Chapter 25 The Economics of Prescription Drugs McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Chapter Outline • Profiteers Or Benevolent Scientists • Monopoly Power As It Applies To Drugs • Important Questions 25-2 Profiteers or Benevolent Scientists? • Spending on drugs accounts for 10% of the more than $2 trillion health care industry • The question of advertising • Ads for particular drugs • These are not unexpected as new cures and remedies are invented • Feel-good political ads • These ads are seen as a means to forestall price controls or regulations 25-3 Patents • A patent is a right granted by government to an inventor to be the exclusive seller on an invention for a limited period of time • Patents motivate innovation with the promise of monopoly profit for a period of time 25-4 Orphan Drugs • An Orphan Drug is one that treats someone with a disease that afflicts few people • The concern is that there is insufficient potential demand to motivate innovation • For orphan drugs the patent life is extended by several years 25-5 The Concern over High Prices • Are prescription drug prices too high? • The answer to many depends on the impact of the disease • For “life or death” drugs price has been an ethical concern • The AIDS “cocktail” (a mix of drugs, used to fight the disease) originally cost $14,000 per patient per year • For “quality of life” drugs it has been less of a concern • Pepcid and Zantac (heartburn medications), Seldane and then Claritan (seasonal allergy medications) cost a great deal but have not raised as much ethical concern 25-6 The Impact of Monopoly Power P MC P* MR Q* D Q/t 25-7 Monopoly vs Perfect Competition P MC=Supply A •Under PC B Pmonop •CS=PPCAC C •PS=FPPCC PPC •Under Monopoly E •CS=PmonopAB MR F •PS=FPmonopBE D Qmonop QPC •DWL=EBC Q/t 25-8 Deadweight Loss • Deadweight Loss (DWL) is the loss in social welfare associated with production being too little or too great • In the case of monopoly, production is too little and prices are too high 25-9 Important Questions • Are prescription drugs expensive necessities or relatively inexpensive godsends? • Expensive Necessities? • Prescription drug prices rose twice as fast as overall prices • The prices are often more than ten times their marginal production costs • Inexpensive godsends • Drug treatments are typically much less than their surgical alternatives (Drugs that deal with blocked arteries are less than a tenth the cost of bypass surgery.) • New quality of life drugs treat ailments for which there are no surgical alternatives 25-10 Why We Should Expect Costs to be High • Innovation costs • Highly trained and highly paid personnel are required to work on the therapies • Expensive equipment is necessary to aid the invention process • Uncertainty about success • Most new therapies that make it out of the lab not make it through clinical testing • Time delay and opportunity cost • Even when therapies are approved the revenue stream begins more than a decade after the invention costs have been incurred • The opportunity cost in terms of lost interest must be counted as a cost as well 25-11 The Cost Debate • Consumer advocacy groups contend that ad spending now exceeds research spending • Drug firms contend that this ignores important “opportunity costs.” 25-12 Induced Demand • Consumer advocacy groups are concerned that drug companies are inventing ailments to treat • e.g Restless legs syndrome & Requip • The drug treats an ailment that was not previously known to be an ailment 25-13 Are Price Controls an Answer? • Price or profit controls in other countries make it such that drug prices are much higher in the U.S than they are in other countries • If the U.S controlled prices or profits it would eliminate the sole high profit market for drugs thereby reducing their motivation to innovate • Economists are generally against price or profit limits for prescription drugs in the U.S 25-14 Buying from Canada • It is against the law for anyone to resell drugs purchased oversees • Canadian and Mexican drug prices are controlled by their governments • It is much cheaper to buy drugs in Canada or Mexico that it is in the U.S 25-15 FDA Approval • The Process • Laboratory trials test the effectiveness of drugs “in the testtube” and on animals • Small scale human testing is done to determine safety • Large scale human testing is done to determine effectiveness This also catches some safety issues 25-16 Too Lax or Too Stringent • Too Lax • If drugs are approved that are later determined to be unsafe (such as the weight loss drug FenPhen) the concern is that screening is too lax • Too Stringent • If drugs that would have saved lives (or otherwise helped people) are delayed in their approval this is a loss as well • Economists evaluate the marginal cost of increasing stringency against its marginal benefits 25-17 Over-the-Counter • When a drug has been deemed to be safe and effective and does not have an adverse interaction with other drugs it can go over-the-counter (sold without a prescription.) • It is not always in the consumer’s best interest for a drug to go over-the-counter • OTC drugs are not covered by insurance • The out of pocket expense to consumers with insurance can often be higher when a drug goes OTC 25-18 ... drugs thereby reducing their motivation to innovate • Economists are generally against price or profit limits for prescription drugs in the U.S 25-14 Buying from Canada • It is against the law... otherwise helped people) are delayed in their approval this is a loss as well • Economists evaluate the marginal cost of increasing stringency against its marginal benefits 25-17 Over-the-Counter... Small scale human testing is done to determine safety • Large scale human testing is done to determine effectiveness This also catches some safety issues 25-16 Too Lax or Too Stringent • Too Lax •