Pricing row hits Pharma industry

In July 2014, the National Pharmaceutical Pricing Authority (NPPA), the country’s
nodal drug price determining body, came out with an order capping the price of
108 drugs not included in the National List of Essential Medicines (NLEM) which
lists 652 formulations. This had drawn the ire of domestic and multinational
manufacturers who went to court against the order.
A core committee of industry experts had been set up by the Department of
Pharmaceuticals, and after two years of consultations, the committee decided on a
list of drugs considered essential based on ‘regional epidemiology’ and taking into
consideration cost effectiveness, safety and efficacy. It went into specifics to cover
27 therapeutic segments and dosage forms with the strengths specified. This was
the genesis of the 652 formulations under the NLEM.
A year after implementation of DPCO 2013 which fixed price ceilings of 352 drugs
with a span of control covering 13 per cent of the pharmaceutical market, in July
2014, the list of 108 drugs sought to hike price control to 20 per cent of the market.
Figures from AIOCD Pharmasoftech showed that out of a total pharmaceutical
market of Rs.75,690 crore, scheduled products under price control amounted to
Rs.9,746 crore (13 per cent) and the addition to the list sought to bring non-
scheduled drugs amounting to Rs.5,484 crore (7 per cent) under price control
taking the total products under price control to Rs.15,210 crore (20 per cent).
Price ceiling in the Pharma industry
• All drugs in a product category must be priced at or below the price
ceiling or the manufacturer will face monetary penalties
• In the case that a drug’s price is already below the price ceiling, a
price increase is prohibited

to be used only for lecture purpose at NMIMS SOC

Why does the government put price ceiling on drugs in Pharma
industry?

• Exists huge inter-brand price differences in drugs, which is indicative

of a severe market failure

• Lower Price

• Protects consumers

to be used only for lecture purpose at NMIMS SOC

Pharma Industry

• Market is competitive enough-not much room to raise price.

• Import of Active Pharmaceutical Ingredients (API) increase to cut cost

• Too much of price ceiling on drugs will induce companies to stop

making them

to be used only for lecture purpose at NMIMS SOC

• Should the Government impose a price ceiling?

• How much price ceiling should be imposed?

To answer the above questions, we need to understand the concepts of

consumer surplus, producer surplus, and dead weight loss
 Consumer Surplus, Producer
Surplus, and Dead Weight Loss
 P
Demand curve represents the buyers willingness to pay
for each level of quantity demanded
P1

D
Q1 Qd
Mint Condition is an American R&B band from
Minneapolis, Minnesota. The band fuses diverse
genres such as jazz, hip hop, funk and dance
into its music.
You own a mint-condition recording of
Elvis-Presley’s first album. Because you are not
an Elvis-Presley fan you decide to sell it.
Four Elvis-Presley fans show up. Table 1 lists
The buyers’ willingness to pay for the album.
 CS (P=70)
T: 100-70=30
(20+10)
C: 80-70=10
Total:30+10=40

20 20
10 10

Consumer surplus: It is the difference between the willingness to pay of a consumer and what the consumer actually
ends up paying (market price)
 CS (P=50)
T: 100-50=50
(20+10+20)
C: 80-50=30
(10+20)
R: 70-50=20
Total
CS=50+30+20=100

20 20
Ria’s willingness to pay
10 10
20 20 20

Market Price

Consumer surplus: It is the difference between the willingness to pay of a consumer and what the consumer actually
ends up paying (market price)
Consumer
Surplus:
1st Consumer:
DE
D
2nd Consumer: G
GF H
k
3rd Consumer:
HJ
.
. E FJ L
.
Adding all
consumers
like this will
give
the area of the
triangle.
1 2 3 4
The market demand function for a product is given by Qd=300-2P.
How much consumer surplus do they receive when
• P=45?
• P=30?

to be used only for lecture purpose at NMIMS SOC

P=45 Qd=300-2P
2P=300-Qd
Qd=300-2(45)=210 P=150-0.5Qd

Area
ABC=1/2*AB*BC P
Qd=300-2P
=1/2*(AO-BO) 150 A Consumer Surplus (ABC)
P=150-0.5Qd
A=150 (when Qd=0)
=1/2*(150-45)*210
P=150-0.5Qd
=11025 rupees
B(45) C

O 210 300 Q
P=45
Qd=300-2(45)=210
Area ABC=1/2*AB*BC
=1/2*(150-45)*210
=11025
Qd=300-2P
P=30 P=150-0.5Qd
Qd=300-2(30)=240 150 A A=150 (when Qd=0)
Area ADE:
½*AD*DE
B(45) C
½*(150-30)*240
D(30) E
=14400

210 240
 P S
Supply curve represents the sellers willingness to sell at a price
for each level of quantity sold (minimum price in which a
seller will be ready to sell at)

P1

Q1 Qd
Imagine that you are a homeowner and you want
to get your house painted. You contact four sellers
of painting services. The table provides each
painter’s painting cost. Each painter is willing to do
the work for you if the price is right
Supplied
 PS (Price=800)
Andy: 800-500=300
(100+200)
Pablo: 800-600=200
Total
surplus=300+200=500

200 200
100 100

Producers surplus: It is the difference between the market price at which the producer sells at and the minimum price at
which she is willing to sell. PS=(Market Price-willingness to sell at)
 PS (Price=900)
Andy: 900-500=400
(100+200+100)
Pablo: 900-600=300
(200+100)
Claude: 900-800=100
Total
surplus=400+300+100
=800
100 100 100 Represented by the
200 200 Claude Area below the market
100 100 Price up to the supply
curve

Producers surplus: It is the difference between the minimum price at which the producer is willing to sell and
what she actually sells at. PS=(Market Price-willingness to sell at)
Producer Surplus:
1st Producer: DE
2nd Producer: GF
3rd Producer: HJ D G H
.
.
. J
Adding all F
producers E
like this will give
the area of the
triangle.
O
The market supply curve for a product is given by P=10+2Qs.
How much producer surplus do they receive when
• P=18
• P=30

to be used only for lecture purpose at NMIMS SOC

The market supply curve for a product is given by
P=10+2Qs.
How much producer surplus do they receive when
• P=18
• P=30 P
P=18:
PS: Area of ACE
=1/2*AC*CE
D(30) F
CE: 18=10+2Qs, Qs=4
C(18) E
A=Qs=0, P=10
=1/2*(18-10)*4
=16 A(10)
P=30
0 4 10 Q
PS: Area of ADF
30=10+2Qs
Qs=10
=1/2*AD*DF
=1/2*(OD-OA)*10
=1/2*(30-10)*10 to be used only for lecture purpose at NMIMS SOC
Calculate the Consumer Surplus and Producer surplus at the equilibrium price and quantity

P=75-0.25Qd
P=40+0.33Qs
Calculate the CS and PS at the equilibrium price and quantity

Market Equilibrium of Telecom Services

80

P=75-0.25Qd
70

P=40+0.33Qs
60

50
Price

40

30

20

10

0
0 20 40 60 80 100 120 140 160
Quantity demanded/Supplied
Calculate the Consumer Surplus and Producer surplus at the equilibrium price and quantity

P=75-0.25Qd
P=40+0.33Qs
ABE: Consumer Surplus Consumer Surplus: 450 CS=Area(ABE)=1/2*BE*AB PS=Area(DBE)=1/2*BE*BD
DBE: Producer Surplus Producer Surplus: 600 =1/2*60*(OA-OB)=1/2*60*(75-60) =1/2*60*(OB-OD)=1/2*60*(60-40)
Total Surplus: AED Total Surplus: 1050 =1/2*60*15=450 =1/2*60*20=600

Market Equilibrium of Telecom Services

80

75 A Step1:
P=75-0.25Qd
70
75-0.25Qd=40+0.33Qs
60 B P=40+0.33Qs In equilibrium, Qd=Qs=Q
E 75-0.25Q=40+0.33Q
50 Q=60
Plug Q=60,
Price

40
D
P=75-0.25(60)
30
P=60

20

10

0
0 20 40 60 80 100 120 140 160
Quantity demanded/Supplied
Producers who sell
loose A, due to
lower price

D
Producers who
cannot sell loose C
Before Price After price
E Ceiling Ceiling
Consumer D+B D+A
Surplus
Producer E+A+C E
Surplus
Total Surplus D+B+E+A+C (1) D+A+E (2)
Dead Weight none B+C (1-2)
Loss
Suppose the market demand and supply functions are given by Qd=60-P
and Qs=P-20.

a) Determine the consumers’ and producers’ surplus at equilibrium price

and quantity. (2)

b) Determine the consumer and producer surplus if a price ceiling of 32 is

imposed in this market. What is the amount of dead weight loss? (4)
 Suppose the market demand and supply functions are given by Qd=60-P
and Qs=P-20.
a) Determine the consumers’ and producers’ surplus at equilibrium price
and quantity.
P

Price=40 60
CS=Area ABE=1/2*20*(60-40) B P=60-Qd
P=20+Qs
=200
PS=CAE=1/2*20*(40-20)=200
A 40 E
TS1=400
F
C 20

0 20 Q
BHJA represents the CS for the consumers OQ2, before the price PS after price ceiling:
Ceiling (at Equilibrium price OA) P CFI
After Price ceiling what is CS of these OQ2 set of consumers? B
BHJA+AFIJ (AFIJ is the addition/ increase in consumer surplus).
This is the gain in CS to the existing consumers due to price ceiling) Supply
for the consumers who are still buying. This is equal to BHIF. H
Q2Q1 consumers are not there in the market any more.
Now if Q2Q1 amount of consumers are not able to buy, gone with them J E
A
Is their CS. So the question is: What was their CS, which is lost now?
Answer: HJE. HJE is the loss in CS due to Price ceiling. F I
PS before price ceiling:
CAE.
Q2Q1 amount of suppliers will not be supplying C Demand
After price ceiling because the price is too less Q2
For them. O Q1 Q
What was the PS of these Q2Q1 suppliers when
They were supplying (at Price OA): IJE
Dead Weight Loss(DWL): The initial total surplus- New Total surplus
What is the PS for suppliers who are still supplying:
PS after Price ceiling: CFI. Initial total Surplus: BEC
What was the PS of OQ2 set of suppliers when price was OA? New Total Surplus: BHIF+CFI=BHIC
CAJI. So what is the difference? By how much PS has fallen DWL=BEC-BHIC=HEI. This is equal to the LOSS IN CS DUE TO
for these suppliers? AFIJ. This is nothing but the gain in CS.
This implies that a price ceiling would transfer some surplus
CONSUMERS NOT ABLE TO BUY (HJE)+LOSS IN PS DUE TO SOME
From the producers to the consumers who are still participating PRODUCERS NOT WILLING TO SELL (IJE)
in the market
Qd=60-P and Qs=P-20.
60-P=P-20
2P=80, P=40, Q=20

Qd=60-PP=60-Qd, Qd=0, P=60

Qs=P-20, P=20+Qs, Qs=0, P=20

Step 1: Plug the price ceiling value in the supply function/equation to get the
quantity supplied.
QS AT P=3212 (Qs=32-20) (OQ2)
Plug the quantity supplied into the demand equation (cause this amount of
demand will be met now) to get the price (willingness to pay for this amount
of demand)
HQ2P=60-Qd=60-12=48
 Price=OF(32)
Price=40 New CS=BHIF (which accrues to OQ2/AJ
CS=Area ABE=1/2*20*(60-40) set of consumers)=1/2(BF+HI)*IF
=200 H?? HQ2. Q2=12, HQ2=48
PS=CAE=1/2*20*(40-20)=200 =1/2*[(60-32)+(48-32)]*12
TS1=ABE+CAE=BEC=400 ½*[28+16]*12=6*44
=264
Change in CS=264-200=64
P Loss of CS=HJE(lack of supply(shortage)
B(60) loss in consumersloss in CS
P=60-Qd Supply Gain in CS=AJIF (consumers who are still
buying are buying at a lower price)
48 H Net loss/gain: HJE-AJIF
New PS: FCI (CAE-AEIF)
E P=20+Qs ½*(32-20)*12=72
A(40) J
Change in PS=200-72=128(AEIF)
I Loss in PS=AEIF (IJE+AJFI)
F(32)
IJE=loss of PS for suppliers not
supplying any more (Q2Q1/JE)
C(20) Demand AJIF: loss of PS for suppliers those
who are still supplying but at a
O Q2 (12) 20 Q lower price (OQ2/IF)
TS2=BHIF+FCI=BHIC 264+72=336

TS1-TS2=HEI (HJE+IJE):400-336=64
DEAD WEIGHT LOSS : IS THE LOSS OF
TOTAL SURPLUS
 Net gain/loss to
Producers who can sell gain C Producers:
C+A
Producers who cannot sell loose A

Consumers who buy loose C Total loss to

Consumers:
Consumers who cannot buy loose B C+B

Before Price After price

Ceiling Ceiling
Consumer E+C+B E
Surplus
Producer D+A C+D
Surplus
Total Surplus E+C+B+D+A (1) E+C+D (2)
Dead Weight none A+B(1-2)
Loss

Total loss to
Society
• The domestic demand and supply and demand curves for petrol are
as follows: Supply: P=50+Qs Demand: P=200-2Qd

What will be the consumer and producer surplus if a price flooring of

125 is imposed? What is the dead weight loss?
Before Price flooring:
Q2?
TS1=CS1+PS1=BAE+CAE
Step 1: Plug 125 in the demand equation: 125=200-2Qd
=[1/2*(200-100)*50]+[1/2*(100-50)*50]
Q2=37.5
=2500+1250=3750 (BEC)
Step 2: Plug 37.5 in the supply equation P=50+37.5 to get P=87.
P New PS: FHIC
=1/2[CF+IH]*OQ2=1/2[(125-50)+(125-87.5)]*37.5
=2109.375
B(200) CS=BFH=1/2*BF*FH=1/2*(200-125)*37.5
Supply =1406.25
G P=50+Qs TS2=2109.375+1406.25=3515.625(BHIC)
F(125) H
TS1=[1/2*(200-100)*50]+[1/2*(100-50)*50]
J E =2500+1250=3750 (BEC)
A(100) DWL=TS1-TS2=BEC-BHIC=3750-3515.625=234.375
I
(87.5)
DWL=HEI=1/2*(125-87.5)*(50-37.5)=234.375
P=200-2Qd
C(50) Demand IJE is the loss in PS: producers who wee supplying earlier are
O Q2 (37.5) Q1 (50) Q Not able to supply now and therefore are out of the market. So
The PS that they were receiving earlier is no longer there.
Gain in PS is AJHF accrued to those producers who are still
Supplying and getting a higher price
Loss to CS=AFHE=AFHJ (loss to consumers who are still buying
As they are paying higher price)+HJE (consumers not willing to bu
Consider the following demand and supply functions:
P = 200-2Qd
P = 50+Qs
What is the consumer and producer surplus at the equilibrium price
and quantity.
The government imposes a price ceiling of 75 on the market. Calculate
the consumer and producer surplus. What is the dead weight loss?
 Q1: Solve demand and supply:
B(200) 200-2Q=50+QQ=50
P=200-2Qd P=200-2(50)=100
Supply
When Qd=0, P=200-0=200
150 H CS1=ABE=1/2*AB*AE=1/2*(200-100)*50=2500
When Qs=0, P=50+0=50
J E P=50+Qs PS1=ACE=1/2*AC*AE=1/2*(100-50)*50=1250
A(100)
TS1=2500+1250=3750 (BEC)
F(75) I K G

C(50) Demand Q2: CS and PS at price ceiling

O 50
Q2 (25)
Total loss in PS=312.5+625=937.5(AFIE)
New PS=1250-937.5=312.5
New CS=2500+625-625=2500
Q Step1: Find out Supply at P=75
P=50+Qs75=50+QsQs=25
Step2: Put Qs obtained from step 1 into the demand equation:
P=200-2QdP=200-2(25)=150
Loss in CS=HJE=1/2*HJ*JE=1/2*(150-100)*(50-25)=625
Gain in CS=AJIF=(100-75)*25=625
New CS=BHIF=1/2*[BF+IH]*IF=1/2*[(200-75)+(150-75)]*25
=2500
Step3: Loss in PS: IJE=1/2*IJ*JE=1/2*(100-75)*(50-25)=312.5
Loss in PS: AJIF=(100-75)*25=625
New PS=FIC=1/2*CF*IF=1/2*(75-50)*25=312.5
TS2=2500+312.5=2812.5 (BHIC)
DWL=TS1-TS2=3750-2812.5=937.5 (BEC-BHIC=HEI)=1/2*HI*JE