Reference no: EM132542184

1. Let's investigate the effect of industries with long run durable goods. (I'm going to make up numbers to make the calculations straightforward, but it is worth remembering that this dynamic is at play in any industry with large fixed costs that are sunk.) A piece of high speed packaging equipment that is used to packaged bottles of pharmaceuticals costs $10 million. Lederle Labs buys the piece of equipment for cash. Let's assume further that the machine will last forever (this is not literally true, but when I worked at Lederle we had some equipment that was over 50 years old). Now assume that due to a redesign an equipment manufacturer has found a way to produce the packaging equipment for only $8 million.

a. TFU and explain: Lederle, and other firms that use the old piece of equipment, will stop using the old piece of equipment and buy the new piece of equipment.

b. If Lederle decides it no longer wants to package pharmaceuticals (it is primarily a research and pharmaceutical manufacturer; it can outsource the packaging), how much will it be able to sell the old packaging equipment for?

c. There exist pharmaceutical packaging specialist firms. Some of these firms borrowed the funds to buy the old packaging equipment. As new entrants to the market adopt the cheaper packaging equipment the old firms can no longer compete because the entrants are able to charge lower prices. Some of these firms are forced out of business, and sell off their old equipment. How does this dynamic of bankruptcy and liquidation affect the profits of the firms that bought the cheaper packaging equipment? Please explain.

d. Please explain the similarity between this example and the airline industry over the last 20 years as many firms were forced into bankruptcy (especially with regard to the durable airplanes).