So, in the previous video, we've looked at the value of an innovation for a firm coming out of a competitive market. And the way we did that, is we looked at the profits of the firm within the competitive market, and then after the innovation. So, how much is a firm willing to pay for an innovation that puts it out of a competitive situation? And we're now going to do the same thing in this video for monopolists. So, we'll take exactly the same setting of 100 consumers of which 60 have a high willingness to pay, 40 have a low willingness to pay. We take the same production technology of 300 Euros, that's the existing one. And the process innovation that's on offer, if you wish, is one that lowers your production cost from 300 to 200 Euros. And again, the monopolist will have to figure out how much they're willing to spend for this innovation? A monopolist represents a single firm producing, and selling motorcycles. There is no threat of entry by competitors. So we're going to relax that in the coming video, but for now, we'll just assume that there is no potential entrant that could come, and take the place of the monopolist. What are the profits of the monopolist without innovation? Again, we're facing production costs of 300 Euros. And we can basically set one of two prices. Either 500 Euros and sell to the high-value consumers, or 400 Euros and sell to all consumers. So, with 500 Euros, we get 60 consumers that buy the motorbike, and we get profits of 60, that's the number of consumers, times 500, that's the sales price minus 300, that's the production cost, which is going to be 60 times 200 equal to 12,000, right? So, if we set a price of 500 Euros our profits are going to be 12,000. But if we set a price of 400 Euros? Well, in that case, we're going to sell to everyone. And again, we can derive our profits, that's going to be 100 times 400, our sales price, minus 300, our production costs. So, of course, the profit margin has gone down, but the quantity has gone up. So, we have 100 times 100, which is 10,000. So just from comparing those two, we'll find that the best strategy that the monopolist can do that, that he can choose, without innovation is to set a price of 500 Euros. So, what now are the profits of the monopolist, if he acquires the innovation? Again, this is going to reduce production costs from 300 to 200 Euros. And again, we're looking at the two prices, 500 and 400 Euros. With 500 Euros, we're going to sell to 60 consumers, and we can derive what the profits are. Profits are going to be 60 times 500 Euros minus 200 Euros, because our profit margin has gone up. That's going to be 60 times 300 or 18,000. If we set a price of 400 Euros, again we're going to sell to everyone. And we're going to make profits of 100 times 400 Euros minus 200, which is going to come to 100 times 200 or 20,000. So if you look at those two, again we'll find that now something's changed, because the monopolist is now better off actually charging the low price rather than the high price. And he's therefore, also going to sell to 100 consumers instead of only 60 as he did with the higher production cost. And again, we can find out what the value of innovation is, by simply comparing profits before and profits after the innovation. So, with innovation, our profits are going to be 20,000. Without innovation, our profits are going to be 12,000, so therefore, the overall value of the innovation is going to be 20 minus 12, is going to be 8,000 Euros. So, we now figured out the value of innovation both for the competitive firm in the previous video, and the firm in the monopolistic setting in this video. So if we compare the two, we will find out that in a competitive market the difference between innovating and not innovating was 9,900 Euros. In a monopolistic setting, the difference is 8,000 Euros. And remember, the overall profits from being a monopolist, were 20,000. So it's not about the overall level of profit, but it's about the difference between with the innovation and without the innovation. So, therefore, we can derive what we think of what we can call the replacement effect. So, the replacement effect shows that, for a given market structure, a monopolist has less of an incentive to innovate, because he has a higher level of pre-innovation profits. So, simply comparing those two, we'll find that in a competitive market the value of innovating is actually higher than for a monopolist. And as we'll see in the next video, this is going to depend very much on the fact that the monopolist, in our setting here, if he doesn't innovate he's just going to remain a monopolist, but he's going to remain with a high production cost. And in the next video, we'll look at the similar setting, but now there's a threat of entry. So, stay tuned and we'll see how we can wrap this topic up. Thanks.
