00:45:10,457 --> 00:45:12,290
Now you might say, well,
that's easy to fix.

1031
00:45:12,290 --> 00:45:14,030
Don't give monopoly
slots in the airport.

1032
00:45:14,030 --> 00:45:15,838
But that's harder to
fix than you think.

1033
00:45:15,838 --> 00:45:17,630
Because whenever the
airport in Minneapolis

1034
00:45:17,630 --> 00:45:19,590
would say to Northwest, we
want to allow other airlines,

1035
00:45:19,590 --> 00:45:21,320
they'd say, great, we're
moving our headquarters out

1036
00:45:21,320 --> 00:45:22,050
of Minneapolis.

1037
00:45:22,050 --> 00:45:23,050
See ya.

1038
00:45:23,050 --> 00:45:25,590
And they'd say, OK,
fine, we won't do that.

1039
00:45:25,590 --> 00:45:28,850
So essentially, there
became political equilibrium

1040
00:45:28,850 --> 00:45:31,462
where these local airlines
were such big employers,

1041
00:45:31,462 --> 00:45:33,170
they'd bully the
governments into letting

1042
00:45:33,170 --> 00:45:35,090
them dominate the airports.

1043
00:45:35,090 --> 00:45:37,730
And they essentially
recreated a monopoly.

1044
00:45:37,730 --> 00:45:39,590
But the monopoly
wasn't on planes.

1045
00:45:39,590 --> 00:45:41,450
It was on airport slots.

1046
00:45:41,450 --> 00:45:45,050
And actually, flying got
much more expensive again.

1047
00:45:45,050 --> 00:45:46,742
So the price of flights
really came down

1048
00:45:46,742 --> 00:45:48,950
until airlines figured out
this hub and spoke system,

1049
00:45:48,950 --> 00:45:50,242
and they've gone back up since.

1050
00:45:50,242 --> 00:45:52,850
Now, they're still cheaper than
they were under regulation.

1051
00:45:52,850 --> 00:45:56,660
But roughly speaking, the price
fell by more like more than 50%

1052
00:45:56,660 --> 00:45:58,880
initially, and then
sort of risen back up.

1053
00:45:58,880 --> 00:46:00,917
It's still lower than
it was under regulation.

1054
00:46:00,917 --> 00:46:02,500
But it's risen back
up because there's

1055
00:46:02,500 --> 00:46:05,810
this sort of new
natural monopoly problem

1056
00:46:05,810 --> 00:46:07,880
that we didn't see.

1057
00:46:07,880 --> 00:46:10,310
So that leads to crazy
things, like a price

1058
00:46:10,310 --> 00:46:13,250
of a nonstop to
San Francisco today

1059
00:46:13,250 --> 00:46:16,250
is something like half
as much from Boston

1060
00:46:16,250 --> 00:46:17,660
as a flight to Minnesota.

1061
00:46:17,660 --> 00:46:18,990
Now, I don't know how
your geography skills are,

1062
00:46:18,990 --> 00:46:20,865
but San Francisco's a
lot farther from Boston

1063
00:46:20,865 --> 00:46:23,690
than Minnesota is, so it's
clearly not a marginal cost

1064
00:46:23,690 --> 00:46:25,100
issue.

1065
00:46:25,100 --> 00:46:26,360
So that's an example.

1066
00:46:26,360 --> 00:46:29,330
It's sort of a nice
case study of kind of,

1067
00:46:29,330 --> 00:46:32,360
our motivation was right, by and
large economists got it right.

1068
00:46:32,360 --> 00:46:35,510
By and large, we're better
off in a deregulated world.

1069
00:46:35,510 --> 00:46:37,145
But not as well
off as we thought,

1070
00:46:37,145 --> 00:46:39,520
because we missed this other
element of natural monopoly.

1071
00:46:42,890 --> 00:46:44,840
Why don't I stop there.

1072
00:46:44,840 --> 00:46:50,150
We will continue next time
by talking about oligopoly.