The Reason, U.S. Pharmaceutical Companies, Raise Prices for Prescription Drugs (Case Study Sample)
Read the above articles and prepare a critical response. In your critical response, please at least answer the following questions:
1. Why could U.S. pharmaceutical companies raise prices for prescription drugs? Comment on the market outcome in terms of market price, quantity, consumer surplus, producer surplus and deadweight loss. (hint: to simplify your analysis, you may assume a pharmaceutical firm to be a monopoly when analysing the market outcome.)
2. Critically discuss how the price ceiling influences market price, quantity and the profit of U.S. pharmaceutical companies.
3. Why do not those U.S. pharmaceutical companies like the proposal of importing prescription drugs? (Hint: consider about what happens to the market structure when the same medicine is allowed to be imported.)
a. Explain how importing will influence the drug price.
b. Explain how such price change influences the pharmaceutical companies' profit, market efficiency and social welfare.
4. Conclude your essay by commenting if you support the proposal?
• Word count: 1,000 – 1,200 words (excluding graphs, figures, citations, appendices)
• Font: Times New Roman; Size: 12pt
In addition to the guidelines of the assignment marking rubric, your report must include the following elements:
• Please ensure your essay starts with a brief description of the issue (background information relevant to the report). Please also clearly state the assumptions of your analysis.
• At least 1 graph demonstrating changes to the equilibrium price and quantity. Graphs and figures may be used to demonstrate direction and relative magnitude—it is not required to include specific dollar values or amounts.
• At least 2 relevant academic references. Research must provide evidence to inform the report's context and analysis. DO NOT cite definitions of common economic terminology. DO NOT cite textbooks, Investopedia or Wikipedia. You may cite articles and other assignment materials provided to you in the course, but these do not count toward the minimum references requirement (i.e., you must conduct your own research).
Prescription Drug Prices
Prescription Drug Prices
The expanding prescription drugs prices have compelled some U.S lawmakers to introduce price control bills in the senate in a move to curb the escalating prices (Mills, 2017). This would ensure that consumers have access to these drugs at affordable costs (Mills, 2017). Nonetheless, pharmaceutical firms are opposition such legislations claiming that they would have significant impacts on their businesses (Mills, 2017). Assuming that the U.S pharmaceutical firms are a monopoly, this paper will discuss why they could increase drug prices, the implications of a price ceiling on market prices, quantity, and profit of the firms, and the reason why the corporations are opposed to the price control proposal. The paper will then conclude by presenting my stand regarding the plan.
The Reason, U.S. Pharmaceutical Companies, Raise Prices for Prescription Drugs
Assuming that a pharmaceutical firm is a monopoly, U.S pharmaceutical firms could raise the prices for prescription drugs due to a myriad of reasons. Monopolies are typified by a lack of economic rivalry to manufacture the service or good besides the lack of feasible surrogate goods (Amir, Jin, Pech, & Tröge, 2016). Consequently, the single producer has control over the good’s market price. As such, in this case, U.S pharmaceuticals are the price makers that can determine the price level by deciding the quantity of prescription drugs to produce. Therefore, as a monopoly, the pharmaceutical firms would raise the prices higher the average cost with the aim of making supernormal profits (Amir et al., 2016). The companies will produce up to the spot where marginal cost (MC) is corresponding to the marginal revenue (MR). Notably, this level will illustrate the equilibrium output (Amir et al., 2016) as shown in the figure below.
Retrieved from /monopoly/determining-the-price-and-equilibrium-of-a-firm-under-monopoly/7248
The monopolist achieves equilibrium at point E because at this point the conditions of equilibrium (MC = MC and MC intersect the MR curve from underneath. At that level, the firms will produce OQ1 output selling it at a CQ1 price that is above the average cost (AC) DQ1 by CD for every unit. As such, the entire profit is equivalent to ABDC.
What is more, as price makers, they would take advantage of producer surplus to increase the prices of prescription drugs (Amir et al., 2016). Producer surplus is when the rate at which goods are sold is greater than the cost used in producing the goods (Amir et al., 2016). In that case, because the demand for good remains unchanged despite the increases in prices, the firm’s profitability would escalate tremendously (Amir et al., 2016).
Besides, the firm may take advantage of the fact that consumers do not have an option to move to an efficient solution and thus increase prices. Specifically, the monopoly faces the similar market demand curve from which it obtains itsMR curve (Amir et al., 2016). As such, it will increase prices at a lower production quantity to maximize profits because consumers will not have a substitute good (Amir et al., 2016). This implies that the firms would not be impacted by deadweight loss, which is the total gain that the producer or the consumer did not achieve as a result of lost transactions (Amir et al., 2016).
How Price Ceiling Influences Market Price, Quantity and the Profit of U.S. Pharmaceutical Companies
A price ceiling takes place when the government places a legal restriction on how high a product's price can be. When the price ceiling is put, there is a shortage of drugs (Acosta et al., 2014). For the ceiling that the rate is placed, there is increased demand as compared to the equilibrium rate (Acosta et al., 2014). Additionally, there is less supply compared to the equilibrium rate. As such, there are more amounts demanded than that which is provided (Acosta et al., 2014). Inefficiency happens because at the price ceiling amount provided the minimall benefit is greater than the MC and firms make abnormal profits (Acosta et al., 2014). The inefficiency is equivalent to the deadweight welfare loss (Danzon, Mulcahy, & Towse, 2015).
Retrieved from http://economics.fundamentalfinance.com/price-ceiling.php
The graph above illustrates price ceiling. Accordingly, P* indicates the lawful rate set, but MB explains the rate at which the marginal buyer is ready to disburse at Q* that is the amount, which the market is ready to offer. Because MB is greater than MC (P*), it leads to a deadweight welfare loss. Besides, P' along with Q' illustrates the equilibrium rate. What is more, the demanded quantity at P* is higher than that which is offered resulting in a shortage. Nonetheless, if the price ceiling of drugs is set above the market price, there is no effect on quantity and profitability of the firms (Danzon et al., 2015).
Why Do Not Those U.S. Pharmaceutical Companies Like The Proposal Of Importing Prescription Drugs?
Importation would affect the market structure of prescription drugs in the U.S. Again, taking the U.S pharmaceutical firms as a monopoly, they have the advantage of setting prices. The importation of the same medicine that they produce means that competition has been introduced to the market (Ali-Yrkkö & Kuusi, 2017). The introduction of the competition implies that the market stops being a monopoly and becomes a competitive one. This means that the firms lose their monopoly power and can no longer be price makers.
Secondly, importation would have an enormous impact on drug prices in the U.S market. As shown in the graph below, before importation, the equilibrium price is at P0 but due to their monopoly nature, the firms are selling at P1 and have set the equilibrium price and quantity at E1. However, due to importation, the supply of drugs in the market would increase forcing U.S firms to reduce their supply from S0S0 to S1S1 due to the reduced demand of their products from D0D0 to D1D1.As such, the equilibrium rate would reduce from P1 to slightly above the equilibrium rate (P0) implying a shift in equilibrium pr...
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