31 TR Co is a pharmaceutical company which researches, develops and manufactures a wide range of drugs. One of these
drugs, ‘Parapain’, is a pain relief drug used for the treatment of headaches and until last month TR Co had a patent on
Parapain which prevented other companies from manufacturing it. The patent has now expired and several competitors
have already entered the market with similar versions of Parapain, which are made using the same active ingredients.
TR Co is reviewing its pricing policy in light of the changing market. It has carried out some market research in an
attempt to establish an optimum price for Parapain. The research has established that for every $2 decrease in price,
demand would be expected to increase by 5,000 batches, with maximum demand for Parapain being one million
batches.
Each batch of Parapain is currently made using the following materials:
Material Z: 500 grams at $0·10 per gram
Material Y: 300 grams at $0·50 per gram
Each batch of Parapain requires 20 minutes of machine time to make and the variable running costs for machine time
are $6 per hour. The fixed production overhead cost is expected to be $2 per batch for the period, based on a budgeted
production level of 250,000 batches.
The skilled workers who have been working on Parapain until now are being moved onto the production of TR Co’s
new and unique anti-malaria drug which cost millions of dollars to develop. TR Co has obtained a patent for this
revolutionary drug and it is expected to save millions of lives. No other similar drug exists and, whilst demand levels
are unknown, the launch of the drug is eagerly anticipated all over the world.
Agency staff, who are completely new to the production of Parapain and cost $18 per hour, will be brought in to
produce Parapain for the foreseeable future. Experience has shown there will be a significant learning curve involved
in making Parapain as it is extremely difficult to handle. The first batch of Parapain made using one of the agency
workers took 5 hours to make. However, it is believed that an 80% learning curve exists, in relation to production of
the drug, and this will continue until the first 1,000 batches have been completed. TR Co’s management has said that
any pricing decisions about Parapain should be based on the time it takes to make the 1,000th batch of the drug.
Note: The learning co-efficient, b = –0·321928
Required:
(a) Calculate the optimum (profit-maximising) selling price for Parapain and the resulting annual profit which TR
Co will make from charging this price.
Note: If P = a – bQ, then MR = a – 2bQ (12 marks)
(b) Discuss and recommend whether market penetration or market skimming would be the most suitable pricing
strategy for TR Co when launching the new anti-malaria drug. (8 marks)
(20 marks)
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