Mirk Labs is a British pharmaceutical company that currently enjoys a patent monopoly in Europe, Canada, and the United States on Zatab (pronounced zay-tab), an allergy medication. The global demand for Zatab is:
Qd=15.0-0.2P
Where Qd is annual quantity demanded (in millions of units) of Zatab, and P is the wholesale price of Zatab per unit. A decade ago, Mirk Labs incurred $60 million in research and development costs for Zatab. Current production costs for Zatab are constant and equal to $5 per unit.
a. What wholesale price will Mirk Labs set? How much Zatab will it produce and sell annually? How much annual profit does the firm make on Zatab?
b. The patent on Zatab expires next month, and dozens of pharmaceutical firms are prepared to enter the market with identical generic versions of Zatab. What price and quantity will result once the patent expires and competition emerges in this market? How much consumer surplus annually will allergy sufferers who take Zatab gain?
c. Calculate the annual dadweight loss to society due to the drug firm's market power in Zatab. What exactly does this deadweight loss represent?
d. Given your answer to part c, would it be helpful to society for competition authorities in Europe, Canada, and the United States to limit entry of generic drugs to just five years for new drugs? Why or why not?
Take a shot. What do you think?
Hint for a: find Q where MC=MR.
for b: find Q where MC=demand.
I'm sorry, I just don't understand this at all. I don't know what to plug in in this problem. It would have to be the $60 million and $5 per unit, correct? I just don't know where. This is the only problem in the chapter we were assigned and there are no examples like it in the text. You are kind to help me, but I don't know what to plug in. Thank you for helping. :)
a. To determine the wholesale price that Mirk Labs will set, we need to find the equilibrium price at which the quantity demanded equals the quantity supplied. In this case, the quantity supplied is equal to the annual production and sale of Zatab by Mirk Labs.
Given the demand function:
Qd = 15.0 - 0.2P
To find the equilibrium price, we set the quantity demanded equal to the quantity supplied:
Qd = Qs
15.0 - 0.2P = Qs
We know that production costs for Zatab are $5 per unit, so we can determine the quantity supplied as follows:
Qs = (Total Production - Costs) / Price per unit
Qs = (Total Production - $60 million) / $5
Now, substitute Qs back into the equilibrium equation:
15.0 - 0.2P = (Total Production - $60 million) / $5
Simplify and solve for P:
15.0 - 0.2P = (Total Production - $60 million) / $5
0.2P = 15.0 - (Total Production - $60 million) / $5
P = (15.0 - (Total Production - $60 million) / $5) / 0.2
With the given information, you can calculate the wholesale price Mirk Labs will set.
To find the quantity Mirk Labs will produce and sell annually, substitute this price value into the demand equation:
Qd = 15.0 - 0.2P
To determine annual profit, subtract the total production costs from the total revenue, which can be calculated by multiplying the wholesale price by the quantity sold.
b. Once the patent on Zatab expires, competition will emerge in the market. In a competitive market, price is determined by the forces of supply and demand. At the new equilibrium, the quantity supplied will equal the quantity demanded.
To find the new equilibrium price and quantity, use the same demand function:
Qd = 15.0 - 0.2P
Now, we consider the supply function to be perfectly elastic because numerous pharmaceutical firms are prepared to enter the market with identical generic versions of Zatab. Therefore, the supply function can be represented as:
Qs = Qd
Solve for price and quantity by substituting the demand function into the supply function:
15.0 - 0.2P = Qs
Now, substitute Qs back into the equilibrium equation:
15.0 - 0.2P = Qs
With the given information, you can calculate the new wholesale price and quantity after competition emerges.
To find the consumer surplus, subtract the total expenditure (price multiplied by quantity) after competition from the total expenditure before competition.
c. Deadweight loss represents the net loss of economic efficiency due to distortions in the market caused by a natural monopoly or market power. In this case, the deadweight loss is the efficiency loss resulting from Mirk Labs' patent monopoly. It represents the value of mutually beneficial transactions that do not occur due to the lack of competition and the resulting higher price for Zatab.
To calculate the annual deadweight loss, we need to determine the difference between the consumer surplus under monopoly (before competition) and the consumer surplus under perfect competition (after competition).
d. Whether it would be helpful for competition authorities to limit entry of generic drugs to just five years for new drugs depends on various factors. One factor to consider is the balance between incentivizing innovation and promoting competition for the benefit of consumers.
Limiting generic drug entry to five years might encourage pharmaceutical companies to invest in research and development (R&D) to create new drugs and recoup their investment through monopolistic pricing. This could lead to more innovation and the development of new drugs.
However, it could also prolong the monopolistic market power of pharmaceutical companies, leading to higher prices and restricted access to drugs for consumers. This may result in higher healthcare costs and limited affordability for patients.
Ultimately, the decision should be based on a thorough analysis of the specific market dynamics, economic considerations, and the overall goal of promoting both innovation and consumer welfare.