Why is there a drug shortage? Economics 101.

Why is there a shortage of generic, injected drugs? What is a shortage? What causes ALL shortages?

What is a shortage?

A shortage is the quantity demanded minus the quantity supplied. A shortage is positive if the price is below the price that would clear the market. The market clearing price is also called the equilibrium price; it is the price that causes the quantity demanded to equal the quantity supplied.

What causes ALL shortages?

The answer is simple. Governmental price controls cause ALL shortages. In the absence of governmental price controls, the price adjusts to the equilibrium price. So there is no shortage unless government imposes a ceiling price below the equilibrium price.

Why is there a shortage of generic, injected drugs?

The answer is that there is a price control on drugs of this sort in the Medicare program. It works like this: Medicare will not allow prices to be greater than the average of the previous 6 months of prices. So if the equilibrium price of the drug is rising, possibly in part because of increased regulations, supply will fall and the equilibrium price of the drug will rise. But the Medicare price of the drug has to be lower than the equilibrium price, because the average of the previous 6 months is lower than the current equilibrium price in an environment of increasing prices. As a result, we get a shortage.

Why does President Obama believe that there is a shortage?

Well, he thinks that there just are not enough firms willing to produce these drugs for some mysterious reason. This is silly, of course. One firm would be enough. The problem stems from price control. Firms, in general, are not willing to produce the quantity demanded at these regulated prices.

What will happen next?

If government can generate shortages, then questions arise as to how the short commodities are to be allocated. Ah yes, the government can ration the commodity. It can set priorities as to who will get the drugs and who will not get the drugs. In this way, one government program begets the next. Death panels anyone?