Class19_Pharma - Prescription Drugs, Intellectual Property,...

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Unformatted text preview: Prescription Drugs, Intellectual Property, and Monopolistic Competition Pharmaceuticals Great example of a product where innova5on is key source of compe55ve advantage Creates a host of interes5ng problems for firms, policy makers Innova5on and intellectual property protec5on Taking life-saving medicines "off patent" Pharmaceuticals Looking at profitability for a drug ex post (condi5onal on being a success) it looks very high. If you look ex ante (before you know whether it's a success) it doesn't look so high. Does pharmaceu5cals pricing differ across des5na5on markets? The re-importa5on debate,3343,en_2649_34631_2085200_1_1_1_1,00.html Pharmaceu)cal Exports in 2009 $70,000,000.00 $60,000,000.00 $50,000,000.00 $40,000,000.00 $30,000,000.00 $20,000,000.00 $10,000,000.00 $0.00 World Total = $418 bn Pharmaceuticals Three Facts: 1. Expenditures on pharmaceu5cals are a large and growing frac5on of US health care costs 2. Drug prices vastly exceed MC of produc5on 3. US drug prices are o]en much higher than in other countries Can we explain any of these data with our models? Monopolis5c compe55on seems perfect Zyrtec, Clari5n, Clarinex, Zyxal, ... All slightly differen5ated an5histamines Pharmaceutical pricing and proAits Profits = (Price- marginal cost)*Quan5ty Fixed costs Since fixed costs (R&D, clinical trials) are so high, markups (P - MC) must be very high But profit maximizing markups are limited by two factors The government grant to act as a monopolist The elas5city of demand facing the firm. Pharmaceutical pricing and proAits Evidence: Joseph A. DiMasi, Ronald W. Hansen, and Henry G. Grabowski, "The Price of Innova5on: New Es5mates of Drug Development Costs," Journal of Health Economics, vol. 22, no. 2 (March 2003), pp. 151-185. The es5mate for the dura5on of the preclinical phase is based on the comprehensive drug database maintained by the Tu]s University Center for the Study of Drug Development. Opportunity costs are the costs associated with keeping capital 5ed up in a specific drug-development project for a given period (that is, the forgone interest or earnings that a company might have gained from inves5ng its capital in other ways). DiMasi and others assumed the forgone rate of return to be 11 percent per year. Innovation costs 2000 data Pre-clinical phase (4.3 years) R&D costs (millions 2000$) Direct Costs Indirect Costs Total 121 214 335 282 185 467 403 399 802 Clinical trials, FDA approval (7.5 years) Total (11.8 years) Innovation Costs are Trending UP Es5mates of average R&D cost of a successful NME (new molecular en5ty) 1976 1987 1990 2000 $137 Million $319 M $445 M $802 M Why? Increased failure rate Lengthier trials; longer preclinical research periods Increased commercializa5on (less free basic research from universi5es) Patent rights Almost all the value of pharmaceu5cals is in the R&D Once a NME is known to have benefits, it is rela5vely easy to reverse-engineer it and produce it at very low cost This is apparent in the price series for drugs that go "off- patent". Various studies from 1990s show: Very liqle is in the "fill and finishing" stage Generic entry price is 25 percent lower than incumbent, and falls by 5-7 percent for each subsequent entrant Generics capture 44 percent of market share a]er 1 year, 65 percent of market share a]er 2 years. Caridzem CD (blood pressure) lost 66 percent of market in 1 year Prozac (depression) lost 80 percent of market share in 2 months Studies cited in "The off-patent pharmaceu5cal market" Monique Mrazek and Richard Frank (hqp:// Intellectual property Why should intellectual property be protected? Innovators pay fixed costs which can only be recouped by charging (possibly large) markups over Once IP is "known", imitators can undercut pricing of innovator (e.g., pharmaceu5cals) Lowers incen5ves to innovate Suppose 1 in 10 drugs make it all the way to sales For profits > 0 => (P-C)Q > 10F Without patent protec5on, generics pay F to reverse engineer drugs and P = C => (P-C)Q << 10F (no incen5ve to innovate) Intellectual property Who benefits: 1. Immediately, the monopolist 2. In the long run, the consumer, by seeing higher rates of innova5on Who loses: People who cannot afford medicine Suppose you could cut prices without affec5ng rates of innova5on AIDs in Africa Trick is appropriately weighing this tradeoff International Intellectual Property Each country has its own "Intellectual Property Regime" (IPR) -- rules for protec5ng intellectual property Rules for filing patent applica5ons "Uniqueness" standards How long IP protec5on lasts E.g., business prac5ces As innova5on fixed costs grow, firms may require global sales to recoup return on innova5on investments. Need strong IPR in all countries. WTO IP Rules Countries must offer "na5onal treatment" Treat all foreign firms like you treat domes5c firms Reaffirms exis5ng interna5onal agreements Paris Conven5on (industrial proper5es), Berne Conven5ons (ar5s5c rights) Extends Berne to cover so]ware, rental rights Grants geographic name trademarks (Champagne) Sets standardized IP protec5on 5me periods 10 years for industrial designs; 20 for patents IPR Concepts Interna5onal agreements work through mutual consent. Small, undeveloped countries are rarely innovators Have to create a mechanism where it is in each country's own interest to enforce rules "Produced" v. "Found" intellectual property Folk tradi5ons in music Ethnobotanists Since they are small, they can take intellectual property without having a big effect on overall innova5on in the world Example: an5-HIV drugs Enforcement Primary issue between US v. China China has strong rules on the books, yet copyright infringement is (allegedly) rampant How it all Fits with Monopolistic Competition The next 4 slides discuss profit maximizing pricing when a firm has a monopoly posi5on The summary: prices should be a markup over marginal cost, and the markup depends on the price elas5city of demand If price elas5city is high, consumers react to price increases with large reduc5ons in quan55es firms should charge small markups If price elas5city is low, consumers react liqle to price increases firms can charge big markups without fear of losing sales Monopoly Pricing (quick review) Profits = Revenues Total Costs = PQ cQ F = (P C) Q F Where, C = marginal costs; F = fixed costs; Q = quan5ty sold To maximize profits => produce un5l MR = MC MR marginal revenue = revenue from marginal unit of quan5ty sold MC marginal cost = cost of marginal unit sold If MR > MC => addi5onal sales general posi5ve profits => sell more If MR < MC => addi5onal sales generate losses => sell less Total Revenue Price P1 Demand Q1 Quantity Marginal Revenue Price Raise quan5ty sold to Q2 Lowers price to P1 TR1 = A + B; TR2 = B + D P1 P2 A MR = D - A B D Demand Quantity Q1 Q2 Marginal revenue algebraically MR = (price you get from the marginal unit sold) + (the reduc5on in price from selling more) * (previous quan5ty sold) Mul5ply by p/p and rearrange. p MR = p + q q p q MR = p 1 + q p Marginal revenue algebraically Elas5city of demand is the percentage change in quan5ty given a percentage change in price q p =- p q p q MR = p 1 + q p 1 = p 1 - p = c - 1 Set MR = MC The price elasticity of demand for pharmaceuticals Consumer willingness to pay for health care rises with incomes Expenditures rise and price elas5city of demand falls. "Consumers" are o]en large en55es HMOs in US nego5ate discounts Single-payer systems (Europe) nego5ate the inclusion of par5cular NMEs on their "formularies" approved lists of drugs in exchange for steep discounts Compare pricing across markets US v. India Higher income means US has lower elas5city of demand, higher markups US v. Europe, Canada Centralized bargaining means Europe, Canada have higher elas5city of demand, lower markups How to equalize prices? Nego5ate Recent Medicare drug benefit in US. Law explicitly forbade Medicare agency from nego5a5ng prices. Re-import. Allow entrepreneurs to buy up low-priced excessive supplies in Europe, Canada, and ship them to US. Already happens to some extent, but inefficiently. Internet Medical tourism Arguments against re-importation Drug companies have to recover fixed costs somewhere, or innova5on slows down Safety of re-imported drugs Elimina5ng FDA approval would reduce 7 years and $468B in the drug R&D process Europe, Canada work in cahoots with pharmaceu5cal companies to limit reverse flow Drug companies use other techniques to prevent arbitrage ...
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This note was uploaded on 02/06/2012 for the course ECON 370 taught by Professor Staff during the Fall '08 term at Purdue.

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