You are the sole domestic producer of the generic antidepressant Sensitrum. Your

Question

You are the sole domestic producer of the generic antidepressant Sensitrum. Your marginal cost is $2 per dose. Demand is given by Q = 400-50p,(Q in millions of doses, p in $). There is a second producer in India whose marginal cost is INR 145 (including transportation cost to the US). Finns set prices simultaneously. What is your equilibrium profit at the current exchange rate of INR 48 / US$? An advertising and retailing campaign costing $80m is expected to increase demand by 40%. Should your firm go ahead with it? One macroeconomics expert tells you that "it is likely that the rupee will appreciate in the near future." How would this influence your decision?

Explanation / Answer

Indian firm's marginal cost in US$ is 145/48 = 3.021$
a) Price equilibrium : we set a price just under foreign firm's marginal cost and get the whole domestic market.

So, the equilibrium profit is (400-50*3.021)(3.021-2)= 248.95*1.021= 254 $ mm.

b) Advertising campaign would increase profits by 40%*254 = 101.6$. This is more than cost. We should therefore go ahead with it.
c) The possibility of dollar depriciating only makes things better. Let e be the exchange rate INR/US$. A depriciation of dollar means e goes down. This implies that the indian firm's marginal cost in US$, 145/e , goes up. This in turn implies that both that profits are higher and the gains from advertising campaign are higher.

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