Price Elasticity of Demand - Essay Example

?Running head: Price Elasti of Demand for Mylan Laboratories, Pittsburg Introduction The price elasti of demand (PED) is used to measure how price changes affect the quantity of goods or services sold. It is therefore a responsive mechanism and is applied to all industries. The most common description as crafted by Alfred Marshall is the percentage change of the quantity of a product demanded in response to a one percent change in the price of the product with all other factors remaining constant (Marshall 1920). When the change in demand is relatively unaffected (where the PED is less than 1), the goods sold are considered to be inelastic. In a business aiming at maximizing revenue, the PED has to be exactly 1. A PED higher than 1 reflects a very elastic product where the quantities demanded are largely affected by the price change. The figures below reflect the way the various curves will look like in different scenarios. Mylan Laboratories Mylan Laboratories is a pharmaceutical company in Pittsburgh. The company announced an increase in prices of their drugs. One client claimed that the company increased the price of a drug referred to as lorazepam from an initial $11 to $85 (Techdirt 2011, p. 2). The man who had been a worker at an oil rig was involved in an accident and is now dependant on those drugs to relieve the pain. He is on a government scheme that entitles him to $1,000 every month. He usually uses around 100 pills every month and he has taken out a loan in order to finance his drug requirements. This move is seen as a means of fleecing the citizens as the pharmaceutical companies await the government to remove patents to some drugs that have long been on the patent list. There are others who are claiming that the move is in anticipation to the new health care bill. The pharmaceutical industry has been under a lot of strain caused by the AIDS pandemic and companies have been criticized for failing to reduce their prices to the benefit of millions of people living with the disease in Africa and Asia. The major point of criticism was the patents that protect these much needed drugs hence driving costs of the medicine up. Pharmaceutical products are very inelastic as they are considered as necessities. Therefore the price elasticity of demand for them would not exceed 1. In this case, Mylan Laboratories has increased their prices by close to 600% and this will have an effect on the demand as many people cannot afford the extra expense that is accompanied by the price increment. There are a number of factors that will inform the elasticity of the demand. First, the availability of substitutes is a major determinant (Wall & Griffiths 2008). With the presence of generic drugs that are supplied by competitors, the increase in prices of the patented Mylan Laboratories’ drugs may decrease the demand. The substitutes’ closeness to the Mylan Laboratories’ drugs, their uniqueness and their prices may be the greatest deterrent to Mylan Laboratories increasing revenues from sale of the drugs even at the increased rates. The second determinant is the cost of switching to the other drugs. Many consumers of drugs are usually covered by insurance companies. If the company is responsible for the purchase of drugs, this might make it impossible or expensive for the consumer to change to other drugs. The price of the patented drugs is too high for the citizens and there has been no significant increase in income. Another problem that may hinder the change in demand for the drugs may be brand loyalty. Some consumers are attached to certain brands such that they become insensitive to price changes (Samuelson 2001). This might be so for the people with greater disposable incomes who still may find the increased prices still within their means. Another determinant of the PED is the time the consumers will take immediately after the increase. Some consumers may wait for some time in order for them to resume buying the product. If the prices do not come down, those that are not dependent on the drugs for their daily operations may eventually give them up whereas those that do need the drugs may reduce the quantity the initially used. Addiction or habituation may also be a factor that will determine whether the drugs are consumed or not (Frank 2008). Where people are addicted, the increase in price may not be a concern as the drugs are then a necessity; otherwise, those that may not be habituated to the drugs may quit using them all together. In calculating the price elasticity of demand for Mylan Laboratories’ drugs,, the following formula will be applied. Ed+ %change in quantity/ %change in price Percentage change in quantity is calculated by multiplying the difference between the initial quantity demanded and the current quantity demanded by 100, represented here below. % change in quantity= initial quantity demanded/ current quantity demanded x 100 Percentage change in price is also acquired by multiplying the difference between the current price charged and that of the initial price by 100. The representation is illustrated below. % change in price= initial price / current price x 100 Conclusion Price elasticity of demand varies depending on the product that is being marketed. Some products have a very elastic demand depending on a large number of reasons. Elasticity is mostly affected by substitution and the presence of similar products in a market reduces the demand for products that have a higher price. Pharmaceutical companies are beneficiaries of an inelastic demand as their products are usually protected under patents. The products are also usually necessary to the well being of the consumers rather than being luxuries. For this reason therefore, an increase in prices for pharmaceutical products usually does not have a large effect on the demand of the products as the consumers need them. Companies that manufacture drugs usually exhibit monopolistic tendencies as they produce unique products that are characteristic to those specific companies. Therefore, government regulation is limited for these companies and they can maximize their revenues without the fear of loosing customers. Mylan laboratories may not suffer decreased demand for their drugs as a result of the price increase. This is because they are the only licensed producers of drugs like lorazepam that are critical to the health of individuals consuming them. This means that the price elasticity of demand for the company will not exceed 1. If however the government was to remove patents for the drugs that ha prices hiked, then the price elasticity of demand would be subject to change and the entry of competitors would shift the demand from being elastic to elastic. References Frank, R. 2008. Microeconomics and Behavior (7th ed.). McGraw-Hill, New York Marshall, A. 1920. Principles of Economics Library of Economics and Liberty. ISBN 0256015473. Retrieved on 25th October, 2011 from http://www.econlib.org/library/Marshall/marP12.html Samuelson, N. 2001. Microeconomics (17th ed.). McGraw-Hill, New York Techdirt. 2011. Desperate Drug Companies Raising Prices on Drugs Still Under Patent. Retrieved on 25th October, 2011from http://www.techdirt.com/articles/20110331/00292613705/desperate-drug-companies-raising-prices-drugs-still-under-patent.shtml Wall, S. & Griffiths, A. 2008. Economics for Business and Management. Financial Times Prentice Hall. Read More