Question

You are CEO of a new firm, DUNSMED, Inc. which has invented a successful Covid-19 vaccine. The US government has given you an exclusive patent on the drug for 10 years. The government, in exchange for granting this exclusive patent, wants all 100,000 doses manufactured for the first year. As CEO of the company, you are in charge of pricing for the drug and the Marginal Cost is equal to the Marginal Revenue at a price of $2,000 per dose. Demand is extremely high for the drug as your firm is the only company that has invented a Covid-19 vaccine and the Marginal Cost is equal Demand at the price of $10,000 per dose but you can only fill the government's order of 100,000 doses. Please answer the following questions given this information.

a. For the first year, what type of market environment is your firm operating in? What characteristics lead you to believe that and why? Explain clearly and thoroughly (5 sentences minimum are required).

b. What is the minimum price your firm should charge for the drug per dose? Why and how did you come up with the pricing? Explain clearly and thoroughly (5 sentences minimum are required).

c. After the patent expires and the drug is no longer in strong demand, assume 10 other companies all create generic versions of the same vaccine. Your competitors are all charging $11 per dose. Marginal Revenue equals Marginal Cost at $11 per dose. What type of market environment is your firm operating in and why? What price should you charge now? Explain clearly and thoroughly (5 sentences minimum are required).

d. Given that 10 other companies are already creating the same vaccine. Would your firm earn an economic profit assuming you priced the vaccine at the same level as your competitors? Additionally, what would happen if your firm would charge more than your competitors? What would happen if you charge less than your competitors? Explain clearly and thoroughly (5 sentences minimum are required).

Answer 1

a. As can be seen from the above sentences, we can say that for the first year the firm is operating in a market structure called monopoly. This is because the characteristics of this firm is matching with that of monopoly, like the firm is the only (single) producer of the vaccine in the market, it has control over the price of the product i.e. market power, there are high barriers to entry as other firm has not developed a vaccine and can't use this formulae because of patent. So these all are the basic characteristics of a monopoly market.

b. The firm can charge a minimum price of $2,000, because at this price MR=MC and hence the firm can easily recover its cost. But since this is a monopoly market here the price is set at the point on demand or AR curve corresponding to the point of intersection of MC and MR curve. So the equilibrium price will be $10,000.

c. After the patent expires and the drug is no longer in strong demand, assume 10 other companies all create generic versions of the same vaccine. Your competitors are all charging $11 per dose. Marginal Revenue equals Marginal Cost at $11 per dose. This market structure is similar to perfect competition because there are now many firms and all are selling similar product which are substitutes for one another and the equilibrium is also taking place at MR=MC=$11, which is also the price charged by all firms. Hence all firms are earning normal profit and I must also charge the same price of $11 now.

d. Given that 10 other firms are already producing the vaccine, my firm will not earn an economic profit if the price is same for all the firms but it will earn only a normal price. If I charge a higher price than my competitors my sale will go down as people will buy other vaccines and I may incurr loss. If I charge a lower price than I will earn a higher revenue due to increase in demand but still I will come up with loss because I can't recover my cost.