Question

Suppose that a black market for the medical drug arises, with pharmaceutical firms secretly selling the drug at higher prices. Illustrate on a graph, the black market for this medical drug, including the implicit supply schedule, the ceiling price, the black-market supply and demand, and the highest feasible black market price.

Answer 1

.In case of medical drugs, especially for severe ailments, price ceiling frequently becomes binding, since the market price often surpasses the ceiling. In such condition, the demand for drugs increases because the consumers are willing to pay a higher price. The suppliers cannot serve the market in a fortnight. Hence in the short-run, there is a shortage of drugs.

The aim of price ceiling is to make a product (here, medical drugs) available to the poor who cannot afford it. But this goal is not achieved since the consumers demand more at the current (binding) price of $1 than what is supplied at this price. Since there are always some consumers who are willing to pay higher prices, people involved in illegal buying and selling in the black market will purchase some portion (sometimes all) of the available supply and then sell it to the consumers who are willing to pay higher prices.

In that case, consumer surplus will reduce to area A and producer surplus will remain unchanged at area F. Black marketers will earn a surplus equal to area (B + C)

The equilibrium is at point O where the equilibrium price is $2 per unit and the equilibrium quantity demanded and supplied is Q1 units. This is shown in Figure 1. A price ceiling of $1 imposed in the market entices the consumers but discourages the sellers. This implies that demand expands but supply contracts so that there is excess demand of (Q3 – Q2) at the ceiling price.

Since consumers demand more at the current (binding) price, people involved in illegal buying and selling (ticket scalpers) often purchase some portion (sometimes all) of the available supply and then sell it to the consumers who are willing to pay higher prices