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?