An incumbent pharmaceutical company (Lone Star) enjoys a monopolistic position i

Question

An incumbent pharmaceutical company (Lone Star) enjoys a monopolistic position in the market for anti-retroviral drugs. Currently, it is earning monopoly profits of 100.

There are two types of barriers to entry in this industry: a patent and capabilities in the efficient manufacturing of drugs. A potential entrant (Upstart) could "work around the patent" by developing a similar but not exact drug. This would cost Upstart 10. Upstart could also invest 15 to produce as efficiently as the incumbent. To enter, Upstart must pay both costs. If Upstart enters, the two companies will share the market equally.

Lone Star could give away its patent to the public. Doing so would imply that Upstart doesn't have to "work around the patent." It would also drastically reduce the size of the market for anti-retroviral drugs. If Lone Star remains as the only supplier in that market, monopoly profits will go down to 40. Upstart enter, again they will share these profits equally.

Write down the decision tree of this sequential game; then, identify the Nash Equilibrium.

Explanation / Answer

The Nash Equilibrium is a strategy in economics where in a stable state of system involving the interaction of different participants; in which no participants gain by unilateral change of strategies if the strategies of others remains constant.

As upstart enters into market it has two problems- Patent and Capabilities. Now by Nash Equilibrium if Lone Star give away its patent rights; there will higher supply and msrket for each stakeholders decrease and no one is going to get benefit. The decision that Upstart should work on around patent is totally depend on cost of his product. If he could provide less costly anti-retroviral drugs than Lone Star; he should work.

If there is monopoly of anyone in the market it is going to hurt consumer's interest and so if there are reasonable number of players in market it going to shared benefits to each one.

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