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Market Failure and Government Intervention

is a cost in dealing with many small firms or individuals in grants, purchasing contracts, or even sales of government products.  The cost effectiveness of forming relationships with a few large firms can defeat the goal of promoting competition.  The merging of railroads, for example, has led to significantly less competition with questionable gains in efficiency.  In the case of Union Pacific, it merger with major rivals has actually led to significant drops in efficiency for years.

Patent policy and regulatory policies also contribute to market power.  While patents give monopolies outright, regulatory agencies often bestow market power in more subtle ways.  When the Civil Aeronautics Board regulated airlines, it would prevent any firms from entering and would assign airline routes to ensure that no major airline firm exited the market.  It therefore eliminated the keystone to competition in the airline market.  

While antitrust law is designed to prevent the undesirable effects resulting from monopoly power, patents are government sponsored rights that create monopoly power.  A patent is an exclusive right to use and sell an invention and to prevent others from using or selling it. The reasons for patents include: (1) encouragement of inventors to invent by helping them to reap the benefits of their inventions, (2) providing an incentive to inventors to disclose their inventions by preventing others from stealing the invention once it becomes public, and (3) helping inventions reach the market place by making it worthwhile for firms to make the initial investment to develop inventions.4

A firm applying for a patent must be aware that they are not a full proof method of protecting an invention:

(1)  The government has had a very difficult time disentangling patents and determining when they have been infringed.  Trials often take a long time and require expensive technical testimony.

(2)Patents can be self defeating.  A firm that announces its invention by filing for a patent may find foreign imitators or illegal imitators that undercut the firm's prices.  The firm then has to undertake the litigation expenses and time to press charges against such violators; this can wear the firm down and it may lose.  

(3)  When illegal product surfaces in a market at cut rate prices, distributors of the patented product are placed in a precarious position.  Any licensed distributors find themselves facing rough alternatives; do they (a) maintain their legal relationship to the firm with the patent and face their demise in the market place by the price cutters or (b) distribute the good illegally and face litigation from the owner of the patent?

(4)  A large firm might simply take a patent to court and try to get it invalidated.  With resources that are superior to those of the inventor, a large firm is likely to accomplish this; 60% of the cases going to court actually do result in such invalidation.  

When patents fail to protect a firm, the firm may be forced to use other techniques to protect itself.

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