MONOPOLY IMBA NCCU Managerial Economics Jack Wu CASE
MONOPOLY IMBA 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 competition Medical clinic Oligopoly Hospital anti-virus system Monopoly software, microcomputer operating – 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
MONOPOLY: MARGINAL REVENUE AND PRICE 250 Price ($ per unit) infra-marginal units 150 130 demand (marginal benefit) 70 marginal revenue 50 0. 4 -50 0. 8 1. 2 1. 4 1. 6 Quantity (Million units a year) 2
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 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 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
3 G 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 Sales Rev R&D exp R&D/sales (million) 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%
MARKET STRUCTURE, I (a) Perfect Competition (b) Monopoly demand 30 Price (Cents per unit) demand supply 0 300 Quantity (Million units a year) 60 marginal cost 30 marginal revenue 0 150 Quantity (Million units a year)
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 q marginal benefit q
MONOPSONY SCALE marginal expenditure Price ($ per ton) 400 supply 350 273 0 marginal benefit 6 8 Quantity (Thousand tons a year)
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=800100 P, 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?
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