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Question 4

a In most of the developed countries, when a pharmaceutical firm develops a new drug, the patent laws give the firm a monopoly on the sale of the drug for a period of time (e.g. 10 to 15 years). Though a monopoly is generally inefficient, why does the government grant the firm a patent on its new drug?

b When the patent runs out after about 20 years, what will happen to the price of the drug? Briefly explain your answer.

c Most pharmaceutical firms are facing decreasing average costs and are always accused of creating deadweight loss because they charge prices higher than marginal cost. Is it feasible for governments to regulate these firms by asking them to charge prices equal to marginal cost (i.e. marginal-cost pricing)?

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Raushan Raj
Raushan RajLv8
28 Sep 2019

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Question 6 (21 marks)

a.) Tamiflu, produced by Roche, has so far been the most effective medicine to tackle bird flu. Roche was granted a patent on the drug which enables the pharmaceutical firm to charge higher prices and earn higher profits. The government knows that the patent harms the benefits of consumers, so why is it still willing to grant such a patent to the firm? (5 marks)

b.) Monopoly is inefficient as it charges prices higher than marginal costs. Is it feasible for the government to regulate a natural monopoly by setting prices equal to marginal costs? (8 marks)

c.) Roche plans to sell Tamiflu at higher prices in Europe and North America and lower prices in developing countries. Why does Roche adopt this pricing strategy? (5 marks)

d.) Under what condition can Roche successfully implement the pricing strategy mentioned in (c)? (3 marks)

Enrodes is a monopoly provider of residential electricity in a region of northern Michigan. Total demand by its 3 million households is given by Q=11 - P so that marginal revenue is MR=11 - 2Q. The total cost of Enrodes is given as C=16 +Q so that marginal cost is $1 per megawatt-hour. Consumers in this region of Michigan have recently complained that Enrodes is charging too much for its services. In fact, few consumers are so upset that they are trying to form a coalition to lobby the local government to regulate the price Enrodes charges.

If consumers are successful in their lobbying efforts and regulation is placed on Enrodes, calculate the price, output and profit of Enrodes under the following circumstances. Show your calculations in each case.

A. Regulator institutes average-cost pricing.

B. Regulator institutes marginal-cost pricing.

C. 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 ($0.50 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 $1.7 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. Based on this information, what can you do to boost profits? Explain with proper calculations.

1) Assume that two firms (Firm A and Firm B) operate in the U.S. steel industry. The owner of Firm A writes the following letter to the owner of Firm B:

Dear Owner of Firm B,

I have concluded that if we both restrict output such that we each produce only 3 million tons of steel per year, we can both charge a price that will allow us to effectively monopolize the steel market and to maximize our joint profits. If you would like to enter into this agreement with me, please draft a contract that specifies this agreement and I will be more than willing to meet with you and sign it.

Sincerely,

Owner of Firm A

If this letter were sent in the year 1944, the:

a) Owners of both Firm A and Firm B would not be guilty of violating antitrust laws because antitrust laws in 1944 contained exceptions for certain nationally important industries like the steel industry.

b) Owners of both Firm A and Firm B would not be guilty of anything because there were no antitrust laws in existence in 1944.

c) Owner of Firm A would be guilty of violating antitrust laws only if she met with the owner of Firm B and signed the contract, but she would not be guilty if the attempt to monopolize the market failed because the owner of Firm B never responded to the letter.

d) Owner of Firm A would be guilty of violating antitrust laws because she merely attempted to monopolize the steel industry.

e) Owners of both Firm A and Firm B would not be guilty of violating antitrust laws because antitrust laws in 1944 applied only to industries made up of three or more firms.

Ā 

2) Entry of new firms will continue in a monopolistically competitive industry until:

a) Marginal cost = 0 (zero).

b) Economic profit is negative.

c) Marginal revenue = marginal cost.

d) Economic profit equals zero.

e) Marginal Revenue = 0 (zero).

Ā 

3) A monopolistically competitive firm usually charges less than a monopoly firm because:

a) It is part of a group of firms that have formally agreed to control the price and the output of a product.

b) Its primary goal is to reap monopoly profits by replacing competition with cooperation.

c) It has a monopoly, but potential entrants exist in the form of contestable markets.

d) It faces some degree of competition due to low barriers to entry.

e) Producing homogenous output is more expensive than producing differentiated output.

Ā 

4) An example of price discrimination is when:

a) A single box of Froot Loops costs $3.50, but when purchased in a case of six, it costs only $3.00 per box.

b) You can purchase a new PC for half the price of a new Mac, even though they are both computers.

c) Procter & Gamble charges $9 for a bottle of Tide laundry detergent, while the store brand costs the consumer significantly less, despite being somewhat similar products.

d) Out-of-state students pay more for the same education as in-state students.

e)Movie theaters do not allow children into R-rated movies without a parent or guardian.

Ā 

5) The Varsity, located in downtown Atlanta, is the world's largest drive-in restaurant. Located near the Georgia Tech campus, the drive-in attracts two distinct types of customers: college students and visitors to Atlanta. The owners are considering offering a student discount of $1 off their combo meal, which is regularly priced at $9. There are 5,000 students interested in purchasing a combo meal, with a maximum willingness to pay of $8. There are 5,000 visiting customers interested in purchasing the combo meal, with a maximum willingness to pay of $9. Assume that each customer, at most, will purchase a single meal and the marginal cost is $5. What will be the amount of total revenue for the Varsity if the owners offer a single price of $8 per combo meal?

a) $65,000

b) $85,000

c) $40,000

d) $80,000

e) $90,000

Ā 

6) A competitive firm would have:

a) More elastic demand than a monopolistically competitive firm.

b) More inelastic demand than a monopolistically competitive firm.

c) A horizontal demand curve.

d) Bowed-in or bowed-out demand.

e) An upward-sloping demand curve.

Ā 

7) It is unrealistic to regulate a natural monopoly at marginal cost pricing because:

a) The government is not allowed to regulate markets.

b) With this type of regulation, the firm will want to shut down, and that outcome is not desirable for society.

c) Firms do not need to follow regulations from the government.

d) Regulating a market causes more deadweight loss.

e) Marginal cost pricing ends up having the natural monopoly firm earn zero economic profits.

Ā 

8) Price discrimination allows businesses to make additional profits and allows markets to work more:

a) Efficiently

b) Unfairly

c) Realistically

d) Equitably

e) Independently

Ā 

9) Antitrust laws are designed to:

a) Increase prices.

b) Promote monopoly practices.

c) Promote awareness of government programs.

d) Promote competition.

e) Decrease output.

Ā 

10) Barriers to entry:

a) Do not exist for monopolies.

b) Exist for perfectly competitive firms.

c) Restrict the entry of new firms into the market.

d) Always lead to profits.

e) Measure the ability of firms to set the price for a good.

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