Friday, October 12, 2012

Paying Competitors Not to Compete

For years brand name pharmaceutical firms have paid generic firms not to produce generic versions of their product after the brand name products patents expire.  The New York Times recently the Third Court of Appeals has ruled that this type of business strategy is anti-competitive.

This is one of the issues that I talk about in my health economics class, and also fits in Industry Analysis.  Comparing the Cournot homogeneous product model to a standard monopolist model, we see that the individual firms produce less output, face lower overall market prices and hence earn lower economic profits.  Yet, if the firm did not face competition, it could increase its output and price and thus increase its profits.  In order to get their competitor not to compete the firm would be willing to pay their competitor an amount less than the gain in profits by moving from competition to monopoly, which potentially benefits both firms, but harms consumers by reducing consumer surplus due to the higher overall price and lower overall market output.

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