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Observation Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 Jan-05 Feb-05 Mar-05 Apr-05

You are 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 summarizing the results of your analysis and any recommendations.
Harry makes it clear to you that he is a “risk neutral” person.

Finally, Harry gives you a copy of one of Selwyn’s spreadsheets. This one contains data that Selwyn collected on the variables he thought would be needed to estimate the short‐run cost functions for DermaPlus™ and the firm’s profit‐maximizing output level. Harry makes it clear that he has complete confidence in Selwyn’s technical abilities and professional judgment and tells you to take the information in Selwyn’s spreadsheet at face value and to use it as a starting point for your analysis.
Observation Month Output TVC TFC AVC Q (average units/day) (average $/day) (average $/day) 1 Jan-05 530 $31,450 $9,000 $59.34 530 280900 2 Feb-05 325 $8,070 $9,000 $24.83 325 105625 3 Mar-05 550 $38,380 $9,000 $69.78 550 302500 4 Apr-05 320 $6,340 $9,000 $19.81 320 102400 Estimated equation: 5 May-05 220 $6,610 $9,000 $30.05 220 48400 6 Jun-05 205 $4,870 $9,000 $23.76 205 42025 Estimates: 82.14418 7 Jul-05 255 $5,640 $9,000 $22.12 255 65025 -0.411966 8 Aug-05 370 $10,500 $9,000 $28.38 370 136900 0.000711 9 Sep-05 480 $21,110 $9,000 $43.98 480 230400 10 Oct-05 175 $5,570 $9,000 $31.83 175 30625 11 Nov-05 325 $7,200 $9,000 $22.15 325 105625 12 Dec-05 160 $5,120 $9,000 $32.00 160 25600 13 Jan-06 445 $16,460 $9,000 $36.99 445 198025 14 Feb-06 220 $6,390 $9,000 $29.05 220 48400 15 Mar-06 170 $5,810 $9,000 $34.18 170 28900 16 Apr-06 280 $7,130 $9,000 $25.46 280 78400 17 May-06 225 $5,550 $9,000 $24.67 225 50625 18 Jun-06 410 $12,910 $9,000 $31.49 410 168100 19 Jul-06 315 $6,670 $9,000 $21.17 315 99225 20 Aug-06 430 $15,740 $9,000 $36.60 430 184900 21 Sep-06 155 $4,710 $9,000 $30.39 155 24025 22 Oct-06 320 $6,260 $9,000 $19.56 320 102400 23 Nov-06 285 $6,960 $9,000 $24.42 285 81225 24 Dec-06 535 $38,080 $9,000 $71.18 535 286225 25 Jan-07 390 $12,810 $9,000 $32.85 390 152100 26 Feb-07 350 $7,780 $9,000 $22.23 350 122500 27 Mar-07 165 $6,280 $9,000 $38.06 165 27225 28 Apr-07 295 $5,990 $9,000 $20.31 295 87025 29 May-07 370 $10,320 $9,000 $27.89 370 136900 30 Jun-07 310 $8,050 $9,000 $25.97 310 96100 31 Jul-07 385 $11,180 $9,000 $29.04 385 148225 32 Aug-07 505 $29,800 $9,000 $59.01 505 255025 33 Sep-07 310 $7,940 $9,000 $25.61 310 96100 34 Oct-07 445 $17,150 $9,000 $38.54 445 198025 35 Nov-07 420 $14,350 $9,000 $34.17 420 176400 36 Dec-07 450 $18,700 $9,000 $41.56 450 202500 Q 2
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SUMMARY OUTPUT Regression Statistics Multiple R 0.9766349158 R Square 0.9538157588 Adjusted R Square 0.9510167138 Standard Error 2.9038167667 Observations 36 ANOVA df SS MS F Significance F Regression 2 5746.759699317 2873.3798497 340.76471971 9.207631E-023 Residual 33 278.2610098861 8.4321518147 Total 35 6025.020709203 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% 82.144176534 4.13812573 19.850575331 6.43403E-020 73.7250964755 90.563256592 73.725096475 90.563256592 -0.4119662011 0.0255539022 -16.121459569 3.29885E-017 -0.4639560057 -0.3599763964 -0.4639560057 -0.3599763964 0.0007107821 3.6749054E-005 19.341508242 1.41965E-019 0.0006360156 0.0007855486 0.0006360156 0.0007855486
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