For your answer in 3a:

(a) Calculate the price elasticity of demand in each market at the optimal price.

(b) Verify that the prices and elasticities are consistent with the profi t-maximizing formula given in Footnote 4.

(c) Why are both elasticities fairly close to unity? (Think about the requirement for profi t maximization when marginal cost is zero.)

(d) If a fi rm fi nds that its price elasticity is numerically less than 1, what advice would you have?

Exercise 3

A pharmaceutical fi rm faces the following monthly demands in the U.S. and Mexican markets for one of its patented drugs:

where quantities represent the number of prescriptions. Assume that resale or arbitrage among markets is impossible and that marginal cost is constant at $2 per prescription in both markets. Monthly fi xed costs are $1 million in the United States and $500,000 in Mexico.

(a) Draw the demand, marginal revenue, and marginal cost curves for each market. Estimate the profi t-maximizing prices and quantities graphically and/or determine the solutions algebraically. What are the fi rm’s total profi ts?

(b) Determine the quantity in each market and maximum possible total profi ts if the fi rm engages in perfect (fi rst degree) price discrimination. Is this behavior possible?

Transcribed Image Text:

QUS = 300,000-5,000 Pus and Qx = 240,000 - 8,000 Px US