Source: 2018 PJC H1

Question 1: Controlling the Price Mechanism

Extract 1: Price mechanism versus government intervention

In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, economist
Adam Smith made the most famous observation in all of economics: Households and firms
interacting in markets act as it they are guided by an “invisible hand” that leads them to
desirable market outcomes. Prices reflect both the value of a good to a society and the cost
to society of making the good. Because households and firms look at prices when deciding
what to buy and sell, they unknowingly take into account the social benefits and costs of their
actions. As a result, prices guide these individual decision-makers to reach outcomes that, in
many cases, maximise the welfare of society as a whole.

Although the invisible hand usually leads markets to allocate resources efficiently, that is not
always the case. Economists use the term market failure to refer to a situation in which the
market on its own fails to produce an efficient allocation of resources. One possible cause of
market failure is an externality, which is the impact of one person’s actions on the well-being
of a bystander. The invisible hand may also fail to ensure that economic prosperity is
distributed equitably. In the presence of externalities and inequitable distribution of income,
government intervention such as taxes, subsidies and price controls are used to enhance
economic efficiency and achieve a more equitable distribution of income.

[Source: N. Gregory Mankiw, Euston Quah, Peter Wilson, Principles of Economics]

Extract 2: Pay-as-you-go government

As cash-strapped Western countries try to balance their books without raising unpopular
taxes, they are charging higher fees for everyday services. Half the countries in the EU have
increased health-care charges since the financial crisis. In Britain, where a severe fiscal
squeeze is under way, new fees are popping up in unexpected places, from the criminal courts
to municipal pest-control agencies.

Pay-as-you-go government has advantages. Charging for services helps allocate resources
efficiently, deterring overconsumption, just as parking meters stop people hogging spaces.
And far from being uniformly regressive, fees can be fairer than general taxation. Selling water
by the litre, as Ireland controversially began to do in January, means frugal users pay less
than those whose taps gush. Tuition fees reduce the subsidies paid to students by those who
never enjoyed the benefit of university. Some of the biggest consumers of free or subsidised
services are the middle classes, who ought to pay.

[Source: The Economist, 27 August 2015]

Extract 3: The pill that costs $9,000 in US sells for $70 in India

Last month, generic manufacturer Natco announced that it would be supplying daclatasvir,
a Hepatitis C drug, to 112 developing countries. In 2013, a medicine to treat Hepatitis C,
sofosbuvir, hit international headlines for its price — $1,000 per pill. The sofosbuivir and
daclatasvir combination used for the disease costs almost $150,000 per patient for the 12-
week regimen in the US. But in India, it is priced at just $700 or a little over Rupees 46,500
per patient for the same regimen. And prices are expected to fall further.

Typically, the price of many expensive patented drugs in European countries like France,
Spain or the UK is half of what these cost in the US. In countries like Brazil or South Africa,
these are a third or a fifth of the US price. The Indian price is often 1/100th. This could be due
to India’s patent law which enhance competition by generic drug manufacturer.

Table 1: Prices of drugs in US and India

Cost per person per month ($) Indian price as

Disease Drug
US India % of US price
Hepatitis C Sofosbuvir + 50,000 233 0.5
Daclatasvir
Lung cancer Erlotinib 6,658 161 2.4

[Source: timesofindia.indiatimes.com, 7 February 2016]

Extract 4: India To Review Drug Price Control To Make It More Lucrative For Pharma
Companies

In a move that could potentially result in higher prices of many essential drugs, the Indian
government is considering a review of its current drug price control policy to encourage private
investments in the sector, Economic Times reported.

According to the ET report that cited a senior government official, Niti Aayog Chief Executive
Officer Amitabh Kant has asked India's health ministry to scrap all regulatory hurdles for
pharma companies. Niti Aayog sees the drug control regime as hindering investments in the
sector, it added.

The policy changing move, which is seeking to dilute the authority of the current drug price
setting authorities, has backing from the Prime Minister's Office, according to the report.

India has had a long history of making its essential drugs affordable for its large population
and has often sidestepped patents on certain major drugs. The country's regulators have been
under increasing pressure from pharmaceutical companies to recognise patents that allow
them to maximise profits.

[Source: Huffpost, 4 October 2016]

Extract 5: Electric cars 'will be cheaper than conventional vehicles by 2022'

Electric cars will be cheaper to own than conventional cars by 2022, according to a new report.
The plummeting cost of batteries is key in leading to the tipping point, which would kickstart a
mass market for electric vehicles, Bloomberg New Energy Finance (BNEF) analysts predict.
The large-scale roll-out of electric vehicles (EVs) is seen as vital in both cutting the carbon
emissions that drive climate change and in dealing with urban air pollution, which leads to
many premature deaths every year. But, despite subsidies in many countries, EVs remain
more expensive than conventional cars and the limited range of battery-only cars is still a
concern. Currently, just 1% of new cars sold are electric.

However, the analysis published by BNEF on Thursday predicts that the total cost of
ownership – combining purchase price and running costs – of battery-only cars will dip below
those with internal combustion engines in 2022, even if the conventional cars improve their
fuel efficiency by 3.5% a year. The analysis uses the US government’s projected oil price of
$50-$70 (£36-£50) a barrel in the 2020s. If the price is $20, the tipping point is pushed back
by between three and nine years.

[Source: The Guardian, 25 February 2016]

Extract 6: Which countries are speeding ahead with electric cars?

China
The emerging middle class in China represents a significant market for electric vehicles. Sales
are on the up, boosted by a generous incentive programme such as subsidies. Infrastructure
investment also aims to boost electric car ownership. Beijing plans to install more than
400,000 charging points by 2020.

Norway
Norway is often credited with leading the world in the charge towards electric vehicles.
Although not a major auto market, the sales of all electric vehicles are reportedly growing
faster than anywhere else. Very generous incentives, such as exemptions from value-added
tax and free travel on toll roads, have been so successful that last year the Norwegian
government was forced to review them.

[Source: https://www.weforum.org, 7 Apr 2016]

Table 2: Electric car stock in China and Norway (thousands)

2010 2011 2012 2013 2014 2015

China 1.91 6.98 16.88 32.22 105.39 312.77
Norway 3.35 5.38 9.89 20.37 44.21 84.18

[Source: International Energy Agency]

Table 3: Market share of electric cars in China and Norway in 2015

Number of electric cars as % of new car in 2015

China 1.2%
Norway 23.4%

[Source: International Energy Agency]

Questions

(a) What is the main characteristic of a normative economic statement? Identify one example of
such a statement from Extract 2. [2]

(b) (i) Suggest a possible value of price elasticity of demand (PED) for drugs in USA and
explain two factors which bring about this value of PED. [5]

(ii) With reference to Extract 3 and using a demand and supply diagram, explain why the
price of drug in Figure 1 is much higher in USA than India given this value of PED. [3]

(c) With reference to Extract 4:

(i) Using a demand and supply diagram, explain the effect of price control on the market
for essential drugs in India. [4]

(ii) Discuss the factors that the Indian government should consider when removing the price
control on essential drugs. [8]

(d) (i) With reference to Figure 2, compare the change in sales of electric cars from 2010 to
2015 between China and Norway. [2]

(iii) Comment on whether the change in sales in electric cars from 2011 and 2015 in China
and Norway is due to price factor. [6]

(e) Using evidence from the case study and/or your own knowledge, assess whether the price
mechanism will always allocate scarce resources in the most efficient manner for all goods and
services in a market economy. [10]

[Total: 40]