2. Assume a pharmaceutical company invented a drug that is more effective in treating (or at least life extending) blood cancers and managed to obtain a patent on the drug making the company the sole provider of this blood cancer drug in the market for the next 30 years. Assume in the long-run (i.e.,in 30 years) as the patent expires, given a perfectly elastic long-run supply in the long-run, the competitive price becomes Pc, which also represents the industry’s marginal cost (MC) and average cost (AC). Assume a typical downward sloping market demand curve and the corresponding marginal revenue curve likely to prevail in a market characterized by monopoly. (20points-each part 5 points)

a) Draw a diagram with P on the y-axis and Q on the x-axis for the market for this drug. Draw the demand curve and the corresponding marginal revenue curve. Show the industry (i.e. firm in the short-run) MC=AC=Pc (long-run competitive price) on the diagram. Show the long-run competitive quantity (Qc) on the diagram.

b) Show the monopolistic firm’s profit maximizing output level (Qm) and the corresponding price level (Pm) on the diagram drawn in part a. Show the area that represents the welfare loss from monopoly on the diagram drawn in part a. Explain why this area represents welfare loss.

c) Assume the government established a maximum price of Pr where Pm>Pr>Pc. Show the Qr, the output produced under this government regulation, on the diagram drawn in part a. Assuming no complications in interventions as in government failure, would this price control help reduce welfare loss? Why or why not?

d) Is there still welfare loss under price regulation with a price of Pr? If no, explain why not. If yes, show the area of welfare loss on the diagram drawn in part a and compare welfare loss under Pr to welfare loss under Pm.