Lecture 13(i) Announcements. Lecture on Game Theory. Average of HW 1-9 posted at Moodle. Two more to go: HW 10 due Tues, Dec 8 HW 11 due Tues, Dec 15

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1 Lecture 13(i) Announcements Average of HW 1-9 posted at Moodle Two more to go: HW 10 due Tues, Dec 8 HW 11 due Tues, Dec 15 We drop the two lowest homeworks. If you skip HW 10 and HW 11, the current average is we will use for your final score. Lecture on Game Theory 1. Finish discussion of Reading 6 Intellectual Property Protection and the Global Economy 2. Start Game Theory The Prisoner s Dilemma Better idea: Do well on HW 10 and HW 11, so two earlier low scores can get dropped.

2 Recall discussion of Econland Big Pharma INC, and unregulated monopoly pricing of wigitor (a cure Economyosis Taken as given that the drug has been already been invented, with enforcement of the patent (compared to case of no patent where price is driven to marginal cost) we get: 1. Price is 6 versus 2 2. There is a deadweight loss 3. There is a transfer of surplus from consumers to Econland Big Pharma What if drug not invented and tested? A patent system provides an incentive to create the drug.

3 Last class discussed changes two proposed changes in policy: Policy Proposal 1 The U.S. adopts price regulation like Canada (say negotiate a $3 regulated price) Point 1: With this proposal there is less incentive to invest to create the drug. Point 2: If the fixed cost is not too high, the company might still invest. In this case, we still get the drug and pay only $3 per dose instead of the monopoly price of $6. Policy Proposal 2 The patent length is changed from 17 years to 5 years. The payout in operating profit is substantially reduced. Again Point 1: Drug might not be developed (minus side for this policy) Point 2: If the fixed cost is not too high, the drug company might do it anyway. In this case, have monopoly for 5 years instead of 17. So less deadweight loss of monopoly (and less transfer of surplus to drug companies.)

4 Really interesting article in New York Times on Friday Hedge fund manager J Kyle Bass has new business: 1. Find questionable drug patents 2. Sell the company short 3. Challenge the patent at the Patent Office Often these patents are for extensions of the original patent. ( evergreening or product-hopping) For example propofol: 30-year old therapy is protected not by the patent on the drug itself, but on the rubber stopper used in its container. Patent approval was extended in 2013 for 12 more years. Have challenged about 33 drug patents and have one half the time. (Generics come in, stock prices goe down, and profit from the short sale.)

5 Policy Proposal 3 Negotiate with the developing world (e.g. India and China) to adopt developed world (e.g. U.S., Europe, Japan) intellectual property standards. International Agreements Trade-Related Aspects of Intellectual Property Rights TRIPS, signed 1995, into effect 2005 India and other developing countries agreed to respect drug patents in return trade concessions made by rich countries on other issues. (Like rich countries opening up markets to textile imports from poor countries.)before this, India did not recognized drug patents. Trans-Pacific Partnership Includes provisions extending patents (this is what the U.S. fought for) and is expected to drive up the costs of pharmaceuticals in poor countries. Doctors Without Borders, for example, is trying to fight it. see

6 One issue with pharmaceuticals and poor countries: Sometimes poor countries are afflicted with diseases that don t affect rich countries, so there is little market incentive to create the drigs. Go back to our example, and suppose wigitor treats tuberculosis (third world problem) (TB) instead of (economoysis, a first-world problem) The table on the right provides the numbers.it is clear that Econland Big Pharma not doing this. Makes no money because the people who get sick with TB don t have any money. Numbers for TB Drug US System Patent, Unreg Other Developed Patent, Reg Monopoly Rest No Patents Monopoly Oper. Profit $16 $7 0 Pop. 300 mil 700 mil 6 bill Share sick Number sick Annual Op Prof. 0% 0%.2% 0 mil 0 mil 12 mill 0 mil 0 mil 0 Global Annual Op. Profit = 0 mil

7 As the free market will not provide powerful incentives for TB innovation, how can it get financed? 1) There are government subsidies (for example, through the United Nations) 2) Private Charity The Bill and Melinda Gates Foundation has paid $750 million for TB research Policy Proposal 4 Finance pharmaceutical research through government research grants and put the results in the public domain to be freely used. We do this to some extent, maybe we should do more? Public radio Health R&D through National Institute of Health Music (grants, Mozart sponsored by various princes Raises issue of international cooperation. How do we split the bill with other countries?

8 Game Theory We have worked through Monopoly and Perfect Competition. What happens in between? Oligopoly With a few sellers, how do they interact? Take OPEC (the cartel of oil producing nations). Gains for the group to for each to hold back oil production to keep up the price. So each county in cartel gets a production quota. Gain for the individual decision marker to deviate from the agreement and secretly sell more than the quota amount at the high price. How does it all work out? Game Theory is a useful tool

9 Prisoner s Dilemma Scenario: Robinson and Friday have been caught trying to steal widgets from S4. Have been brought in for questioning. They are being kept in separate rooms. Each chooses between two actions: Confess or Remain Silent. The outcome depends upon what they both do. Let s look at the Payoff Matrix

10 Payoff Matrix (minus) How Years in Jail Depend Upon Both Actions Robinson Look at incentives for Friday. Suppose he thinks Robinson is staying silent... Friday Confess Stay Silent Confess F gets 8 Stay Silent R gets 8 R gets 20 R gets 0 F gets 0 F gets 20 F gets 1 R gets 1 Strategy: a rule for how a player in the game behaves. Suppose he thinks Robinson is going to confess... Nash Equilibrium Player 1 s strategy is optimal for him or her taking as given how Player 2 is behaves. Likewise for Player 2 s strategy.

11 Nash Equilibrium of this game: This equilibrium is particularly compelling because it is special. Each choice made is a Dominant Strategy Optimal regardless of what they other person does Let s look at the efficiency of the equilibrium outcome from the perspective of the two players of the game. Equilibrium Outcome: Both confess and each gets 8 years in jail. If instead neither confess, each gets only 1 year in jail. If they could cooperate, (somehow commit to not confessing), both parties would be better off.