Transcript Monopoly

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 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

MONOPOLY: MARGINAL REVENUE AND
PRICE
250
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
Price
($)
200
190
180
170
160
150
140
130
120
110
100
90
Sales
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
Total
Revenue
($)
0
38
72
102
128
150
168
182
192
198
200
198
Marginal
Revenue
($)
190
170
150
130
110
90
70
50
30
10
-10
Total
Cost ($)
50
52
56
62
70
80
92
106
122
140
160
182
Marginal
Cost
($)
10
20
30
40
50
60
70
80
90
100
110
Profit
($)
-50
-40
16
40
58
70
76
76
70
58
40
16
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
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 brandswitchers, 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)
USD
11,244
168
1.5%
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%
General
Mills
Kellogg
MARKET STRUCTURE, I
(a) Perfect
Competition
(b) Monopoly
demand
30
Price (Cents per unit)
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
 marginal benefit

MONOPSONY SCALE
marginal expenditure
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=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?