You are the manager of a small pharmaceutical company that received a patent on

Question

You are the manager of a small pharmaceutical company that received a patent on a new drug three years ago. Despite strong sales ($225 million last year) and a low marginal cost of producing the product ($0.80 per pill), your company has yet to show a profit from selling the drug. This is, in part, due to the fact that the company spent $1.9 billion developing the drug and obtaining FDA approval. An economist has estimated that, at the current price of $1.60 per pill, the own price elasticity of demand for the drug is -2.

Based on this information, what can you do to boost profits?

a. Raise price.

b. Reduce price.

c. Keep price the same

Explanation / Answer

The own price elasticity of demand for the drug is -2.

The value of price elasticity of demand is greater than 1.

So, the demand for drug is elastic.

When demand for a good is elastic then a decrease in price of drug leads to increase in total revenue and thereby boost profiit.

As demand for the drug is elastic, company should reduce price of the drug as it will enable it to increase total revenue and boost profit.

Hence, the correct answer is the option (b). [reduce price].

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