Question

You are the manager of a small pharmaceutical company that received a patent on a new drug three years ago. Despite strong sales ($150 million last year) and a low marginal cost of producing the product ($0.55 per pill), your company has yet to show a profit from selling the drug. This is, in part, due to the fact that the company spent $1.6 billion developing the drug and obtaining FDA approval. An economist has estimated that, at the current price of $1.50 per pill, the own price elasticity of demand for the drug is -2.5.

Based on this information, what can you do to boost profits?

• Raise price.

• Reduce price.

• Keep price the same.

Answer 1

The own price elasticity of demand for drug is given by:

E = -2.5

The marginal cost faced by the firm to produce per pill is given by:

MC = $0.55

The current price charged by the firm per pill is given by:

P = $1.50

Since, the case is of the firm that has the patent on the new drug, the firm is a monopoly firm.

The marginal revenue of the monopoly firm is given by:

MR = P * [(1+E) / E]

= $1.50 * [(1 + (-2.5)) / (-2.5)]

= $0.90

Since, the MR = $0.90 per pill and MC = $0.55 per pill, MR > MC

This implies that in order to boost profit the firm shall reduce price such that the monopoly firm eventually attains the profit-maximizing condition MR = MC