m onopoly imba nccu managerial economics jack wu
TRANSCRIPT
MONOPOLYIMBA NCCU
Managerial Economics
Jack Wu
CASE: ATORVASTATIN( 降膽固醇藥 )BY PFIZER
Pfizer markets atorvastatin under the brand name “Lipitor”.
In 2010, Lipitor was Pfizer’s best-selling drug. Even while protected by patent, Lipitor faced
competition from other statins- particularly simvastatin.
The US patent on simvastatin, owned by Merck, expired in 2006, and Merck cut the price of Zocor, its branded simvastatin.
Pfizer’s US patent on atorvastatin expired in June 2011.
GENERIC DRUG In 2003, Ranbaxy Lab (Indian generic drug
manufacturer) filed for a generic version of atorvastatin.
To encourage the manufacture of generic drugs, the H-W Act provides six months of exclusivity to the first generic manufacturer approved by the FDA. The six-month period of generic exclusivity begins immediately after the expiry of the patent of the original drug.
Typically, the exclusive generic manufacturer would price its drug at 70-80% of the price of the original patented drug.
Once the generic exclusivity expires and open competition ensues, the price may fall to 5% of the price of the patented drug.
MANAGERIAL ECONOMICS QUESTIONS
Pfizer must decide how to manage the competition.
How much should it spend on advertising? At what scale should Pfizer produce the
branded drug? How would generic production of atorvastatin
affect the market for the ingredients in the production of the drug?
MARKET
Pure (Perfect) competition – least freedom in pricing
Monopolistic competitionMedical clinic
OligopolyHospitalanti-virus software, microcomputer
operating system Monopoly – single supplier of good or a
service with no close substitute: most freedom in pricing
MARKET POWER
Definition: ability to influence price monopoly -- single supplier of good or a
service with no close substitute oligopoly -- few suppliers monopsony -- single buyer oligopsony – few buyers
SOURCES OF MARKET POWER unique resources
human natural
intellectual property patent Copyright
economies of scale / scope product differentiation government regulation
-50
50
70
130
150
250
0.4 0.8 1.2 1.4 1.6 2
demand (marginal benefit)
marginal revenue
Quantity (Million units a year)
Pri
ce (
$ p
er
unit
)
MONOPOLY: MARGINAL REVENUE AND PRICE
infra-marginal units
Price ($)
Sales
Total Revenue
($)
Marginal Revenue
($)
Total Cost ($)
Marginal Cost ($)
Profit ($)
200 0.0 0 50 -50 190 0.2 38 190 52 10 -40 180 0.4 72 170 56 20 16 170 0.6 102 150 62 30 40 160 0.8 128 130 70 40 58 150 1.0 150 110 80 50 70 140 1.2 168 90 92 60 76 130 1.4 182 70 106 70 76 120 1.6 192 50 122 80 70 110 1.8 198 30 140 90 58 100 2.0 200 10 160 100 40 90 2.2 198 -10 182 110 16
REVENUE, COST, AND PROFIT
MONOPOLY: PROFIT MAXIMUM, I
Operate at scale where marginal revenue = marginal cost
Justification:
If marginal revenue > marginal cost, sell more and increase profit.
If marginal revenue < marginal cost, sell less and increase profit.
OPERATING SCALE: PROFIT MAXIMUMPROFIT MAXIMUM
MONOPOLY: PROFIT MAXIMUM, III
contribution margin = total revenue less variable cost
profit-maximizing scale: selling additional unit does not change the contribution margin
DEMAND CHANGE
Find new scale where marginal revenue = marginal cost should change price new scale and price depend on both new demand and costs
COST CHANGE
Find new scale where marginal revenue = marginal cost change in MC --> should change price (but
less than change in MC) change in fixed cost --> should not change
price or scale
3G LICENSING
“There’s good and bad in auctioning off spectrum … it may raise costs for telecoms providers” Anthony Wong, Director-General, OFTA, Hong Kong
� How does one-time license fee affect price and scale of operations?
ADVERTISING
benefit of advertising -- increment in contribution margin
advertising elasticity = % increase in demand from 1% increase in advertising
ADVERTISING: PROFIT MAXIMUM
Profit-maximizing advertising/sales = incremental margin x advertising elasticity
• incremental margin = (price - MC)
PROZAC: ADVERTISING
Competition from generics would reduce incremental margin raise advertising elasticity
COKE VS PEPSI, NOV. 1999
Coke raised prices by 7% increased advertising and other marketing
Pepsi raised price by 6.9% what about advertising?
ANSWER Pepsi should increase advertising
expenditure for two reasons: price increase --> increase in incremental
margin; Pepsi’s increase in advertising will attract
some marginal consumers -- those who are brand-switchers, relatively less loyal to Pepsi/Coke; so Coke’s demand will be more sensitive to advertising (higher advertising elasticity)
DOLLAR GENERAL
“Our customer lives within three to five miles of the store, knows we’re there” cut advertising from 3.8% to 0.2% of revenue sales dropped but profit rose
ADVERTISING
Industry/Company
Curr. Sales Advertg Ratio
IBM USD 89,131 1,406 1.6%
Anheuser Busch USD 15,036 850 5.7%Fosters AUD 3,972 380 9.6%Microsoft USD 32,187 1,060 3.3%
General Mills USD 11,244 477.0 4.2%Kellogg USD 10,177 858.0 8.4%SAP EUR 7,025 162 2.3%Unilever EUR 39,672 4,999 12.6%Units: millions
RESEARCH AND DEVELOPMENT
The profit maximizing R&D/sales ratio is the incremental margin percentage x the R&D elasticity of demand
R&D/sales should be raised if price is higher, marginal cost is lower, or if the R&D elasticity is higher
R&D SALES RATIOS (2005)
Company
Units
(million)
Sales Rev
R&D exp R&D/sales
General Mills
USD 11,244 168 1.5%
Kellogg USD 10,177 181 1.8%Unilever EUR 39,672 953 2.4%IBM USD 91,134 5,842 6.4%Microsoft
USD 39,788 6,184 15.5%
SAP EUR 8,512 1,089 12.8%
0
30
300
Quantity (Million units a year)
Pri
ce (
Cents
per
unit
)
0
30
Quantity (Million units a year)
Pri
ce (
Cents
per
unit
)
supply
demand
150
60
marginal revenue
marginalcost
demand
(a) Perfect Competition
(b) Monopoly
MARKET STRUCTURE, I
MARKET STRUCTURE, II
Relative to competitive market, monopoly sets higher price produces less earns higher profit
COMPETITIVENESS
entry and exit barriers perfectly contestable market -- sellers can
enter and exit at no cost Lerner Index (incremental margin
percentage) -- measures the degree of actual and potential competition
MONOPSONY
buyer with market power restricts purchases to depress price
trades off
marginal expenditure marginal benefit
0
273
350
400
6 8
marginal expenditure
marginal benefit
supply
Quantity (Thousand tons a year)
Pri
ce (
$ p
er
ton)
MONOPSONY SCALE
DISCUSSION QUESTION Suppose that Iron Music has the copyright to the latest
CD of the heavy Iron band. The market demand curve for the CD is Q=800-100P, where Q represents quantity demanded in thousands and P represents the price in dollars. Production requires a fixed cost of $100,000 and a constant marginal cost of $2 per unit.
(A)What price will maximize profits? (B)At that price, how will be the sales? (C)What is the maximum profit? (D)Calculate the Lerner Index at the profit-maximizing
scale of production. (E)Suppose that the fixed cost rises to $200,000. How
would this affect the profit-maximizing price?