Reference no: EM13153240
A pharmaceutical company has a patent on a lung cancer treatment drug that gives them a monopoly over the production of the drug until the patent expires. The annual demand for the drug is given by the following demand function:
Demand: QD = 15 - 0.2P
Note: P = per unit price of the drug; QD = quantity demanded of the drug (in millions of units).
The research and development costs of the drug amounted to $60 million. The firm amortizes the fixed cost over 10 years on a straight line basis (i.e., $6 million per year).
The cost to the firm of producing an additional unit of the drug is $5, and this cost is constant across all units of the drug.
(a) What price will the firm set for the drug and how much will it produce per year? What is the firm's profit per year?
(b) Suppose that the patent expires and that many pharmaceutical companies enter the market with generic versions of the drug. What price and quantity will result when the market becomes perfectly competitive? Assume that the per unit cost of production does not change.
(c) Calculate the deadweight loss (i.e., the welfare loss) associated with this market being monopolistic. (Math reminder and hint: the area of a triangle is equal to 1/2 x base x height).
(d) Calculate the difference in consumer surplus under perfect competition compared to monopoly.