In the booming market for weight loss drugs, Novo Nordisk, the maker of Ozempic, initially held a monopoly. Suppose it uses lab equipment (K) and technicians(L) to manufacture a quantity of drug doses per hour Q

Principles of Microeconomics Final Examination

1.    (50) In the booming market for weight loss drugs, Novo Nordisk, the maker of Ozempic, initially held a monopoly. Suppose it uses lab equipment (K) and technicians(L) to manufacture a quantity of drug doses per hour Q according to the following production function:

Q = F(K,L) = √KL.

Fix the rental price of capital at r = 36 and the wage at w = 1.

(a)     (10) Suppose that in the short run, Novo’s capital stock is fixed at K¯ = 1. Use the following table to find its total, average, and marginal cost at each output level:

(b)     (10) Now consider the long run so that Novo’s capital stock is variable. Fill out the table to find the capital to labor ratio that produces Q = 12 doses per hour for the minimum cost, and use this to find Novo’s long run marginal cost LMC.

(c)     (10) Suppose that the demand for weight loss drugs is given by the schedule in the table below. Fill out the table to determine Novo’s total and marginal revenue at each quantity.

(d)     (10) Fill out the table to determine Novo’s profit maximizing output Q∗ and monopoly price P∗ in the short run. How much profit Π∗ does it earn? Is this outcome efficient?

(e)     (10) Fill out the table to determine Novo’s profit maximizing output Q∗∗ and monopoly price P∗∗ in the long run. How much profit Π∗∗ does it earn? Is this outcome efficient?

2.    (50) Now suppose that Novo Nordisk must face a challenge from a new competitor, Eli Lilly, whose drug Mounjaro should be considered for the purposes of this problem to be identical to Ozempic. Suppose that Lilly’s production technology and input costs are identical to Novo’s, and that both firms are considering their long run output decisions and thus consider both inputs to be variable.

(a)     (10) Suppose that Novo and Lilly decided to collude and operate as if they were a single firm. What would the price be, and how much profit would each firm earn?

(b)     (10) Now suppose that Novo and Lilly each consider whether they should continue to maintain the cartel, or attempt to seize the entire market by undercutting their rival by the smallest possible increment. Set this up as a normal form game, and fill in the payoffs to both players in each of the possible outcomes.

(c)     (10) What is Novo’s best response to each action that Lilly could take, and what is Lilly’s best response to any action that Novo could take? Find the equilibrium in this game.

(d)     (10) Suppose that, rather than being restricted to two possible actions, both firms could set whatever prices they wanted. At what point would it no longer be worthwhile for a firm to try to undercut its rival, and what would the equilibrium be in this game?

(e)     (10) Now suppose that producing drugs requires not only the usual inputs but also an investment equivalent to hourly profits of D = 60 in order to research and develop the drug in the first place. Given this barrier to entry, how many firms will persist in this industry?