Question

You are the manager of a small pharmaceutical company that received a patent on a new drug three years ago. Despite strong sales ($125 million last year) and a low marginal cost of producing the product ($0.40 per pill), your company has yet to show a profit from selling the drug. This is, in part, due to the fact that the company spent $2 billion developing the drug and obtaining FDA approval. An economist has estimated that, at the current price of $1.20 per pill, the own price elasticity of demand for the drug is -1.5. Based on this information, what can you do to boost profits?

Answer 1

Answer: Reduce the price of the drug

Step-by-step explanation:

The own price elasticity of a good shows how much its quantity demanded will change as a result of an increase in price.

A -1.5 own price elasticity means that if the price of the drug is reduced by 1%, quantity demanded will increase by 1.5%.

The company is incurring a relatively low marginal cost of $0.40 to produce the pills and charges $1.20. If they can reduce this price by 17% for example, to $1, they would still make a profit and the demand for the pill would increase by 25.5%.

Scenario.

A hundred people were buying the drug at $1.20. Revenue:

= 100 * 1.20

= $120

Reduce price to $1 and 25.5% more people buy:

= 1 * (100 * 1.255)

= $125.50

Profit will increase by $5.50 proving that to boost profits, you should reduce prices.