Against Intellectual Monopoly

shoes, they always command a positive price.
    Nowhere is limited capacity more important than in a nascent industry.
The first entrants earn large rents, over and above the opportunity cost of capital, for quite a while, until enough productive capacity is built up to
push prices down toward marginal cost. The presence of large initial rents
are the carrots for which innovators innovate, while the threat and arrival of
imitators is the stick that forces capacity to grow until the rents are almost
completely dissipated. The newcomers not only will try to replicate the
leader, but also will probably try to go one better than her by cutting costs
or improving the product, or both; and she will do the same to inhibit their
arrival and keep her rents from falling. This is what, in everyday language,
we call economic competition. It is this competitive process that rapidly
improves new products and makes them cheaper, which makes all of us
better off in the meanwhile.

    Eventually the competitive process increases capacity and reduces competitive rents, but not to zero. This is true in both the shoe and the idea
industries. To the extent that even the last entrant must build a costly plant,
she will have to earn some rents on the price of shoes, to pay for the cost
of the plant. Similarly for the imitator who is trying to compete with an
innovator: as long as imitating an idea and learning how to make copies of it
involves some fixed cost, a positive distance will remain between the market
price and the marginal cost of reproduction. Hence, rents will be earned for
a long while, and the rents earned by the innovator are commonly much
larger than those earned by his imitators: the market shares of Aspirin,
Coca-Cola, and Tide are still very large indeed.
    An observation for the technically inclined reader. Nothing depends
upon the fact that, in the previous graph, the MC line is a straight horizontal
line, representing what economists call constant marginal cost. Imagine
that, for given capacity, marginal cost was increasing, which means that
the MC line would slope upward. Everything we said is still true, and the
competitive rents are still there, as long as the dotted vertical line crosses
the sloped line of demand before the MC curve does. What matters is that
total installed capacity is not too large with respect to the size of the market,
that is, demand. In the next section, "Indivisibility" we look at the case
in which this does not happen and the initial productive capacity is too
large.
    When the innovation is particularly good and making copies particularly
easy, many people will imitate the innovator. We have seen this happen
over and again in new industries: too many people enter and too rapidly,
too much capacity is built, and some firms, usually the least efficient, earn
negative rents, which in the real world are called losses, and exit. Economists
call this stage in the development of an industry the shakeout. Shakeouts happen in the market for shoes and in that for lollipops, so we expect them
to happen in a competitive market for copies of ideas as well. You may
recall when the last shakeout in a competitive market for ideas took place -
it was the dot-com bust of 2000-1. Using the Internet to do business, from
selling airline tickets to managing your financial portfolio, was a great,
innovative idea that someone, perhaps Al Gore, had. Fortunately for us all,
it was not yet patentable, and once the first dot-com business was created,
other entrepreneurs started to make copies of this idea, and other dot-com
companies were created. This was the boom to which the bust followed, and
then the more stable but still fast growth we have witnessed during the past
years. We would have not had an efficient dot-com sector without a boom
and the following shakeout, and we would not have had either if intellectual
monopoly had its way there.

    Although entrepreneurs whose inefficient firms are forced to exit do not
like to hear this, shakeouts are good and socially valuable events. It is a
pity that all those ill conceived and inefficient companies are forced to shut
down, but competition is not a gala dinner,6 and getting rid of inefficient
firms while allowing efficient ones to blossom is exactly what competition is
supposed to accomplish. We all agree that this is good for the shoe industry.
It is good also for the idea industry. We may have forgotten, but it was