Guide to Questions 9 and 10 of “Additional Multiple Choice Questions” for Weeks 11-15

To answer these questions, you need to know what perfect price discrimination is. (For review see the notes from Lec 11(ii), or the text, Chapter 15.4.) With perfect price discrimination, the output level is the same as with perfect competition. However, consumer surplus is zero because the monopolist takes it all.

Question 9. This question asks how the long the patent should be to maximize total surplus. If the drug is developed and is protected by a patent, the firm obtains an operating profit of 300 in a year. If there is no patent at all, the firm cannot recover its investment of 200. If the patent is at least one year, the firm has an incentive to develop the drug. (Because the 300 operating profit in a year more than covers the 200 investment.) Consumers are happiest if the patent lasts only a single year, because then the price would fall to the competitive level in year two. However, total surplus is the same regardless of whether the patent extends into year two, because total surplus under perfect price discrimination is the same as with perfect competition.

In summary, a patent length of one or two years maximizes total surplus. (Answer (e)).

Question 10. Following the above discussion, a patent length of one year is best for consumers. (Answer (c).) The patent is long enough to get the drug get invented, but short enough so consumers can enjoy the benefit of competitive pricing in year two.