# Managerial Economics for Remox Corporation

4. Remox Corporation is a British firm that sells high-fashion sportswear in the United States. Congress is currently considering the imposition of a protective tariff on imported textiles. Remox is considering the possibility of moving 50 percent of its production to the United States to avoid the tariff. This would be accomplished by opening a plant in the United States. The following table lists the profit outcomes under various scenarios:

Profit in 2008

No Tariff Tariff

Option A: Produce all output in Britain $1,200,000 $800,000

Option B:Produce 50% in the United States 875,000 $1,000,000

Remox hires a consulting firm to assess the probability that a tariff on imported textiles will in fact pass a congressional vote and not be vetoed by the president. The consultants forecast the following probabilities:

Probability

Tariff will pass 30%

Tariff will fail 70

a. Compute the executed profits for both options.

b. Based on the expected profit only, which option should Remox choose?

c. Compute the probabilities that would make Remox indifferent between options A and B using that rule.

d. Compute the standard deviations for options A and B facing Remox Corporation.

e. What decision would Remox make using the mean-variance rule?

f. What decision would Remox make using the coefficient of variation rule?

5. Mirk Labs is a British pharmaceutical company that currently enjoys a patent monopoly in Europe, Canada, and The United States on Zatab (pronounced zay-tab), and allergy medication. The global demand for Zatab is

Qd =15.0 - 0.2P

Where Qd is annual quantity demanded (in millions of units) of Zatab, and P is the wholesale price of Zatab per unit. A decade ago, Mirk Labs incurred $60 million in research and development costs for Zatab. Current production costs for Zatab are constant and equal to $5 per unit.

a. What wholesale price will Mirk Labs set? How much Zatab will it produce and sell annually? How much annual profits does the firm make on Zatab?

b. The patent on Zatab expires next month, and dozens of pharmaceutical firms are prepared to enter the market with identical generic versions of Zatab. What price and quantity will result once the patent expires and competition emerges in this market? How much consumer surplus annually will allergy sufferers who take Zatab gain?

c. Calculate the annual deadweight loss to society due to the drug firm's market power in Zatab. What exactly does this deadweight loss represent?

d. Given your answer to part c, would it be helpful to society for competition authorities in Eurpose, Canada, and the United States to limit entry of generic drugs to just five years for new drugs? Why or why not?

#### Solution Preview

...5000=$962,500

b. Based on the expected profit only, which option should Remox choose?

The expected profits are higher under option A, hence option A is recommended. Produce all output in Britain.

c. Compute the probabilities that would make Remox indifferent between options A and B using that rule.

Let p is the probability that tariff will pass, then we have

(1-p)*1200000+p*800000=(1-p)*1000000+p*875000

1200000-p*400000=1000000-p*125000

275000*p=200000

p=200000/275000=0.7273

d. Compute the standard deviations for options A and B facing Remox Corporation.

Standard Deviation for Option A = (0.7*(1200000-1080000)^2+0.3*(800000-1080000)^2)^0.5=$183,303

Standard Deviation for Option B = (0.7*(1000000-962500)^2+0.3*(875000-962500)^2)^0.5=$57282.2

e. What decision would Remox make using the mean-variance rule?

On the basis of risk, the portfolio B is better. However, on the basis of return portfolio A is better. Thus, based in mean variance rule there is no dominant choice. Thus, we can not suggest which option will the management should take.

f. What decision would Remox make using the coefficient of variation rule?

CV=Standard Deviation /Mean

For option A: CV=183303/1080000=0.1697

For option B: CV=57282.2/962500=0.0595

Since option B has lower risk per unit of return, it is recommended to go with ...