Earlier this week, Colorado instituted a cap on the prices of insulin, ensuring its residents will not pay more than $100 per month for their life-carrying medicine.
At first glance, Denver’s cap on insulin may appear to be a remedy for the products being excessively priced. But the law of supply and demand says it isn’t.
A cap on prices is otherwise known as a price ceiling, and has unintended consequences that are not first visible to consumers. When price ceilings are enacted, the lowered prices increase demand while the supply simultaneously decreases. The repercussion for this market inefficiency is a shortage. This same concept applies to the many other instances where public outcry pushes politicians to enact laws to remedy highly-priced products or services, such as rent control, price ceilings on water during natural disasters, and so forth.
I don’t expect a shortage to ensue, since Colorado is merely one state and they can simply import the medicine from the companies that supply it around the country. However, if this policy were to spread, there could be severe consequences.
Woefully, necessity or not, you cannot manipulate market laws regardless of the absolute need for the product without there being negative outcomes. This creates what is known as the Pareto optimality. This is an unfortunate feature of the market, but it is unavoidable regardless of what policy legislators enact.
Many people simply do not grasp the importance of price gouging. It is merely the market correcting itself by increasing prices to guarantee a shortage does not ensue.
Regarding insulin and other pharmaceuticals, these current market prices do not reflect actual consumer demand which naturally dictates the price. This is because the pharmaceutical behemoths are able to restrict supply, therefore setting prices to their liking to maximize profits. With insulin and other medicines essentially being inelastic goods, consumers must purchase the medicine or face life-threatening outcomes. It should be noted, this market inefficiency is not the product of the free market. Instead, the prices reflect a shady relationship between the large pharmaceutical companies and government officials.
Naturally when demand is high in the market, prices are also high. The market conditions attract entrepreneurs to enter the industry and fill the excessive demand in pursuit of profits. With their entry, their competitive presence will create a consumer-friendly atmosphere that will increase the supply, lower the price, and increase the quality of the products. However, in this case and many others, the government has granted special privileges to the companies already in the industry, and creates barriers to entry to disallow new competition from entering the market, thus granting these companies monopolies. With the absence of competition, these monopolies granted companies are free to do as they wish, which includes restricting supply and raising prices.
This is a common occurrence when the government interferes and regulates a particular market. With the government having legislative power, companies are incentivized to lobby to officials to make laws for their own benefit while harming their competition. In other words, legislators will make rules in favor of the highest bidder.
If you want to see a natural decrease in the price of insulin, the government must diminish its stranglehold of the healthcare market. It is guilty of creating barriers to entry. It is outright prohibiting competition to enter the market to compete with the major pharmaceutical companies. By demanding the government enact price ceilings, you are asking it to fix a problem it initially created. Any attempt to mitigate the problem by attempting to artificially maneuver around market laws will only further expand it. Price controls are not the answer, and historically never have been. Deregulation of opening the pharmaceutical market is.