Spending on health care now constitutes a significant fraction of total expendit

Question

Spending on health care now constitutes a significant fraction of total expenditure. Understanding the efficacy of this spending is therefore relatively important. When it comes to contagious diseases, there are generally two strategies that can be adopted. The first involves prevention, which includes vaccinations to lower or eliminate the risk of contracting a disease. The second involves treatment of those unfortunate enough to get sick, treatment typically requires some form of a drug. Since pharmaceutical companies can produce both vaccines and drugs, we would like to understand the incentives they have to develop each type of medicine. To explore this question, consider a population of 100 consumers, 90 of whom have a low disease risk, say 10%. The remaining ten have a high risk – to make things simple, assume they are certain to contract the disease. In addition, suppose the disease generates personal harm equal to the loss of $100 for each individual when they are infected. Suppose also that pharmaceuticals of either form (vaccines or drugs) are costless to produce (once R & D has occurred) and are perfectly effective

Question 2. What price would a profit maximising monopolist charge for a vaccine? What are the monopoly profits on the vaccine? What is the efficient outcome (i.e. SMB = SMC)? What is the welfare under the monopoly and at the efficient allocation?

Question 3.Now consider the demand for the drug (assume that the vaccine is not available). Construct the demand function for the drug and plot it on a diagram. What price would a profit maximising monopolist charge for the drug? What are the monopoly profits from the drug? What is the efficient outcome? What is the welfare under the monopoly and at the efficient allocation?

Question 4. If the R&D costs of the vaccine and drug are the same, what will the pharmaceutical company do? Explain your answer in terms of the variation in the willingness to pay and the size of the R& D costs. What would a social planner do?

Question 5. What are the R&D cost for the vaccine and the R&D cost for the vaccine drug that would make a pharmaceutical company indifferent between developing the vaccine and the drug? Is the social planner indifferent in this case? Explain any difference. [5 points]

Explanation / Answer

Q-2 Considering a population of 100 consumers, 90 of whom have a low disease risk i.e. 10% and the remaining ten have a high risk, let us assume 90%.

Now the chanches of these 100 to get affected=(90x0.1+10x0.9)= 18

Hence overall chances of getting affected= 18%

The disease generates personal harm equal to the loss of $100 for each individual when they are infected, profit maximising monopolist charge for a vaccine would be= 18% of $100 i.e. $18

Monopoly profits on the vaccine= $18 (as these are costless to produce due to expenses made at one go during R&D)

The efficient outcome will be the fixation of pricing of $18 resulting in a revenue and profit of $1800 for 100 people.

The welfare under monopoly would then be=$100-$18=$82 per person who had managed to save from spending after suffering from it.

Q-3

The vaccine is not available and the demand remains the same.

The profit maximising monopolist would charge a price of$100 for this.

Profit would be $100 per person as there is no other variable cost involved

There would be no welfare under this condition

Q-4

If the R&D costs of the vaccine and drug are the same, the pharmaceutical company may invest the same in the R&D of the vaccine from profit point of view as the vaccine may be considered for consumption by 100% of the population whereas the drug may be consumed by the affected ones consisiting of 10% of the population (0.09+0.01). Once the prevention is taken into consideration, the willingness to pay will be more for the vaccination and chances of inclination for the population would be more towards vaccination.

A social planner may consider an option of vaccine production due to the reduction of the degree of the desease and the presvention for better social good.

q-5

Chances of using a vaccine would be= 100%

Chances of using a drug would be=(.90x0.1+.10x0.9)= .18 or 18%

Hence the ratio of the cost should be 18:100 (menas if vaccine development costs $100, drug development should cost $18) and that would result in indifference

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.