Reference no: EM132518385

BUSHMAN Ltd operates in an imperfectly competitive industry. It's the only producer of several herbs and supplements that are very effective for treating symptoms of flu. Its unique products gave it a competitive advantage because there were no close substitutes available in the market at that time. For over a decade, BUSHMAN Ltd was able to earn supernormal profits but its earnings and market share has declined drastically because it can no longer collect royalty income from some of its patented products.

The expiration of some of BUSHMAN Ltd patents gave new firms the opportunity to enter the market. The first firm to enter the market was IRIE enterprise, a low-cost producer of generic drugs. For the next decade BUSHMAN Ltd and IRIE enterprise dominated the entire national market. During this time, price wars were common between BUSHMAN Ltd and its new rival and experts warned that if this practice continued BUSHMAN Ltd could possibly be driven out of the market. However, some economists disagreed and reasoned that price rivalry was better for consumers as this was more likely to lead to an efficient outcome when compared to a strategy where both firms collude.

To determine if BUSHMAN Ltd and IRIE enterprise was in contravention of the Fair Competition Act (FCA) the Minister ordered an investigation into the pricing practices of both firms. Although neither firm was prosecuted for engaging in predatory pricing, the government implemented policies that increased the total number of firms in the market. In this new market environment where many firms are competition against each other BUSHMAN Ltd strategy is now focused on building brand loyalty through product differentiation and advertising. BUSHMAN Ltd has also been mandated by its Board of governors to avoid competing in price wars and instead purse strategies which will maximize its profits in the long-run.

a) From an economic standpoint, what would be the implication of BUSHMAN Ltd losing their patent protection?

b) In its first decade of operation BUSHMAN Ltd earned supernormal profit. Draw a profit-maximizing graph representing this phase.

Ensure that you label the axes curves. Identify the profit maximizing price, ATC and output. Shade the area representing the profit/loss

c. On the same graph in part (d), use the letters Qp and Pp to show the efficient output level and price

d. Compare the profit maximizing output and price in part (d) with the efficient price and output in part (e )

e. Do you agree with the statement made by the economists that "price rivalry was better for consumers as this was more likely to lead to an efficient outcome"? Why or why not?