Innovation in Large versus small firms compared

Joseph Schumpeter argued that innovation increased more than proportionately with firm size. The R&D funding of the firms is greatly influenced by the transaction cost of information transfer. To fund large scale innovation processes small firms have to seek external funding from financial institutions. However, due to the high degree of uncertainty, these financial institutions have to charge a higher interest rate to smaller firms. Large firms are more likely to raise funds to fund innovation projects faster. However, it is important to note that these large firms will be disadvantaged by managerial diseconomies of scale. Due to the corporate management structure of most big firm, employees working in the R&D unit will be required to explain their ideas to a less informed corporate board. Although the larger firms are still subject to the high information transmission costs, they still have a comparative advantage due to their ability to attract external funding (Martin 458).

Monopoly function: Q = 100 – P

Under the monopoly c1=50, c2=25, q1=25

Depending on the average costs, the monopolists can enjoy profit by selling 25 units when the cost is 50. In this case, the monopolists will enjoy a profit of 625. On the other hand, a producer in a perfectly competitive market would not earn any profit because the long run equilibrium price of the product is equal to the marginal and average cost (c1=p2=p1). In this case, the seller can only enjoy profits if it is able to exclude competitors through a patent (Martin 454).

Patents are considered a necessity because innovators have a natural property right in their original ides. It is through patents that the innovator would be compensated by for his contributions to society (Martin 500). Furthermore, patents encourage innovation as they encourage private investors seeking monopoly power. On the other hand, I believe the patent system is fundamentally flawed. First, patents have a finite life, and they also permit the holder to maintain the price over the marginal cost before death, discouraging the use of the invention. Second, the patent system is prone to strategic abuse by competing firms such as the use of strategic licensing. By protecting patent holders from rivals, the system leads to the slow diffusion of innovation.

The patent system is not the most effective system for protecting intellectual property. In the US, the leading methods for product and process innovations are secrecy, know-how, and taking advantage of lead-time. It is important to note that companies use a combination of initiatives to safeguard their intellectual property. According to Martin all three methods rank better than patents in protecting process and product innovations although in varying levels (501). Secrecy is the most efficient method for protecting process innovations e.g. Coca-Cola formula, while lead-time is considered the most effective means of protecting product innovations e.g.  iPhone. The patent system reduces the rate of diffusion of an idea into the market. Companies prefer to gain an advantage over competitors in the marketplace over owning a patent that prevents entry into the industry.

Out of the fifteen top oil producers in the world, eight are members of OPEC (Organization of the Petroleum Exporting Countries). Non-OPEC producers accounted for 60% of the total global production in 2007. The brief period of control enjoyed in the early 1980s by OPEC created the incentive for the entry on new oil producing nations. The output of oil from western countries spiked in the 70s and experienced a downward trend since. OPEC is continuously losing its dominance with the emergence of developing countries such as China in the Oil supply market. This increased output from China as LDCs will have an effect on the supply of the market, but only to satisfy the increasing demand from the west (Brock 45).

In OPEC, Saudi Arabia acts as a dominant firm with the power to restrict output. Some OPEC member nations which have limited resources, such as Nigeria and Algeria, are forced to minimize output although they are dependent on oil revenue to accelerate growth. As a result, OPEC is not an effective cartel. This is most evident when the prices are high; some countries start overproducing and selling at lower prices effectively undercutting themselves. The resulting fall in global oil prices forces the Saudi Arabia and some major suppliers to cut back. OPEC is unable to take advantage of its ability to dictate prices as a cartel.

Predatory Behavior in American Industry

The American Sugar Refining Company
The American Sugar Company used below cost pricing to drive out competition for a period of twenty years as it expanded horizontally. This allowed the company to drive out competition in the growing industry. At its peak the company controlled 72% of the total sugar market. Once it had established its position as a market leader, the sugar company began to expand vertically, making significant investments in cane farming and production of raw sugar in countries such as Cuba. The company secured its position as a near-monopoly throughout the 20th century as a result of its predatory actions (Martin 238).

The American Tobacco Company
The Old American Tobacco rose to a monopoly position in the U.S. plug tobacco by purchasing more than 43 other geographically separated competitors from across the country. The company targeted each individual business by selling a cheaper imitation of the current local seller. New companies were unable to compensate the losses accrued as a result of the lowering of the prices. New companies often have a problem raising funds especially when facing a competitor that is dominant. The high level of uncertainty creates a high risk investing in the new and smaller companies. The size of the American tobacco Company allowed it to limit its losses, forcing rivals to sell (Martin 240). By 1906, the American Tobacco company as the monopoly was able to dictate prices. The government was forced to dissolve the company following an antitrust lawsuit.

Southern Bell Telephone Company
When the South Bell Telephone Company was a major player in the telephone market, it always lowered prices on account of competitor activity in a predatory attempt. The company would significantly lower prices before the entry of a new player in the market. Additionally, the prices would remain significantly lowered upon entry of the competitor. Although Bell’s profits fell during the entry of a competitor, they were guaranteed to recoup this loss through future profits. However, the company’s predatory attempts were unsuccessful as customers often waited until the entry of a competitor to purchase services from Bell at a lower price. The telephone market was too competitive for Bell to charge monopoly prices.

Works Cited
Brock, James. The Structure Of American Industry. 13th ed. Long Grove: Waveland Press, 2016. Print.
Martin, Stephen. Industrial Organization In Context. Oxford: Oxford University Press, 2010. Print.