You’re BioMed’s resident economic expert. Harry the CEO is asking you to complete a

time-sensitive project that another person, Selwyn, had started working on before he retired.

Harry explains that BioMed has a manufacturing plant that produces a prescription topical cream

called DermaPlus™, which is used for treating certain skin conditions. Hospitals and pharmacies are

the main buyers of DermaPlus™.

A number of other firms produce creams that are almost identical to DermaPlus™ and the market

for these creams is extremely competitive. In fact, BioMed’s current share of the market for this

type of topical cream is small, so it has no ability to influence the market price. On the other hand,

because Biomed is relatively small compared to the size of the market, it can sell as much of the

cream as it likes at the prevailing market price.

The plant producing DermaPlus™ has been operating for a little over three years with the same

manufacturing equipment. Currently there are no plans for upgrading or adding to this equipment.

Over the last three years, the price of DermaPlus™ and related creams has been quite volatile and

BioMed has tried to react to the changing price by varying its output level to constantly maximize its

monthly profit. To date, BioMed has been able to vary monthly production quite easily by taking

advantage of a flexible, non-union workforce with a large number of part-time workers. However,

the workforce at the DermaPlus™ plant is just about to be unionized. Once that happens, it will

become much more difficult to vary the amount of labour used in the short run and therefore much

more difficult to vary the monthly production of DermaPlus™.

Before he left, Selwyn had been asked to estimate the short-run cost functions for the DermaPlus™

manufacturing plant. The goal was to use this information to determine the profit-maximizing

output level and use that information to estimate the optimal size for the new unionized workforce.

Harry tells you that DermaPlus™ and related products are just about to come under the umbrella of

a new reference-based pricing scheme. Under the new scheme, the government will set the price of

DermaPlus™ and competing creams, and review that price every two years. Once the price has been

set, BioMed and other manufacturers simply have to decide how much of the cream, if any, they

want to produce and sell.

Unfortunately, although the workforce will be unionized in just over a week, the referenced-based

price for DermaPlus™ will not be announced for another two months. Consequently, BioMed has to

choose the size of its workforce (and therefore its production capacity) before it knows the price it

will get for its product. To reduce the uncertainty about this decision, Harry recently hired a

consultant with expertise in the pharmaceutical industry and reference-based pricing to estimate

the price that will be announced for DermaPlus™. The consultant estimates that there is a 5%

chance that the price will be $50 per unit, a 20% chance that the price will be $100 per unit, and a

75% chance that the price will be $150 per unit. This is the best estimate the consultant can

provide given the lack of information coming from the government about the issue. After giving

you this background information, Harry asks you to complete the following tasks:

1. Determine the profit-maximizing average monthly production capacity for DermaPlus™ for each

of the possible reference-based prices identified by the consultant. Estimate the expected

monthly profit in each case.

2. Recommend an average daily production capacity for the next 12 months given the uncertainty

about the price of DermaPlus™. Your recommendation will be used to set the size of the

manufacturing plant’s unionized workforce. (Note: You simply have to determine the best daily

production capacity for the next 12 months, not the number of workers required.)

3. Write a short report (1000)summarizing the results of your analysis and any recommendations.

Attachments:

MEQA-Assignme….pdf

MEQA-assign2-….xls