5) Assume the graph below represents the market demand for a patented prescription drug together with the long run marginal cost and average cost functions for producing the drug. (note: the diagram assumes that at output levels over 50 million AFC ~ 0, and MC is constant so that ATC = AVC =MC = $20)
A) Draw the marginal revenue function for this firm
B) What is the profit maximizing price for this firm?
C) On the graph show the area which represents the net loss to society resulting from the monopoly power conferred by the patent.
D) What do you predict will happen to the structure of competition and to the price in this market when the patent expires ? (Hint: use the concept of "Minimum efficient scale " of production in your answer.)
#5Graph
P/prescription
120
100
80
60
atc
40
mc
20 MC & ATC
40 80 120 160 200
To answer these questions, we need to analyze the graph and use economic concepts. Let's break down each question and explain how to find the answers:
A) Draw the marginal revenue function for this firm:
The marginal revenue (MR) function is the derivative of the total revenue (TR) function. To find the MR function, we need to observe the demand curve in the graph and consider that a monopoly firm faces the entire market demand. The MR curve will have the same intercept as the demand curve but with a steeper slope. You can find the MR function by sketching a line parallel to the demand curve but with double the slope. The graph should show the MR curve intersecting the y-axis at the same point as the demand curve.
B) What is the profit-maximizing price for this firm?
To find the profit-maximizing price, we need to identify the output level at which marginal revenue equals marginal cost (MC). In the graph, given that MC is constant, we can assume that MR also equals MC and is constant at $20. Therefore, the profit-maximizing price for this firm is $20.
C) On the graph, show the area which represents the net loss to society resulting from the monopoly power conferred by the patent.
To show the net loss to society resulting from the monopoly power, we need to compare the potential social welfare under perfect competition with the monopoly. In perfect competition, price equals marginal cost (MC), and the socially optimal output level is determined by the demand curve. On the graph, draw a rectangle between the demand curve and the MC curve from the quantity produced under the monopoly to the quantity at the socially optimal level. The area of this rectangle represents the net loss to society.
D) What do you predict will happen to the structure of competition and the price in this market when the patent expires? (Hint: use the concept of "Minimum efficient scale" of production in your answer.)
When the patent expires, the market will no longer be a monopoly. New firms will enter the market, leading to increased competition. The concept of "Minimum efficient scale" refers to the lowest level of output at which the average total cost (ATC) is minimized. In the graph, the ATC curve intersects the demand curve at a quantity higher than the monopoly level. This indicates that the monopoly is producing below the minimum efficient scale. As new firms enter the market, competition will increase, and the market price will decrease towards the minimum efficient scale level.