How Effective Are Price Ceilings?
This is an economic analysis I wrote a few months ago (from the date of publication) evaluating the price ceiling imposed on knee surgeries by the National Pharmaceutical Pricing Authority (NPPA) of India in 2013. Although it uses an old example, the economic concepts and evaluation within this article are still relevant to the imposition of price ceilings globally.
Introduction:
India’s regulatory body on pharmaceutical pricing, the NPPA[1], ratified a price ceiling of Rs. 38,740 for primary knee replacement surgeries. This price ceiling was allegedly implemented due to the fact that many patients could not afford to undergo this surgery, thanks its exorbitant price.[2]
Analysis:
A price ceiling is a maximum price limit set in a market by the government below the equilibrium price. Prices cannot cross this limit. Supply is the willingness and ability of producers to produce/sell a particular good. Demand is the willingness and ability of consumers to purchase a particular good.
Before the price ceiling was imposed, the market was at equilibrium. Suppliers were willing and able to sell a quantity of Qe knee surgeries at a price Pe, while consumers were willing and able to purchase a quantity Qe of knee surgeries at price Pe. However, the regulation authority felt the original price Pe of knee surgery was too expensive. To counter this, they introduced a price ceiling of price Pc. The goal of the price ceiling was to make the good more affordable to consumers.
The Law of Demand states that there is an inverse relationship between price and quantity demanded, and so naturally, as the price of knee surgery was reduced from Pe to Pc, the quantity demanded increased from Qe to Qd. The Law of Supply states that there is a positive relationship between price and quantity supplied, and producers were not willing to sell at a quantity of Qe anymore. Thus, the quantity supplied decreased to Qs.
As a result of this price ceiling, the quantity demanded has increased while the quantity supplied has decreased. This has created a shortage in the market of quantity Qd-Qs. In this market, the total quantity sold is limited to Qs since that is the maximum quantity suppliers are willing to supply at this new price of Pc. Thus, quantity sold has reduced from Qe to Qs, making knee surgeries accessible to less people instead of more.
In addition to this, this price ceiling may have another adverse effect. The increased quantity demanded of Qd knee surgeries may serve as incentive for producers to produce and sell their goods at a price higher than the legally-mandated price of Pc. This incentivisation leads to the creation of a black market, an illicit market in which goods are traded at illegal prices.
In this case, producers may begin selling their goods in a black market at a price of Pd. Knee surgeries are fairly price inelastic products, due to the fact that they are necessary for survival. As a result, consumers who weren’t able to purchase the surgery at the price of Pc with the quantity of Qs, may turn to the black market and pay an exorbitant price of Pd in order to acquire the surgery. Moreover, the quality and safety of the surgeries offered in the black market are dubious due to the fact that there is no governmental or legal oversight.
Finally, compounding the issue is the fact that correctly estimating the price ceiling is incredibly difficult. This is because it depends greatly on the elasticity of a good, which is hard to quantify accurately. It is very easy for governments to accidentally implement a price ceiling that is too high and will not have much of an effect, or one that is too low, as in this case.
Thus, we can conclude that it is difficult to correctly estimate a price ceiling, and incorrect implementation can harm consumers instead of benefitting them.
References:
1. Dey, S., 2021. Regulator May Permit Rejig Of Pharma Packaging Cost. [online] Business-standard.com. Available at: <https://www.business-standard.com/article/companies/regulator-may-permit-rejig-of-pharma-packaging-cost-112052800027_1.html> [Accessed 21 January 2021].
2. Firstpost. 2017. Centre Fixes Price Ceiling Of Knee Implants; NPPA Notification Brings Huge Relief For Patients — India News , Firstpost. [online] Available at: <https://www.firstpost.com/india/centre-fixes-price-ceiling-of-knee-implants-nppa-notification-brings-huge-relief-for-patients-3938331.html> [Accessed 21 January 2021].
