The San Francisco based ophthalmologist Dr. Alan Scott discovered that the deadly Botulinum toxin could be turned into a miracle drug that could cure two serious eye conditions which had previously left 25,000 Americans functionally blind. Dr. Scott sold the rights to this drug to the pharmaceutical company Allergan, Inc., who now has monopoly control over the provision of this drug. What really made the fortunes of Allergan, however, was the discovery that the drug has cosmetic uses. In 2002, the Federal Food and Drug Administration (FDA) approved the use of the drug for cosmetic purposes. Almost overnight, the drug became a sensation. In 2002 Allergan used to charge consumers $400 per vial of the drug. Dr. Scott, however, has gone on record saying that each additional vial only costs $25 to prepare.1 For the purpose of the following questions, assume that Allergan, Inc. Maximizes profit.
(a) What was the elasticity of demand for the drug in 2002? (Remember that there is a certain relation between marginal revenue and elasticity of demand.)
(b) Economists have estimated that the inverse demand function facing Allergan in 2002 was given by p=775-375q , where output q is measured in millions of vials. What was the equilibrium level of output?
(c) Illustrate the equilibrium in a diagram. You must clearly label all axes, intercepts and curves.
(d) What was the producer surplus obtained by Allergan, Inc. in 2002?
(e) What was the consumer surplus in the industry?
(f) What was the deadweight loss?
(g) Assume that Allergan, Inc. becomes capable of practicing perfect or first degree price discrimination. What is the industry output and producer surplus?