Class #29: Economics of Drug Pricing
Prof. Wolaver

Economics of Drug Pricing

First, let me introduce the concepts of opportunity cost and economic (vs. Regular) profits

Opportunity cost is the value of the best alternative activity you could engage in:

Regular profits = Total revenues minus costs of production

Economic profits = Total revenues - costs of production - opportunity cost

Results from Perfect market:

Recall from public goods lecture that markets are perfect only if there are many buyers and sellers.

The result from this type of market is that the right amount of the good is provided at the lowest possible price (Which is essentially the costs of production: firms should not make “economic profits” in the long run.)

Cost of producing drugs:

Article had quote: cipro costs 5 cents for raw material, and
5-80? Cents to form into pills
2 per day for 60 days:
$220 for regular prescription price
$114 for new discounted price

Production costs are not why drugs are so expensive

Results from monopoly Market:

The market for pharmaceuticals are not perfect because there is, at least for a long period of time, only one (legal) seller of a product:

Sources of monopoly
Patents are a government-created (by the fact of patents) monopoly.

Also, have asymmetric information (one agent has more information than the other agents)
Secrecy to protect market
Secrecy if trials don’t show added effectiveness over existing, cheaper treatments

Drug companies therefore have market power: there is no competition to drive the price of the of the good. Therefore, with monopolies, the basic model predicts that:
•The price is higher than optimal and (acc. To dean baker, prices would be a quarter of what they are w/o the patent)
•Therefore, fewer of the good is sold than a free market would provide.
•Monopoly firms do make economic profits
.Not EFFICIENT:

Why do we allow patents, then?

Recall, other goals may be important besides efficiency
Innovation might be a goal (
Question is then: what is the most efficient way to get innovation?

Pharma’s argument is that the monopoly profits stimulate and encourage innovation

Does that mean this is the only or best way to encourage innovation?

No, in fact, we give tax credits for research and development in addition to patent protection.
Makes the dollar cost of R&D lower for firms, therefore encourages more research

other examples of the inefficiency
When a successful drug comes out, many other companies try to make copycats- is not really generating new benefits (question for Dee and Marie- could these help ameliorate effects of drug resistance?)
Also

Underground market - people getting Cipro w/o a prescription

Other alternatives
Government funded research
argument that government is “inefficient” not clear that this is true’
Funded research critical to the development of AZT, taxol, and other drugs
Might start to be affected by political considerations ( but pharmaceuticals could already do this w/ political contributions, and they will be more apt to research only big population drugs)
Charities, universities, etc...

Together, they spend 25% more on R&D than private pharmaceuticals

Government vs. Private companies inefficiencies
Janet Reno story about privatizing

Who “owns” an idea?
Even if companies develop drug, are they doing this in a vacuum? No, have built on previous, public research

CIPRO AND AIDS

Bayer agreed to lower price from $1.83 to 95 cents after Tommy Thompson threatened to override the patent (he was kind of coy, on the one hand, said, oh, I’m not sure if I can do it legally then in negotiations put the vise on ) Flip flopped then flapped back again.

legally, for defense or welfare purposes, we can override the patents of any good
was to get price lower, not b/c we were worried about have enough supplied

Contradiction of stance on international patent protection;

Other questions: Where do they run drug trials?
Many in sub-saharan Africa, use people there as test subjects, may get treated for a time, but then, what chance do they have to keep on regimen?

International trade issue:
World Trade Organization TRIPS (Trade-Related Aspects of Intellectual Property Rights)

Price Discrimination
Some firms with monopoly power can charge more than one price: charge high prices to those w/ high willingness and ability to pay, and lower prices to those w/ lower willingness and ability to pay:

Why have drug companies been unwilling to do so?
Worry about reimportation- cheaper drugs funneled back to US and Europe will cut into their high price market
can buy Cipro on line

Time line:

1997 S. Africa passes law to allow import of low cost medicines

PHRMA brought complain to USTR under Clinton/Gore against S. Africa, who was proposing to license s. african firms to produce drugs generically
If damage is found, would’ve imposed trade sanctions on S. Africa

Clinton/Gore supported drug companies (lobby money influence?) until AIDS activists shamed Gore on the campaign trail.

2001 Feb to march: Many companies offer to reduce prices charged to developing nations
no change in intellectual property rights