The equilibrium price of a drug is $10 a unit. A price ceiling is implemented by

Question

The equilibrium price of a drug is $10 a unit. A price ceiling is implemented by the government – drug cannot be sold for more than a unit price of $2. Based upon the current sales volume, the company spent the equivalent of $6 per unit in R&D to develop this drug (this number is the total amount spent on R&D divided by the estimated quantity to be sold over time). The company must spend the equivalent of $1.50 per unit to manufacture, distribute, and market the product.

1. In the textbook world, what will happen to quantity supplied after the implementation of this type of price ceiling?

2. Would a drug company really reduce quantity supplied if this price ceiling were implemented? Considering marginal costs/benefits, why or why not?

3. If the drug company did not curtail supply – so the price ceiling achieves its stated goal – would anyone be hurt by the implementation of a price ceiling (other than the drug company and its evil shareholders)? Explain briefly. Hint: Could the long-term and the short-term effects of this price ceiling be different?

Explanation / Answer

1) After the implementation of price ceiling the quantity supplied will fall drastically since at that price companies cannot supply drugs . The unit price of $2 does not cover any costs of manufacturing drugs .

2) Yes they would really reduce supply . The unit cost = 1.50$ + 6$ = 7.50$ . So this is the marginal cost of producing a single unit of drug . If the price ceiling is 2$ per unit then the cmpany faces loss . The marginal private benefit is lower than marginal cost .

3) The main goal of the price ceiling was to reduce supply or sondumption of drugs in the market because drugs harm the consumers . If the drug company do not curtail supply , then at 2$ per unit market equilibrium occurs . Quantity demanded rises since price has fallen . Hence in short run it may seem that price ceiling is successful but actually it did not meet its target . Rather quantity of drugs consumed increases because the equilibrium price has fallen .

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