Economy

Managerial Economics

Remember, I am solely interested in your economic thought process (i.e., the how’s and why’s of your answer). Be explicit about any assumptions you make.

1. Business: Jester Drug

Background: Jester Drug compounds pain-control pharmaceuticals—they make epidurals and other specialty, often last-resort, pain-control drugs. The drugs are special-ordered, often tailored to the disease and patient, and Fed-Ex’d to hospitals, clinics, and hospices in 21 states. Hospitals also frequently compound drugs in-house. Given the narcotic nature of their product, non-hospital compounding companies are legally required to have FDA and DEA approval and licensing. Licensing is expensive, requiring training and frequent quality-control inspections. The law has never been rigorously enforced: of the six other compounding firms in the 21 states Jester Drug currently serves, only one has FDA and DEA approval. Compounding is labor-intensive: high-paid pharmacists grind chemicals using cheap equipment. Other Jester employees take orders, ship orders, buy materials, and do basic accounting and human resource services.

a. Define Jester’s market by identifying both their customers and their competitors. I only ask this to know how to grade the next question. (5 points)

b. Compared to their competitors, does Jester have a benefit position, a cost position, both or neither? If they have a benefit and/or cost position, what is/are the source(s) of their advantage? Be explicit and complete in identifying the source(s) of their advantage. (10 points)

c. Jester is considering an expansion—the current 21 states Jester ships to contain only 40% of the U.S. population, so Jester believes there is room for growth. Jester also believes that with a bigger facility and more employees, he can achieve enough economies of scale to compete on cost with non-FDA+DEA-licensed compounders. Do you agree—given the limited information, do you see enough opportunity for economies of scale to justify expansion? Don’t forget about possible diseconomies of scale. (20 points)

d. Would you expect competition for compounding pharmaceuticals to behave like Cournot or like Bertrand? Why? Is your answer here consistent with your answer to the previous question? (10 points)

e. Given your answer to parts (a) thru (d), should Lester use a market-share or profit-margin approach? (5 points)

f. What can Jester do to motivate exit by current competitors—both the licensed and unlicensed firms—and inhibit entry by potential competitors? Would the expansion help or hurt Jester’s attempt to deter competition? Be sure to discuss effective commitments. (10 points)

2. Business: QuickHitch

Background: Most trucks on highways pull single trailers, but a rising number pull dual-trailers (over 1 million per day pull two or more trailers). The current process for hooking and dropping dual trailerstakes 49 steps and 32 minutes on average. Worse, hooking and dropping requires manually moving a heavy dolly and is far and away the most dangerous activity in the trucking industry—more dangerous than driving. Three years ago, QuickHitch invented a simple patent-pending device that removes the need for a heavy dolly (so removing risk of injury), requires only 4 steps and takes 5 minutes on average to hook and drop. QuickHitch manufactures the device, employing about 50 machinists to make every component. Last year, another firm (actually, a truck driver) applied for a patent on a device that performs the same function in roughly the same time, but has fewer parts (less likely to break) and is sold for 20% less. Right now, QuickHitch has 95% of the market; the new guy is still putting his operation together.

a. Define QuickHitch’s market by identifying both their customers and their competitors. (5 points)

b. Compared to their competitors, does QuickHitch have a benefit position, a cost position, both or neither? If they have a benefit and/or cost position, what is/are the source(s) of their advantage? Be explicit and complete in identifying the source(s) of their advantage. (10 points)

c. QuickHitch knows that it can’t compete head-on with a better, cheaper product, so it must encourage price cooperation from the new guy. Based on its market research, QuickHitch thinks the profits resulting from a price cooperation game looks like this:

	The New Guy
	Raise Price	Lower Price
QuickHitch	Raise Price	100, 80	-20, 100
	Lower Price	80, 10	0, 20

i. Assume both players move at the same time with no information on the other’s move. Play the game and determine the outcome. (5 points)

ii. Does either player have a dominant strategy? (5 points)

iii. Is the outcome a Nash Equilibrium? (5 points)

iv. What strategies could QuickHitch use to encourage cooperation? Be sure to discuss effective commitments. (5 points)

v. What factors will make the attempt to develop cooperation easier, and what factors will make it more difficult? (5 points)