A drug company produces a new drug to treat baldness. The inverse demand curve for the drug is P = 205 - 20Q, where Q measures the number of pills in millions. The various costs of production are given by TC = 100 + 5Q, ATC = 5 + 100/Q, and MC = 5. If the government grants this firm a patent, it will earn profits of _____. If the government revokes the patent and the firm must sell its drug at marginal cost because of competition, it will earn profits of _____.

Question

Quizplus · Accepted Answer

To find the profit-maximizing quantity of pills, we set MC = MR:

5 = 205 - 40Q

40Q = 200

Q = 5

So the profit-maximizing price is:

P = 205 - 20Q = 105

Total revenue (TR) is PQ, which is:

Q x P = 5 x 105 = 525

Total cost (TC) is:

100 + 5Q = 125

So profits with a patent are:

TR - TC = $400 million

If the patent is revoked and the firm must sell at marginal cost, it will earn zero profits since:

P = MC = 5

And:

TR - TC = PQ - TC = 5Q - (100 + 5Q) = -$100 million

Therefore, the best choice is C, since the firm would earn profits of $400 million with a patent, but would lose $100 million without it.

A Drug Company Produces a New Drug to Treat Baldness