Question

A pharmaceutical company acquired a 10 year drug patent, making the company a monopolist in the corresponding market for this period. Suppose the marginal cost of producing the drug is zero and the demand curve has a downward slope and a positive intercept.

(a) Plot the demand, marginal revenue and the marginal cost curves and show the quantity produced by the monopolist.

(b) Suppose after the patent runs out, new firms enter the market for this particular drug and the new market outcome is the same as under perfect competition. Show on the graph the new quantity produced.

(c) What is the change in consumer surplus when moving from the monopoly setting in (1) to the perfect competition setting in (2)? What is the change in producer surplus? Can the increase in consumer surplus when moving from monopoly to perfect competition compensate the corresponding decrease in the producer surplus?

Answer 1

a) In the diagram below, we have shown the demand curves and marginal revenue curve for the monopolist. Here, demand curve is downward sloping with horizontal and vertical intercepts of Q and P respectively whereas, MR curve has horizontal and vertical intercepts of Q/2 and P respectively. Now, as Marginal cost is zero, marginal revenue is equal to marginal cost at equilibrium quantity of Q/2. Equilibrium price for the monopolist is P. We have also shown the consumer and producer surplus for the monopolist.

Price Consumar surplus Producer surplus Demand Quantity al2 MR

b) In the diagram below, we have shown equilibrium for the firm in a perfectly competitive market. Now, equilibrium in a perfectly competitive market is attained at the point where P=MC=0. Thus, equilibrium price is 0 and equilibrium quantity is Q. Consumer surplus is the entire area below the demand curve above the X-axis whereas, producer surplus is zero.

Price Consumel Surplus Demand Marginal revenue Quantity Q/2

c) Consumer surplus increases while producer surplus decreases to zero when the firm moves from monopoly to perfect competition. As profit falls to zero while moving from monopoly to perfect competition it is not beneficial for the economy.