Monday, February 22, 2010

Welfare Costs of Free Vaccines

Should pharmaceutical firms give away (price at zero) vaccines, such as swine flu in developing countries? The Financial Times makes a case against it. This is consistent with the economic argument that setting prices below equilibrium prices is economically welfare reducing (i.e. making society economically worse off). How?

While lower prices are beneficial to consumers (increases consumer surplus), low price only increase consumer surplus if consumers have more stuff to buy. The problem is that when prices are below the equilibrium price, then shortages occur as firms are unable to supply enough to meet the increased consumer demand. The reason is that as firms supply more, their costs rise, and to overcome these higher costs, firms typically have to raise prices. Ah, but prices are falling, thus firms have less of an incentive to increase the amount of output they are producing, and in fact they have an incentive to decrease it, and shortages occur.

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