Question

. You are the manager of a small pharmaceutical company, Advent Pharmaceuticals, Inc. that received a patent on a new drug four years ago. Despite strong sales ($200 million last year) and a low marginal cost of producing the product ($0.50 per pill), your company has yet to show profit from selling the drug. This is, in part, due to the high upfront costs of about $2 billion of developing (R&D) and obtaining FDA approval. As an economist working for Advent, you have estimated that, at current price of $2.0 per pill, the price elasticity of demand for the drug is -2.0.

a. Does the company have a monopoly power on this particular drug? How can we measure the degree of monopoly power? Explain.

b. Based on this information, what can you do to boost profits? Explain.

Answer 1

a. The degree of monopoly power is measured by 1/|ed| which is the Lerner index. Here we have 1/2 = 0.5. This figure indicates that the firm has sufficient market power. A value close to 1 implies absolute market power while a value close to 0 shows no market power.

b. Note that the profit maximizing price should satisfy the rule

P = MC * (Ed / Ed + 1)

2 = 0.50*(-2/-2 + 1)

2 = 1

Since current price is 2 while the profit maximizing price should be 1, the company should decrease its price to 1. This will increase its profits.