Question

You are the manager of a small pharmaceutical company that received a patent on a new drug three years ago. Despite strong sales $\mathbf{(}\mathbf{\backslash (}\mathbf{150}$million last year) and a low marginal cost of producing the product ( \)0.50 per pill), your company has yet to show a profit from selling the drug. This is, in part, due to the fact that the company spent \(1.7 billion developing the drug and obtaining FDA approval. An economist has estimated that, at the current price of \)1.50 per pill, the own price elasticity of demand for the drug is -2. Based on this information, what can you do to boost profits? Explain.

Short answer

Answer:

The manager should reduce the price in order to boost the profit of the company.

Step-by-step solution

To formula used to find the profit.

The goal of this task is to determine what should be done in order to increase the profits of a company. In order to do so, the manager should first identify the marginal cost per one product from the given information, then calculate the marginal revenue and compare the results.

We use the following formula to obtain the Monopolist's marginal revenue:

$\mathit{M}\mathit{R}\mathbf{=}\mathit{P}\frac{\mathbf{1}\mathbf{+}\mathbf{E}}{\mathbf{E}}$

Where E represents the elasticity of demand for the monopolist's product and P is the price of the product.

Finding the profit of the company.

By substituting the given data, i.e. P=1.5 and E=-2 into the formula, we get –

$$\begin{gathered} \mathit{M}\mathit{R}\mathbf{=}\mathbf{1}\mathbf{.}\mathbf{5}\frac{\mathbf{1}\mathbf{+}\left(-2\right)}{\left(-2\right)} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{0}\mathbf{.}\mathbf{75} \end{gathered}$$

Again, given $\mathit{M}\mathit{C}\mathbf{=}\mathbf{0}\mathbf{.}\mathbf{5}$

We should observe that the marginal revenue is greater than marginal cost i.e.

$\mathbf{0}\mathbf{.}\mathbf{75}\mathbf{>}\mathbf{05}$.

By setting a quantity at which marginal cost equals marginal revenue, the manager of a monopoly will maximize profits.

Therefore, the manager should reduce the price if the profit of the company requires boosting.