Question

A pharmaceutical firm named NovoFarm is introducing a novel long-term weight management drug, Ozemgovy, to the market in the Federated Republic of Brobdingnag. The country has a strong pharmaceutical regulatory agency, the Federal Drug Administration. NovoFarm’s marginal cost of producing Ozemgovy is $2 per dose. Having already spent $8 million developing Ozemgovy, NovoFarm is now prepared to bring Ozemgovy to the market. However, the patent on Ozemgovy will expire next week unless NovoFarm pays $2 million to renew the patent for one year. If the patent expires, the market will become perfectly competitive, with many other firms sharing the same per-unit cost for the drug as NovoFarm. The per-year demand for Ozemgovy in Brobdingnag is

= 800 − 20P, where is measured in thousands of doses, and P is in dollars per dose.

(a) Suppose that NovoFarm has decided to renew its patent. As a monopolist, what price should NovoFarm set for Ozemgovy? What quantity should be produced? What would
consumer surplus be?
(b) Suppose that the FDA can influence the prices of drug in Brobdingnag. If it sets a price ceiling (i.e., a maximum price that is allowed to be charged) of $25 for Ozemgovy, what
quantity would be produced? What would consumer surplus be?
(c) If the FDA commits to a price ceiling of $5 for the next year, should NovoFarm renew its patent? Explain your answer. You may assume that no further renewals are possible
after this year—the market will become perfectly competitive one year from now no matter what.
(d) Suppose that the FDA’s goal is to maximize total economic surplus in Brobdingnag. What price ceiling (if any) should the FDA impose? Explain.

Answer 1

As a monopolist, NovoFarm should set a price where marginal revenue equals marginal cost to maximize profit. If the FDA sets price ceilings, it affects the quantity produced and consumer surplus. The FDA's goal should be to maximize economic surplus, which might involve setting a price ceiling that considers both consumer and producer surpluses.

Step-by-step explanation:

Monopolist Pricing and Production Decisions

The pharmaceutical firm NovoFarm is considering whether to renew the patent for its weight management drug Ozemgovy, given certain market conditions and regulatory actions by the Federal Drug Administration in the Federated Republic of Brobdingnag. The marginal cost of producing Ozemgovy is $2 per dose.

Monopolist Decision

As a monopolist with a patent, NovoFarm would set the price where marginal revenue equals marginal cost to maximize profits. To determine this price, we would calculate the marginal revenue from the demand equation, set it equal to the marginal cost, solve for the quantity, and plug it back into the demand equation to find the monopolistic price.

Impact of a Price Ceiling

If a price ceiling of $25 is set, the quantity produced would be found by plugging the price into the demand equation. The consumer surplus would increase as the price is lower than the monopoly price. For a price ceiling of $5, NovoFarm must consider if the reduced revenue would cover the fixed cost of the patent renewal plus variable costs.

FDA's Maximization of Economic Surplus

The FDA's intention to maximize total economic surplus may involve setting a price ceiling to balance consumer access with maintaining producer incentive to supply the drug. The exact price would depend on the evaluation of combined consumer and producer surplus at different price levels.