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home / study / business / economics / questions and answers / when patent protection expires for a pharmaceutical ... Question When patent protection expires for a pharmaceutical company, it forces changes within the company to adjust its business strategies from a monopolist position to a position that is much more competitive. With that premise, answer the following questions: Do the variable costs and marginal costs vary much between these two market positions for a specific drug? Why or why not? What happens to the average total cost curve for the same (now generic) drug with regards to the original (prescription) manufacturer and the new generic manufacturers? If you were the person in charge of a drug manufacture moving from a patent-protected position to a position of competition with generic manufacturers, what would you do? For example, would you adjust manufacturing processes in-house and revamp processes to sell your own generic brand while continuing to sell the original prescription drug at a higher price? Or would you buy one of the generic drug companies and bring them into your responsibility and let them manufacture the drug for you? Or would you think about “tolling” a generic brand with a production company? (Tolling means you just contract out the production to an independent company.

Explanation / Answer

1) No. Pharmaceutical industry grants sufficient monopoly to the drug producing companies that enjoy patents but the industry becomes oligopolistic as soon as the patent expires. This implies that a price rise or a price cut are immediately matched by the rival firms. Firms that have recently developed a drug, register for patent rights and thus they can charge a high price without the fear of losing their customers. Patents costs are fixed costs that are spread over the price and quantity range so the marginal cost or variable cost which are independent of fixed costs remain unchanged.

2) As mentioned, Patents costs are fixed costs that are spread over the quantity so ATC rises.

3) A manufacturing unit indulges in vertical integration only when the gains from producing the unit internally outweighs the cost of purchasing it from outside. This is the basic principle of vertical integration. So tolling generic brand with a production company seems unfit since before the expiry of patents the firm must have covered a significant portion of its cost so that outsourcing it would be costly.

Adjusting manufacturing processes in-house and revamp processes to sell firm's own generic brand while continuing to sell the original prescription drug at a higher price would lead to a loss in sales and revenues for the original prescription drug.

This implies the best strategy would be the one of buing a generic drug companies and bring them into firms's responsibility.

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