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A pharmaceutical company can produce each pill of a new drug at a constant marginal costgiven by MC = 5. Note that since the marginal cost is constant, then the average cost ofproducing pills is also 5. Inverse demand for the pills is given by P = 25 – Q and the company’smarginal revenue curve is thus given by MR = 25 – 2Q.
a) Suppose the company initially has market power and acts as a monopolist. How manypills will the company sell and what price will it charge consumers?
b) What are the consumer and producer surpluses when the company prices as amonopolist?
c) Suppose the government mandates that the company can only sell the pills at marginalcost (i.e. at P = 5). How many pills will the company sell?
d) What are the consumer and producer surpluses once the government mandate is in place?Consumer surplus is now area (A+B+C+D+E), a triangle with height and width of 20:CS =1/2* (20)*(20) = 200
e) Does the government pricing mandate satisfy the Kaldor-Hicks Criterion relative to thestatus quo? Is the government pricing mandate Pareto superior to the status quo? (Usechanges in consumer and producer surplus as your measures of the value of the policy tothese agents.)
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