Question

Magicdrug is the only permitted producer in Cityland selling sleeping pills.

(i)Explain the type of market structure Maglcdrug belongs to.

(ii)Suppose Magicdrug is making positive economic profit.illustrate this situation with a diagram. Explain how Magicdrug determines its profit-maximising output price, and the total profit theoretically.

(iii)Suppose the rent of Magicdrug factory will increase. This will turn the amount of profit earned by Magicdrug to zero. Illustrate this situation in the same diagram of part (b)(ii). How does it affect the profit-maximising output and price of Magicdrug? Explain briefly.

Answer 1

a) The market type the Maglcgrug belongs to is a monopoly. In a monopoly market structure, there is only one seller of the good in the market and there is no close substitute of the product.

b) The below graph shows the drug selling company making a profit in the market. In a monopoly market, the firm will produce at a quantity where the marginal cost of the firm is equal to the marginal revenue earned by the frim. At this quantity, the firm will make a profit because the average cost of the firm is very low and the firm will not expand the production to provide more goods which can reduce the price and reduce its profit. So there is an excess capacity with the firm.  

The above graph shows the firm making a profit. At quantity Q and the price of the product is P.

c) If the rent of the factory increases the profit of the drug company will decrease because the average cost of the production has increased. But, the firm will continue to produce at the same point i.e. where the marginal cost and the marginal revenue curve meet.

The graph shows the same firm only breaking even because the average cost has increased.