Question

1A) You are managing a pharmaceutical company that makes a patent-protected drug. According to your calculations, at the current level of production the marginal revenue of one unit of the drug is less than the marginal cost of producing that unit. To maximize your profit, should you increase, decrease, or maintain the current level of production? Explain your answer.

1B)Australian yogurt is a new product that is not strained and is made from whole milk, so it is creamier than regular or Greek yogurt. Suppose that you are a manager for Publix supermarkets and some colleagues suggest that the company produce a Publix-brand Australian yogurt. They explain that producing Australian yogurt is currently very profitable, and they predict this trend will continue. How do you respond to your colleagues, and why?

Answer 1

(1A) I should decrease production.

A monopolist will maximize profit (or minimize loss) by equating marginal revenue (MR) with marginal cost (MC). When MR is less than MC, there is a marginal loss which can be decreased by reducing output until MR equals MC and marginal loss equals zero.

(1B) Since the market is currently profitable and the trend is supposed to continue, each producer including Publix will earn positive economic profit. This will attract new entry which will lower the market share of each individual firm, lowering their profit until in the long run, each producer earns zero economic profit. Therefore, adding this product will increase by short-run profit but in long run, Publix will earn zero economic profit.