Answer to Question #158101 in Economics of Enterprise for Abdul Mannan

Question

AVAC is the only pharmaceutical firm producing a Vaccine. 

The Demand Curve for its product is Qd = 250 – 50 P

where P is Price and Q are packs of vaccines in ‘000

Total Cost Function estimated by the firm is   TC = 15 + 0.5Q

where Q is monthly output.

a. What is the market structure of AVAC? State its characteristics.

b. To maximize profit,

(i) What will be the optimum price and how many packs of Vaccine should the firm produce and sell per month?

(ii) If this number of packs is produced and sold, what will be the firm’s monthly profit?

c. Using available information, draw AVAC’s demand, marginal revenue and marginal cost curves in a graph and clearly label thefirm’s profit maximizing price, quantity and profit. Do you observe any welfare loss? If so, also indicate and label the area on the graph.

d. Assume all other pharmaceutical firms in the market start producing the Vaccine and the market becomes competitive. What will be the impact on price and marginal revenue?Would the market structure of the firm remain the same? Support your answer with help of the firm’s graph.

Answer 1

Demand curve;

Qd = 250 - 50P

50P = 250 - Q

P = 5 - 0.02Q

Total cost;

TC = 15 + 0.5Q

a.      AVAC is a monopoly because it is the only pharmaceutical producing the vaccine.

Characteristics of a monopoly;

Single seller

High barriers to entry

Price maker

Unique product

b) Total revenue;

TR = P*Q

TR = 5Q - 0.02Q2

Marginal revenue;

MR = dTR/dQ

MR = 5 - 0.04Q

Marginal cost;

MC = dTC/dQ

MC = 0.5

(i) At profit maximising level;

MR = MC

5 - 0.04Q = 0.5

4.5 = 0.04Q

Q = 112.5

P = 5 - 0.02*112.5

= 5 - 2.25

P = 2.75

(ii) Profit;

Profit = TR - TC

= 2.75*112.5 - 15 - 0.5*112.5

= 309.38 - 15 - 56.25

Profit = 238.13

c) AVAC's demand curve, marginal revenue curve and marginal cost curve can be shown as;

Yes. Welfare loss exists when there is a monopoly in the market. The welfare loss is the red area shown above.

d)

Let’s assume other pharmaceuticals start producing the vaccine. The market becomes competitive.

Profit maximizing condition changes to;

P = MC

5 - 0.02Q = 0.5

0.02Q = 4.5

Q = 225

P = 5 - 0.02*225

P = 0.5

In competitive market structure, the price levels are lower.

Marginal revenue curve and marginal cost will remain same as before.

There is no welfare loss since the firm is producing where price is equal to marginal cost.