Consider the following scenario. A pharmaceutical company has spent 230 million dollars developing and testing a new drug. The company projects the total revenue from sales to be about 850 million dollars over the course of three years after the drug approval by the Food and Drug Administration (FDA). The company is close to the completion of the research phase, when they learn that a competing drug has entered the market. Sales projections have been downgraded to 150 million dollars. An investment of an additional 9 million dollars would be required to complete the research and obtain the FDA approval, if the company decides to do so. The cost of producing actual pills, after the research phase is complete, will be close to zero and can be ignored for simplicity. The best advice for this company would be to abandon the production of this drug.

Question

Quizplus · Accepted Answer

Marginal cost (MC) of completing the research is 9 million dollars, while the projected marginal revenue (MR) is 150 million dollars. Since MR > MC, the company should complete the research and start producing the drug. The production would still result in a loss rather than profit, but the loss from this decision would be smaller than the loss from the alternative decision.

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