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Saturday, September 21, 2002How did the drug industry get to be so unpopular? "Murray suggests that much of the problem is internal - pharmaceutical PR has been so heavy-handed that people assume that we must have something to hide. He suggests that the industry lobbying group, PhRMA, give up the front-group ads and campaigns, and reign in the marketing excesses that make it look like we have to buy doctors to prescribe our drugs. He concludes "If the drug industry wants less criticism from the public, it will have to start by giving people less to criticize.” There’s an even more fundamental reason people hate drug companies - drug prices. When they hear how much cheaper drugs are in Canada, they assume that the drug companies are price gouging here. That may not be true, but that’s the perception, and nothing stirs a visceral dislike more than the perception of being played for a fool. COMMENT: A reader emailed this defense of drug prices: It's not at all clear what "price gouging" means in the context of drugs. [0] Drugs are effectively an "information good" in that the upfront development cost is very high but the marginal cost of production is very low. This has two implications: (1) In order to make a long-term profit you need to charge much more than it costs to make the product. In order to do so you must have at least a temporary monopoly. [1] (2) You have something like a monopoly so you can practice what economists call "price discrimination". The reason for price discrimination is simple. If you charge too high a price you price people out of the market. Since every extra unit sold brings you some profit, this is bad. If you price too low you forego the opportunity to make a bunch of money from people who would pay more. So, if you set one price, no matter what you do you forego money. The idea behind price discrimination is: (1) Figure out some way to differentiate between people who are willing to pay more and those who won't. (2) Stop people who are willing to pay more from getting the product at the cheaper price. Generally it's not possible to do this perfectly, but doing an OK job is possible in many cases. The classic example is airline tickets. Business travelers are less price sensitive but more schedule sensitive. Thus, airlines offer discounts preferentially to vacation travellers by requiring cheap tickets to be bought well in advance and for inconvenient travel times (like staying over Saturdays). A similar situation obtains with drug sales to Canada. The Canadian government isn't willing to pay as much as American HMOs and so the drug companies lower their prices to Canada rather than forego sales in Canada entirely. They couldn't afford to sell drugs in the US at that price. [2] This may seem unfair, but price discrimination allows products to be sold that otherwise wouldn't exist. Consider the following example, lifted from Hal Varian's Pricing Information Goods. Imagine that a publisher manufactures an electronic book. It costs $7 to make the first copy and $0 to produce additional copies. Now, there are two consumers, A and B. A is willing to pay $5 for the book and $B is willing to pay $3. Now, there's no single price at which this book can be sold since at $3 both A and B buy but the publisher only makes $6, which isn't enough to recover costs. At $5 the publisher only sells to A and only recovers $5. In either case he loses money. The only way to make money with this cost and demand structure is price discrimination. If the publisher can price discriminate (e.g. charge A 4.75 and B 2.75) then everyone is better off. I don't expect any scheme designed to equalize prices between the US and Canada to have the desired effect. Rather, I expect one of three things will happen: (1) Drug companies forego the Canadian market entirely. (2) There's a uniform price that is very much higher than the current Canadian price and only very slightly lower than the current US price. (3) The price falls to the Canadian price and the number of new drugs produced drops dramatically since the potential profit is so much lower. [0] Actually, to an economist, it's not at all clear what price gouging means, period. [1] This is what is provided by drug patents. Once the patents expire the drug becomes a commodity and so the price gets driven down to near the marginal cost of production. [2] If drug companies COULD afford to sell drugs in the US at those prices then it would pay one of the companies to start offering their drugs at lower prices and capture the market. Consider, for instance, the case with PPIs. Aciphex and Prilosec aren't totally substitutable since some people prefer one to the other, but they're mostly substitutable and if Aciphex were half the cost then it would be the first round drug of choice and would dominate the market, since it's good enough for most people. All of these are valid points. That’s why I was careful to use words like “perception”, “assume, and “may not be true.” The reality, however, is that the average consumer puts the blame squarely on the drug companies. Believe me. I listen everyday to rants about greedy pharmaceutical companies and greedy insurance companies executives. The “root cause” of my patients’ discontent is always the high prices they have to pay for their drugs and their insurance policies. They don’t care about the finer economic points. Even a misperception can have powerful force if enough people believe it. posted by Sydney on 9/21/2002 07:18:00 AM 0 comments 0 Comments: |
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