Giving inventors of new technology patent rights will often give them monopolistic power and make them price makers. Explain how economic theory can justify this government policy.
New technology is associated with the problem of positive production externality. If the allocation of resources to develop new technology is left to the market, there will be a problem of misallocation. Giving inventors of new technology patent rights could help improve efficiency.
In developing a new technology, the developer has to pay for the cost of production. While consumers understand their benefit obtained from using the newly developed products and are willing to pay for it to compensate developers' costs of production, they will not be willing to pay for new technology's external benefit to the third party. For example, when a new model of a personal computer is developed, though consumers are willing to pay for the convenience provided by the new products, which compensates the developers' cost spending, consumers won't be willing to pay for the reduction of cost as a result of the new product making the economy more productive as a whole. This benefit spreads to people who aren't users of this new model of a personal computer, the party, since their life will benefit from the improvement of productivity in the labor force. However, since when paying for goods and services, consumers won't consider this type of benefit, their willingness to pay will not be high enough to capture the entire benefit of the reduction in cost.
Using marginal analysis, one can see that market equilibrium achieved via the mechanism is where marginal cost is equal to marginal benefit. However, the socially optimal output, where marginal cost is equal to marginal benefit, is then market equilibrium output, since the marginal social cost curve is then the marginal private cost curve as a result of the new technology's development.
When the government gives patent rights to developers of new technology, this barrier protects the firms from free-riding competitors and helps them earn more profit as a result of their innovation. This incentivizes firms to allocate more to new technology's development and improves efficiency.