Question

Suppose that the pharmaceutical company Abstergo Industries successfully develops the first successful vaccine for COVID-19. If the United States government implements regulation that requires Abstergo to sell vaccine doses at marginal cost (rather than charging a higher price as it otherwise would), this will reduce Abstergo’s profit from the vaccine by $12 billion and increase the well-being of vaccine consumers by $17 billion, creating an overall efficiency gain of $5 billion. Explain why this regulation would not result in a Pareto superior outcome even though it would lead to an efficiency gain.

Answer 1

Pareto superior outcome is defined as an outcome where at least one person is better off and no person is worse off.

Thus in this case, the consumers gain from the vaccine cost being set at the marginal cost of production wherein the well-being increases by $17 bn.

But the firm is worse off as it is not able to seek higher profits from the sale of business, thus they are worse off because the profit from the vaccine reduced by $12bn.

Thus even though there is an efficiency gain, one of the players is worse off by $12bn, if they would not have lost anything, for example the government would have subsidised the cost of the vaccine to the consumers, then the outcome could have been Pareto superior as the government would have paid for the difference and the firm would have earned a higher profit.

But the outcome is not Pareto superior as the Pharma firm is worse off because of the government regulation, by seeking that money, it could have invested in more Research and development to increase the efficiency of the drug, and further improved profitability.