Question

Estimates of the marginal cost of Daraprim are $100 for a 100 pill bottle. If Turing Pharmaceuticals charged $75,000 per bottle, what is the elasticity of demand that Turing believe it faced? Suppose that the FDA does not regulate Imprimis and allows its drug to immediately compete with Daraprim. Under Cournot competition and the assumption that the competitor faces the same marginal cost of $100 / bottle, what is the profit maximizing market price of the drug? What is the responsibility of the CEO to the shareholders of Turing and to society? Should Martin Shkreli lower the price for Daraprim?

Answer 1

Solution:

Given

marginal cost of Daraprim are $100 for a 100 pill bottle

Turing Pharmaceuticals charged $75,000 per bottle

elasticity of demand that Turing believe it faced:

Revenue (R) = P*Q

Marginal revenue (MR) = dR/dQ= P +Q*dP/dQ = P*[1+(Q/P)*(dP/dQ)]

= P*(1+1/e_d) … [where, e_d = elasticity of demand]

Now at equilibrium, MR = MC

=> P*(1+1/e_d) = MC

=> 75000*(1+1/e_d) = 100… [Putting the values for price and marginal cost of a 100 pill bottle]

Or, (1+1/e_d) = 1/750

Or, 1/e_d = (-)749/750

Or, e_d = (-)750/749 = (-)1.0013 = (-)1 (approximately)

So, the elasticity of demand is (-)1 (approximately)

FDA does not regulate Imprimis and allows its drug to immediately compete with Daraprim. Under Cournot competition and the assumption that the competitor faces the same marginal cost of $100 / bottle,  profit maximizing market price of the drug is:

When another company comes to the market to compete with the manufacturer, depending on the nature of market, the price quantity decision will be made.

As there is a large scope of profit making, the newly entered company will engage in price cut. It will reduce the price by a little margin, which will enable them to grab the whole market. As a response, the manufacturer will set price to a lower level again to capture the full demand. In the same way, the price will be lowered to a level at which both the firm will charge the same price that is nothing but the marginal cost price earning zero profit.

If the market is perfectly competitive, price level would move towards a zero-profit point where P = MC. So, the price will be set at $100 per bottle.