Pharmacists in small Italian cities where they are effectively monopolies will jack up the prices of products desperately needed by hard-pressed parents when there is a rise in the number of newborn babies. That is the central finding of research by Giacomo Calzolari, Andrea Ichino, Francesco Manaresi and Viki Nellas, published in the November 2018 issue of the Economic Journal.
Their study, which analyses data on increases in monthly births and changing prices in over 3,000 pharmacies across Italy, also shows that competition is a formidable antidote against such price-gouging behaviour. In similar cities where there are two pharmacies simply because of a few additional inhabitants, a rise in the number of newborns does not produce any increase in prices.
The researchers conclude that governments should do more to increase the degree of competition between sellers in these markets. Not much is needed in this case: just one additional pharmacist is enough to destroy the ‘quasi-monopolistic’ power of a single pharmacy in a city of under 7,500 inhabitants.
Consider a pharmacist who observes more newborn babies in her catchment area. She therefore expects an increase in the number of hard-pressed parents willing to buy products that their babies need urgently – an ointment for rashes, for example.
It is then tempting for the pharmacist to raise the price of these products, even if this implies chasing away other customers who can wait to find what they need elsewhere at a lower price. The reason for this temptation is that the pharmacist gains from the new parents, who want to buy at ‘almost any price’, more than what she loses from other customers.
The new study shows that pharmacists in small Italian cities actually behave in this way, but competition is a formidable antidote against such behaviour, which reduces consumers’ welfare.
The research analyses Italian data on monthly births at the municipal level over the period from 2007 to 2010 to identify quasi-random shocks in the fraction of inelastic buyers (parents) of hygiene products for babies that are demanded by other customers as well. The researchers also observe prices charged by over 3,000 pharmacies (around a fifth of the Italian market) for these products.
The study considers cities with a number of inhabitants just below and above the threshold of 7,500 inhabitants that, according to the Italian law, determines whether a local area should have one or two pharmacies.
These cities are arguably similar in all respects, but in those in which only one pharmacy operates, there is a significant increase in the price of hygiene products in response to an increase in the number of newborns. In contrast, in similar cities in which, just because of few additional inhabitants, there are two pharmacies, the same increase in newborns does not produce any increase in prices.
It is often the case that regulations and other administrative constraints artificially restrain competition. As a consequence, our economies still feature many markets in which sellers have considerable market power that they exploit to their advantage and at a loss of consumer welfare.
More effort should be exerted by governments to increase the degree of competition between sellers in these markets, the researchers conclude. At least in the case analysed in their study, not much is needed: just one additional pharmacist is enough to destroy the quasi-monopolistic power of a single pharmacy in a city.
‘Inelastic Buyers and Competition’ by Giacomo Calzolari, Andrea Ichino, Francesco Manaresi and Viki Nellas is published in the November 2018 issue of the Economic Journal.