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Definition of a Patent:

A patent is a government grant that provides inventors the sole right to make and sell their invention for a set period of time.

Detailed Explanation:

Patents are government granted monopolies. How is this so? Patents make it illegal for companies other than the patent-holder to produce the same good for many years. (In the US patents protect the holder for between seventeen and twenty years.) They create a monopoly by preventing competitors from entering the market. Patents are issued to promote the development of new products. Pharmaceutical companies spend millions of dollars developing new drugs. Once developed, the drugs could easily be copied by competitors. Without patent protection, fewer drugs would be developed because companies would wait for another company to produce a drug and then copy it rather than investing in developing new drugs themselves. The reduced competition enables a company to raise the prices of its patented products to earn back its investments. Patents encourage innovation.

The market structure changes from a monopoly to a highly competitive market structure (but not perfect competition) after a patent expires. The introduction of generic drugs sharply reduced prices for drugs like Lipitor and Motrin shortly after their patents expired. However, pharmaceutical companies are not monopolies just because they own a few patents. There are many pharmaceutical companies that aggressively compete. A pharmaceutical company only has monopoly power related to a drug it has patented. This power is further eroded by the development of substitute drugs that treat the same disease. Crestor is a drug commonly prescribed to treat high cholesterol. AstraZeneca has a patent on Crestor. Other drugs such as Lipitor and Zocor also treat high cholesterol. Their patents have expired resulting in the development of less expensive generics. AstraZeneca is able to charge a premium for Crestor because of its patent, and its superior results in clinical trials.

Dig Deeper With These Free Lessons:

Market Structures Part I - Perfect Competition and Monopoly
Market Structures Part II - Monopolistic Competition and Oligopoly
Entrepreneurs - Their Vital Role in the Economy

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