Who Deserves a Surplus?

Pharmaceutical giant Pfizer has been fined £84.2 million after the Competition and Markets Authority declared that the price-hike of an anti-epilepsy drug in 2012 was “excessive and unfair”. When the drug lost its patent protection, Pfizer sold the drug to Flynn Pharma, who were fined £5.2 million, where it was debranded so it was no longer subject to price regulation. The CMA accused both companies of costing the NHS and therefore the taxpayer millions of pounds. The public will be glad to see this headline but it raises the question: What is fair when it comes to economic transactions?

In the case of Pfizer, people tend to feel more strongly about its anti-competitive behaviour than if the same scandal occurred in the markets for deckchairs. Medicines are considered a necessity so when prices jump, protests are bound to happen. There seems to be a point where any price above is considered unfair and that the company is exploiting both the government and the people. By seeking its own interests, the firm is lowering the standards of living of the consumer to a level which is considered unacceptable.

Economics does not account for this issue. All this situation represents on a graph is a highly inelastic demand and increases in price are merely the result of firms acting rationally. A firm will use its monopoly power and decrease its output whilst increasing the price to maximise its profit. The graph does not describe how the reduction in supply translates into real life impacts. The only welfare it implies is a lowering in consumer surplus and an increase in producer surplus.

What drives this perception of unfairness is the question of whether consumers are more entitled to a surplus than producers. The majority of people are likely to answer ‘yes’. This is because our society views the consumer as more important than the firm. The ultimate end in life is happiness and economic activity can be seen as only a means to that end. This is possibly why neoclassical economics has pushed for allocative efficiency. Consumer surplus is maximised when the price of the good or service is equal to the marginal cost of producing an extra unit. Firms make only normal profits in the long run where they can cover all their costs, from wages to rent.

For pharmaceuticals, this world would be enthusiastically received. For a good so important, the price of medicines should be as low as possible. This allows for as many people who need the drug to purchase it and leaves savings to be spent on other goods and services. However, in this world, drugs would never improve as there would be no funding for the development of cheaper or more effective healthcare. This is possibly why people are happy for firms to make some form of (abnormal) profit. Or it may just be that consumers would like to see producers rewarded for their entrepreneurship even though it is against rational self-interest.

Fairness will always be subjective but even though it cannot be demonstrated in graphs, it affects all economic activity. In the UK, the NHS and pharmaceutical firms have a non-contractual agreement when it comes to the fair pricing of drugs or healthcare systems. Throughout the world, regulatory agencies keep a close eye on what they consider anti-consumer or anti-competitive behaviour. Firms often bow to the indignation of their consumers when their actions are considered unjust. It seems that equilibria decided by the intersection of curves make way for the equilibria created by social pressure.

Leave a Reply

Your email address will not be published. Required fields are marked *