Essay #2:Mirk Labs is a pharmaceutical company that currently enjoys a patent monopoly in Europe, Canada, and the United States on Zatab, an allergy medication. The global demand for Zatab is: Qd = 15.0 – 0.2P where Qd is annual quantity demanded (in millions of units) of Zatab, and P is the wholesale price of Zatab per unit. A decade ago, Mirk Labs incurred $60 million in research and development costs for Zatab. Current production costs for Zatab are constant and equal to $5 per unit. (a) What wholesale price will Mirk Labs set? How much Zatab will it produce and sell annually? How much annual profit does the firm make on Zatab? (b) The patent on Zatab expires next month, and dozens of pharmaceutical firms are prepared to enter the market with identical generic versions of Zatab. What price and quantity will result once the patent expires and competition emerges in this market?

(a-1, 2).What wholesale price will Mirk Labs set? How much Zatab will it produce and sell annually?

The global demand for Zatab is Qd = 15.0 – 0.2P. The total cost (in this case) is constant and equal to $5 per unit, thus C = 5Q. A firm in a market to maximize profits would set Price and Quantity where MR = MC (Marginal Revenue = Marginal Cost). Need to find MC and MR using the information provided. Also, add to the cost function, cost incurred which is the $60 million in R&D (research and development). So, total cost = $60M + 5Q. Within the cost function, find MC. The formula for MC is MC = ΔTC (how much change in total cost when quantity changes). ΔQ

So, if Q = 1, TC = $60M + 5(1) = $60M + 5. If Q = 2, TC = $60M + 5(2) = $60M + 10. Q changed in 1, because 2 – 1= 1. TC changed in 5, because $60M + 10 - $60M + 5 = 5. MC would then be 5/1 which is 5. MC = 5.

Next, find MR (marginal revenue). To find MR, TR (total revenue) must be determined. Formula for TR is TR = P x Q; however, P (price) has to be determined. Use the Q function and solve for P. P = 15.0 – Q/0.2. Replace the value P and then multiply by Q.

TR =

TR =

TR =

Find Marginal Revenue (MR). MR = . There are 2 functions for total revenue, so they will need to be split to find the change. First expression, if Q = 1, so TR = 75.0 (1) = 75.0, and Q = 2, so TR = 75.0 (2) = 150. TR changed in 75.0. Second expression, if Q = 2, TR = 2*5 = 10Q.

MR = 75.0 – 10Q. MC is still 5. To find optional Price and Quantity, MR = MC, thus 75.0 – 10Q = 5. Solve for Q. 75.0 – 10Q = 5 (subtract from both sides of equation); 70 – 10Q = 0 (subtract 10 from both sides of equation); 70 = 10Q; ; 7 = Q. Zatab will produce and sell 7 million units annually.

To find price that Mirk Labs will set as a monopoly: Replace Q = 7 on the P function;

P = 15.0 – Q= ;15.0 – 7 = 40. Mirk Labs as monopoly will set price at $40 per unit.

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(a-3).How much annual profit does the firm make on Zatab?

Use the Profits formula: Profits = Total Revenue (TR) – Total Cost (TC). Recall that TR = P x Q and TC = $60M + 5Q. Replace the values of P and Q.

P x Q – (60M + 5Q)

= $40 x 7M – $60M – 5 (7M)

= $280M – $60M – $35M

= $185M

Annual profit for Zatab would be $185 million.

(b-1).The patent on Zatab expires next month, and dozens of pharmaceutical firms are prepared to enter the market with identical generic versions of Zatab. What price and quantity will result once the patent expires and competition emerges in this market?

Patent is no longer a monopoly once competition enters the market (i.e., competitive market). Recall that firms will always produce where MR = MC. Q = 7 million. To find price, replace

Q = 7 on MR function; MR = 75.0 – 10Q

75.0 – 10(7)

= 75.0 – 70

= 5

In a competitive market, the price will result in $5 per unit and they will produce 7 million of units. Thus, the price is lower than it was when they held a monopoly on the patent.