When the government interferes in the market, the purpose of "Price ceiling" is to set to the maximum price at which a good can be sold. If price ceiling is put above equilibrium price, it has no effect on demand and supply of the goods. But, if price ceiling is set below the equilibrium price, it creates a shortage. If market is competitive, price is determined by forces of demand and supply. Unfortunately, the market of prescription medicine is not very competitive. A company holding patent for a medicine has market power. The demand of prescription medicines is relatively inelastic. So, the percentage fall in demand of prescription medicine is less than the percentage rise in price. As demand of these medicines is relatively inelastic, pharmaceutical companies may set very high price. In such cases, government intervention is required to bring down the price of prescription medicines. For example, in August 1976, a program called Maximum Allowable Cost (MAC) (Evaluation of the maximum allowable cost program. Health Care Finance Rev 1983 Mar; 4(3) :71-82) came into effect which placed price ceiling on prescription drugs whose patents had expired.
In this case, the purpose of the price ceiling is to keep the prescription medicines affordable to the patients and general public. The price ceiling generates shortage as at a price lower than equilibrium price, quantity demanded exceeds quantity supplied. But for inelastic goods like prescription medicine, shortage is less as demand and supply both and relatively inelastic. Market inefficiency occurs because of price ceiling. The inefficiency is equal to the deadweight welfare loss.
The patients always gain from price ceiling on prescription medicines. But profitability of
References: - Krugman, P., & Wells, R., (2009). Microeconomics: Second Edition , New York. Worth Publishers. - Fundamentalfinance.com (2012) Economics. Retrieved June 29th, 2012 from: http://economics.fundamentalfinance.com/price-ceiling.php - Unboundmedicine.com (2012) Evidence. Retrieved June 29th, 2012 from: http://www.unboundmedicine.com/evidence/ub/citation/10309857/Evaluation_of_the_maximum_allowable_cost_program_ - Patentbaristas.com (2010) Archives. Retrieved June 29th from: http://www.patentbaristas.com/archives/2010/06/22/medical-patents-are-they-necessary-evils/