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CA Foundation · Business Economics · Public Finance

A pharmaceutical company has a patent and is the only seller of a life-saving drug. It charges a very high price and restricts output. Which type of market failure is this, and which government response is most appropriate?

The case is market failure due to market power, and the appropriate response is price regulation or encouraging competition. The patented monopolist restricts output and charges more than the competitive price. The drug is rival and excludable, so it is not a public good, and no externality is described.

  1. AExternality; impose a lump-sum subsidy on buyers
  2. BPublic good problem; provide the drug free to all
  3. CMarket power; regulate the price or encourage competitionCorrect
  4. DInformation asymmetry; ban advertising of the drug

Explanation

A single seller with a patent has monopoly power, restricting output and raising price above the competitive level, which is a market failure due to market power. Government can control prices, regulate, or allow competition such as compulsory licensing. The drug is rival and excludable, so it is not a public good.

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