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ECO401 Economics GDB Solution Spring 2013

Under competitive market structure, price is determined by the forces of demand and supply. If the market is not competitive then government intervention is required to settle the prices. Pharmaceutical industry is one of the fastest growing industries in Pakistan dealing with health business.  The market of prescription medicine is not very competitive because the company holds patent for a medicine and has a market power that’s why pharmaceutical companies charge high prices for medicines. People are bound to purchase the medicines at high prices. Most of the current health reform debate agrees on the need to curtail health care costs. Evidence of price ineffectiveness for health services is found in the huge price variations that can be observed for similar services.

Requirement:

Being a student of economics, analyze the above case carefully and suggest how the government can intervene in the pharmaceutical market to curtail the pricing ineffectiveness. Discuss why people don’t decrease the demand for prescribed medicines in spite of increase in medicine prices.

Solution: GOVERNMENT’S ROLE IN PRICE-DETERMINATION & EQUILIBRIUM ANALYSIS

Identification problem is the problem of how to identify demand & supply curve. This problem arises
when both price and quantity.
Government can impact on equilibrium by two fundamental ways. The government may intervene in the
market and mandate a maximum price (price ceiling) or minimum price (price floor) for a good or
service.
PRICE CEILING:
A price ceiling is the maximum price limit that the government sets to ensure that prices don’t rise
above that limit (medicines for e.g.).
If a price ceiling is placed below the market-clearing price, as Pc, the market-clearing or equilibrium
price of Pe becomes illegal. At the ceiling price, buyers want to buy more than sellers will make
available. In the graph, buyers would like to buy amount Q4 at price Pc, but sellers will sell only Q1.
Because they cannot buy as much as they would like at the legal price, buyers will be out of
equilibrium. The normal adjustment that this disequilibrium would set into motion in a free market, an
increase in price, is illegal; and buyers or sellers or both will be penalized if transactions take place
above Pc. Buyers are faced with the problem that they want to buy more than is available. This is a
rationing problem.
PRICE FLOOR:
A price floor is the minimum price that a Government sets to support a desired commodity or service in
a society (wages for e.g.).
Price ceilings are not the only sort of price controls governments have imposed. There have also been
many laws that establish minimum prices, or price floors. The graph illustrates a price floor with price
Pf. At this price, buyers are in equilibrium, but sellers are not. They would like to sell quantity Q2, but
buyers are only willing to take Q3. To prevent the adjustment process from causing price to fall,
government may buy the surplus, If it does not buy the surplus, government must penalize either buyers
or sellers or both who transact below the price floor, or else price will fall. Because there is no one else
to absorb the surplus, sellers will.
RATIONING & SUPPLY SHOCKS (ALTERATION OF EQUILIBRIUM PRICE BY THE GOVT)
There are two ways for this:
1. Through Tax :
Tax (to be paid by the producer) will increase the Supply Price, Supply Curve shifts left ward, Price
increases & quantity decreases.
2. Through Subsidy :
Subsidy (given to the producer) will decrease the Supply Price, Supply Curve shifts rightward, Price
decreases & quantity increases.

People cannot decrease the demand because its matter of their life and death .diseases is not in the hand of humans .so peoples are bound to buy medicine and in this way the demand of medicine is increase day by day not decrease and prices are still high in market.

so here the government take steps to reduce the price of medicine so in this regard goverment gave subsides,gives more licenses to Pharmaceutical companies ,bound doctors to prescribe cheep medicines ,import medicines form other countries and give in market in low rate.

 

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