What is Market Equilibrium and when it achieves efficiency?
When consumers and suppliers are making a decision, they are always hoping to get the best out of the product and service given with limited resources. This situation is known as efficiency. When exactly will the market be efficient and how it benefits us?
It has been discussed by many people that when the market is at its equilibrium, Quantity demanded equals to Quantity supplied, it will generate the largest possible total surplus, hence, the market is efficient. A total surplus is the sum of consumer surplus and producer surplus. Consumer surplus is the when consumers are willing to pay more for a good or services while producer surplus the received benefits for selling a product.
Graph 1: Market equilibrium and total surplus
Referring to the graph, we can see Market equilibrium is efficient. This condition can be generated when four conditions are met. These are, when there is no external benefits, No external cost, with perfect information on the product in terms of selling or buying and perfect competition to prevent firms from being a price maker. When these conditions are being met, government intervention is inefficient as they decrease the total surplus of the market.
What happens when the government interfere in the market by changing the price?
When government set a maximum price on a certain product or service, it is known as price ceiling or price cap. When maximum price is below the equilibrium price, there will be a great effect. It is logically explained that when the price is being reduced under the equilibrium, the demand will increase because the price will be cheaper when below the market price, but from the perspective of the supplier, they will earn lesser, hence, they will decrease the quantity supplied. This condition will lead to shortage of that product in the market.
Graph 2 : The effect of price ceiling
The graph above shows the effect of cancer drugs on consumer and producer surplus. Point ‘a’ shows the market equilibrium at the price of $10 per drug and a quantity of 100 quantity demanded. When a Price cap is being imposed at $8 per drug, it causes movement downward along the supply curve from point ‘a’ to point ‘b’, and the quantity of cancer drug supplied decreased from 100 to 60. The demand increases from 100 to 135. We can clearly see a shortage of 75 quantity supplied when the price is set below the price equilibrium. For the first 60 drug supplied, consumer gain at the expense of producer, paying $8 rather than $10. Drug from 61 to 135 disappear from the market. Therefore, the total surplus decreases and it signified an inefficiency in the market. Since a price control is being imposed on the cancer drug, the policy generates a Deadweight loss. In the graph, the dead weight loss can be seen at the triangle with points ‘a,b,c’. Deadweight loss is a situation where there is no gain to anyone. The consumers and producers who are excluded from the market will loss the surplus they could have gain from the market.
People in Turkey waiting for their turn to be treated.
A shortage can be explained with pharmaceutical companies cutting down on drug supply. Pharmaceutical companies find it hard to cover the cost of certain drugs like cancer drug, as the cost is often high due to various experiment and process to approve drugs. Therefore, when there is a price cap, they could not supply the amount demanded by the market due to high cost. Not only, due to difficult manufacturing and lots of regulations on approval, the competitor in the market is lesser. This has make matter worst. There is evidence which can be read from an article written in Us. (Jain, 2013)
The maximum price reduces the total surplus of the market, hence it causes inefficiency in the market. When this happens, it will not accommodate everyone, therefore to make both parties better off, a few scenario will happen. First, a black market will work alongside with the selling of the drugs . A black market is an underground economy where goods are being traded in an illegal manner without government intervention to avoid tax and price controls. Usually prices in the black market is very high because middleman will take advantage of people who desperately need the goods, like medication for cancer, and people don’t mind paying that amount to get it in order to save loved ones or themselves. Since there is a price cap on cancer drug, it is being discussed in this article by Balkan.com about how black market comes into play. (Balkan.com, 2013).
The next scenario is the quality of the treatment for cancer and medications might drop if there is a maximum price being imposed. Due to shortage, hospitals might not even get the certain medications even if they can afford to. Therefore, many patients are waiting in line to be treated. Not only, the quality of the drug may not meet the pharmaceutical standards. Due to lesser profit they can generate after a price cap is being imposed, companies will cut down on researching further for new drugs and cutting as much cost as possible. Therefore, drugs won’t be improvised and some companies may even use unscrupulous method to manufacture these drugs. There is such article as an evidence of poor quality for cancer treatment (Rourke, 2013).
As discussed earlier, when there is government imposed a maximum price, some party will benefit and some don’t. What happens when there is no price ceiling?
An American citizen seeking treatment in India, Mumbai.
In a free market economy, there is limited or even no government intervention in the market because the market economy is based on the demand and supply. The market economy goes by mutual agreement on the price between consumer and producer. In other words, take it or leave it culture. Citizens of America have raised issues on the high medical cost in their country, and a survey has been conducted by Dr.Mercola on this matter. (Mercola,2013).
- Search activity cost may be high and time consuming as discussed in theory, but in real life, others comment otherwise, the effort is worth it when they have found a better solution to their problems. Plus and besides, nowadays it takes a few clicks on the computer to search what we want, it may be troublesome but when we look at long terms, it might even save a lot of money if compare to their current situation where government is not doing much to solve the problem of high medical cost. This can be proven in this artical by UsaToday.com (USAToday.com,2005).
- Due to finding a cheaper treatment in countries that supplies cheaper medical cost, many people doubt the standards of the product and the reliability of it. What I have in this article stated otherwise (Stephanie,2013)
As discussed earlier, government imposed a maximum price to make medical drugs and treatments more affordable. They can do the same with licensing of certain drugs to bring down the price. In Malaysia, by issuing license to firms to import cheaper generic drugs enables the government to treat more patients within the budget. This can be supported by the following article on Asian countries act to get cheaper drugs. (Khor,2012).
Graph 3 : The effect of licensing of drugs.
As shown in the graph, we can see how the method of licensing can affect the market of healthcare in the country. The graph shows that the healthcare industry only provide 100 prescription of the drugs at the price of $10 per unit, as shown at point in the graph. The total surplus of the market equals to the sum of consumer surplus and producer surplus.
Now, when the government allows license for companies to import generic drugs that are cheap from countries like India, the supply of the drugs moves upward along the supply curve as shown by the arrow along the red line. While, the demand of the drugs moves downward along the demand curve as shown in the graph. This situation has gave a positive outlook to the consumers as the quantity has increase from 100 unit to 150 unit. While, the price of the drug also dropped from $10 to $8. This can be concluded that, the licensing increases the consumer surplus but decreases the producer surplus. Although the total surplus is not the largest but it is benefits the larger picture of the economy which are the benefits towards patients.
In conclusion on this blog post, a market that generates the largest possible surplus is efficient. It has been discussed that market equilibrium generates the most total surplus and hence it is efficient. When government intervene into the market, sometimes it promotes efficiency and other time preventing it. Healthcare and medications has been highlight in this topic because it is an issue in the current economy with rising number of people getting sick and the limited resources in the market to cater these sick people. When the government intervention into the market by setting a maximum price, it promotes consumer surplus. When the government allow licensing to import cheaper generic drugs to treat diseases like HIV and cancer, the consumer will benefit as well.
Reference
Balkans.com (online). (2013). Shortages of cancer medicine in Turkey leads to a booming black matket. Available from :http://www.balkans.com/open-news.php?uniquenumber=175591 [Access on 5 June 2013].
Jain, S. (2013). Sun Pharma: Initiating Coverage. Available from: http://www.morningstar.in/posts/18163/sun-pharma-initiating-coverage.aspx
[access on 4 June 2013].
Khor, M. (2012). Third World Resurgence. Third world network (online). Available from : http://www.twnside.org.sg/title2/resurgence/2012/266-267/health1.htm. [Access on 5 June 2013].
Mercola. D (2013). Why are Americans Getting So Little in Return for the Highest Medical Bills on the Planet? Available from : http://articles.mercola.com/sites/articles/archive/2013/03/16/high-health-care-costs.aspx[Access on 4 June 2013].
Rahi, A. (2005). Westerners seek cheap medical care in Asia. UsaToday.com (online). Available from: http://usatoday30.usatoday.com/news/health/2005-09-24-asia-health_x.htm[Access on 4 June 2013].
Rourke, k. (2013). Survey: Drug Shortages May Weaken Cancer Care. Pharmacy practice news.com (online). Available from : http://www.pharmacypracticenews.com/ViewArticle.aspx?d=Operations%2b%26%2bManagement&d_id=53&i=May+2013&i_id=957&a_id=23204 [Access on 3 June2013].
