Chapter 24 The Economics of Prescription Drugs Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

24-2 Chapter Outline PROFITEERS OR BENEVOLENT SCIENTISTS MONOPOLY POWER AS IT APPLIES TO DRUGS IMPORTANT QUESTIONS

24-3 You Are Here

24-4 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.

24-5 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.

24-6 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.

24-7 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.

24-8 The Impact of Monopoly Power P* Q* MRD MC Q/t P

24-9 Monopoly vs Perfect Competition MR P monop Q monop D MC=Supply Q/t P P PC Q PC A F B C E Under PC CS=P PC AC PS=FP PC C Under Monopoly CS=P monop AB PS=FP monop BE DWL=EBC

24-10 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.

24-11 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.

24-12 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 do 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.

24-13 The Cost Debate Consumer advocacy groups contend that ad spending now exceeds research spending. Drug firms contend that this ignores important “opportunity costs.”

24-14 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.

24-15 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.

24-16 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.

24-17 FDA Approval The Process –Laboratory trials test the effectiveness of drugs “in the test-tube” 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.

24-18 Too Lax or Too Stringent Too Lax –If drugs are approved that are later determined to be unsafe (such as the weight loss drug Fen-Phen) 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.

24-19 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.