The Case of J&J and Changes to Drug Pricing of Treatment for TB
The world's largest pharmaceutical market is the US. But there is social contention about the monopoly pricing strategies of big drug firms, e.g. see

Consider the firm Johnson & Johnson (J&J) and the production of the drug bedaquiline to treat tuberculosis (TB), and its recent decision to cut the price of bedaquiline from $46 to $8 per month, as discussed in the following freely available articles:
For this task, you will be required to illustrate and explain to a typical first-year undergrad student who has no economics background what has happened to profit (producer surplus), markup, consumer surplus and the output as a result of the price reduction.

▪ You will hand draw one (1) diagram with an isoprofit curve, which is an adaptation of Figure 7.9d from the CORE ESPP text. An adaptation means that you modify the main diagram from the text to suit the case study at hand, for the drug to fight TB. Assume unit costs of production of this drug are a constant $5 per month.

▪ Youareonlyrequiredtodrawoneisoprofitcurvewiththeprofit-maximisingpriceof$46.Beaccuratewhen you draw your isoprofit curve, but there is no need to calculate with precision all the points on the isoprofit curve. Calculate and show workings of what the iso-profit would be for any price greater than $10 but less
than $40 (pick any one price but stick to an integer).

▪ Fortheincrementalquantitiesofdrugproductiononthex-axis,usehypotheticalvalues(roughguessesfrom
your imagination). Also use your intuition for making up other prices/costs of the drug on the y-axis and
make up a demand (straight-line) 'curve'.

▪Calculateandshowworkingsforthechangeinproducersurplusandmarkup,butyouonlyneedtoshadein
the change in consumer surplus.

Williams Inc. produces a single product, a part used in themanufacture of automobile transmissions. Known for its quality andperformance, the part is sold to luxury auto manufacturers aroundthe world. Because this is a quality product, Williams has someflexibility in pricing the part. The firm calculates the priceusing a variety of pricing methods and then chooses the final pricebased on that information and other strategic information. Asummary of the key cost information follows. Williams expects tomanufacture and sell 50,000 parts in the coming year. While thedemand for Williams's part has been growing in the past two years,management is not only aware of the cyclical nature of theautomobile industry but also concerned about market share andprofits during the industry’s next downturn.

Cost-Based Pricing

Companies use various strategies to set price. Since cost is animportant determinant of supply and is known to the producer, manycompanies base price on cost. Still other companies use atarget-costing strategy, or strategies based on the initialconditions in the market.

A cost-based pricing approach starts with product cost and thendesired profit is added. Usually, there is some cost base and amarkup. The markup is a percentage applied to base cost; itincludes desired profit and any costs not included in the basecost. Companies that bid for jobs routinely base bid price oncost.

Example: Linder Company makes and sells vitaminsupplements. The following information from last year's accountingrecords showed:

The markup percentage must include all costs that are not a partof cost of goods sold plus the desired profit. For Linder Company,the markup on COGS is found as follows:

Now, if Linder Company produces a new product with manufacturingcost of $2 per unit, the unit price at this markup is:

A Company does not have to use Cost of Goods Sold as the basisof the markup. For example, a job-order firm might decide to usethe markup on prime costs (direct materials and direct labor) tocost jobs. Suppose that Carl's Custom Cabinetry wants to price jobsbased on prime costs plus a markup on prime cost. Last year'sincome statement revealed the following information:

Carl is pricing a new job with estimated direct materials of$4,300 and direct labor of $1,800. The estimated price is:

Neither Linder Company nor Carl's Custom Cabinets must use theprice figured according to the markup. This is just a firstapproximation. Carl, for example, may want to set a lower price inhopes of getting more business from this particular customer.Linder Company may want to charge a higher price based on marketconsiderations.

Target Costing

Another approach to pricing a product or service is targetcosting. The target cost is based on the price (target price) thatcustomers are willing to pay. The Marketing Department determineswhat characteristics and price for a product are most acceptable toconsumers. Then, it is the job of the company's engineers to designand develop the product such that cost and profit can be covered bythat price. Japanese firms have been doing this for years; Americancompanies are beginning to use target costing. So first the targetprice is set. Then the desired profit is deducted, and theremaining amount is the target cost.

Determining the target cost is relatively easy. Actuallydesigning and manufacturing a product that will achieve the targetcost and sell for the target price is more difficult. As a result,target costing is an iterative process as the firm works to refinethe proposed product to meet the cost and price targets.

Price Discrimination

Price discrimination refers to the charging of different pricesto different customers for essentially the same product. TheRobinson-Patman Act was passed in 1936 as a means of outlawingprice discrimination by manufacturers or suppliers; services andintangibles are not included under the act.

The Robinson-Patman Act does allow price discrimination undercertain specified conditions: (1) if the competitive situationdemands it and (2) if costs (including costs of manufacture, sale,or delivery) can justify the lower price. According to the secondcondition, a lower price offered to one customer must be justifiedby identifiable cost savings and the amount of the discount must beat least equaled by the amount of cost saved.

To compute a cost differential, the company creates classes ofcustomers based on the average costs of selling to those customers.Then all customers in each group are charged a cost-justifiableprice.

Example: Raul Company manufactures specializedelastic bandages used to reinforce athletes' wrists or ankles. Raulsells to a number of individual physical therapists and athletictrainers as well as to Medallion Gym, a national chain of physicalfitness facilities. The average manufacturing cost is $169 per case(a case contains 100 plastic-wrapped elastic bandages). RaulCompany sold 350,000 cases last year to the following two classesof customer.

Medallion Gym requires that the bandages be individuallypackaged in boxes with the Medallion name on the label. This boxand special labelling costs $0.34 per unit. Raul also pays allshipping costs, which amounted to $1,400,000 last year.

The individual trainers and physical therapists order in smalllots that require special picking and packing in the factory; thespecial handling adds $20 to the cost of each case sold. Salescommissions to the independent jobbers who sell Raul products tothe trainers and physical therapists average 10 percent of sales.Bad debts expense amounts to 1 percent of sales.

The cost per case for each customer category can be computed asfollows:

Profit and profit percentages are as follows:

The company will need to see if the profit percentages range areclose to one another; if so, there would be a cost justificationfor the price differential. If not, the company may need toconsider potential price discrimination and change its price forthe customer group that it considers to be "out of line."

For each of the following situations, determine whether or notthere is price discrimination according to the Robinson-PatmanAct.