Critically analyze the pros and cons of putting a price ceiling on prescription

Question

Critically analyze the pros and cons of putting a price ceiling on prescription medicine. Make sure to use concepts from the chapter in this unit such as government intervention, inefficiencies, price elasticity, etc. in your answer.

In the first case, assume the medication is for a life threatening illness for which your child has been diagnosed.

In a second case, assume the medication is for an improved quality of life issue, such as achieving a healthy weight.

What are the impacts that the pharmaceutical company that makes the medications in question will experience? How will that affect the pharmaceutical company’s production decisions? What about its decisions to conduct further research into new drugs

Explanation / Answer

(First case)

For a life-saving drug, a price ceiling is the most efficient policy measure for the consumers because the ceiling will cap the maximum price that the drug firm could charge. Usually the ceiling is kept below market equilibrium price, therefore consumer surplus (difference between a consumer's willingness to pay & the maximum price he actually pays) increases.

But the drug firm receives a lower price and so, they lower supply of the drug. There is a reduction in producer surplus (difference between the minimum price at which a firm sells its goods & the price he actually receives).

However, at lower price, demand for the drug increases and supply decreases, resulting in a shortage. Many patients who require the drug canot purchase it due to the shortage. It leads to a social inefficiency, or deadweight loss. This may also compel the drug firm to stop or reduce R&D activities into developing new life saving drugs (fearing future price ceilings on new drugs).

A point to note that life-saving drugs have inelastic demand, so buyer responsiveness to price change will be very low. But government intervention will make it affordable within the rich of the poor, and it is a social welfare measure.

(Second case)

A quality-of-life medication is not a life-saving drug and its price be better left to market forces (and to the seller if he has patent over the drug). If market forces dictate the price, then consumers (users) will be careful about their own health and consumer the drug accordingly. In this case too, consumer surplus will increase, producer surplus will decrease and deadweight loss will arise. But the social welfare effect of such price ceiling will be much lower in this case.

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