Economic tools are used to analyze the production of goods and services in markets. They explain the outcomes and the relationship between the production and prices of different sectors. The production of prescription drugs is very expensive due to the research and development and marketing expenses. Companies are allowed to patent their drugs in order to recoup their costs creating monopolies in the market. This paper analyses monopoly and perfect competition market structures when it comes to prescription drugs. Companies offer benefits to employees by providing insurance for prescription drugs. What happens when consumers have to dip more in their pockets to pay for these drugs? The price and cross elasticity of prescription drugs compared to other variables is also analyzed in this paper.
Demand and Supply of Prescription Drugs
There are four types of market structures that exist in the capitalist system due to the interactions of demand and supply. Perfect competition occurs where there are many buyers and sellers in the market. There is perfect competition and there are no barriers to entry.
Market Demand and Supply
The price in the market is the average demand for the product. The firm will maximize its profit where the MC (marginal costs) meets with the average demand at point Q2. The profit that the firm makes will be the region between average costs and Marginal costs which will be in the long run. In a market where there are barriers to entry such economies of scale, advertising restrictions and collusion among sellers, a monopoly market will be created that creates efficiency. The prices of the product will not be at the point where demand intersects with supply. The monopoly companies will be able to provide fewer products but charge at higher prices. There will also be inefficiency in the company. As shown in the figure, the monopoly will maximize its profit at the point where Marginal revenue meets with the monopoly demand. This causes the company to produce a less quantity at Q2 yet the prices are higher at P2 than the price P1. This shows the costs to the consumer of having a monopoly in the market. The monopoly is not motivated to be efficient in its production of goods and services.
The health care system in America creates monopolies in the drug prescription industry and the consumers are the ones who end up paying. In America, drug companies are able to patent their innovation for a number of years. During this period the companies are able to set the prices for the drugs and the prices cannot be pushed down by competition as the company is the only one selling the prescription drug. The patent protection is justified on the basis of allowing the companies to recover their costs in bringing the drug to the market and selling it. Without patent protection, any company can copy the drug and the innovators will not be rewarded for their efforts (Glasgow, 2001).
Companies invest high capital amounts in the research and development process. The costs of developing of new drugs are between $250 Million to $ 500 Million. There are also high marketing costs incurred. Unlike the typical transaction where the seller advertises directly to the consumer to purchase the product, prescription drugs can only be received through the intermediary. The intermediary is the physician who prescribes the drugs to the patient. The physician does not profit in any way from the transaction since the patient has to purchase the drug from an independent pharmacist. In the past, the companies used to focus on reaching the physicians however since the Food and Drug Administration (FDA) started allowing the companies to advertise drugs directly to the consumers, the advertising costs have shot up. The idea behind the change in policy was that the patient who is educated about prescription drugs will be able to request what he wants from the doctor.
At this point of time, the market structure is a monopoly system. However after the patent expires, other companies are allowed to produce generic forms of the drug. These companies do not have the high capital outlay required in launching new products in the market. They therefore reproduce and market proven innovations in the industry. Once these companies enter the market, the market structure changes to become a perfect competition system where the consumers benefits. The entry of these generic drugs pushes the price of the brand name drugs down and the customer has a wide variety of products to choose from at lower prices (Frank & Salkever, 1997).
The generic companies are still able to make a substantial amount of money since they have incurred less research and development costs. There are times where the brand name drugs prices may not decrease. This happens where there are loyal customers who would rather buy the brand name products than the generic drugs. There is market segmentation where the prescription companies lose some of the market share to generic companies.
Elasticity of Prescription Drugs
Elasticity refers to the effect that a change in one economic variable affects another variable. Companies are interested in knowing the effect change in prices would affect the demand of the products in the market. This measure is known as own-price elasticity of demand. It is also important for companies to know what would be the effect on the demand of their products if a competitive reduced the prices of its products. This is known as the cross-elasticity of demand. There is also the income elasticity of demand which refers to the change in demand of a product once an individual has access to higher levels of income.
The amount of expenditure on prescription drugs has been increasing over the years. As a consequence, health insurance companies have started decreasing the value of their prescription drug benefits. In the years between 2000 and 2006 there was an increase in the cost-sharing US employer-sponsored health plans in the generic drugs from $7 to $ 11 dollars. In the preferred brands category the increase was from $13 to $ 24 while in the non-preferred brands category, the increase was from $17 to $ 38. Patients now have to use more of their money to buy prescription drugs. This approach has been justified on the basis that patients will now operate economically when it comes to health care (Kathleen, 2008). The people should switch to using lower-cost prescription drugs.
This view however has been contested with several scholars concerned that the people will stop buying essential drugs resulting to more serious diseases that may lead to higher inpatient and outpatient costs. There have been studies conducted to compare the relationship between drug spending by patients and cost-sharing. The studies have shown that an increase in the prices of the drugs by $1 dollar reduces the patient expenditure by $ 23.62 in the first year and in the second year there is a further reduction of $8.95 by the patients. This data gives a short-run elasticity of -6 while the long-run elasticity comes to a figure of -8 (Gaynor, 2006). This confirms that an increase in the prices of the prescription drugs causes the patients to reduce their spending. The decrease in the market share of prescription drug companies when the generic drugs enter the market also show that the price elasticity of the prescription drugs. When the prices go up, the people substitute the brand use with the generic products.
The value of economic tools is high as they assist researchers understand the outcomes in the market. They can also be used to predict outcomes in the future when certain variables change. These tools can also be used in the health sector when it comes to the production of health products and their selling prices in the market. The prescription drug market is better understood using economic tools.
Frank, R.G., & Salkever, D. S. (1997). Generic entry and the pricing of
pharmaceuticals. Journal of Economics and Management Strategy, 6(1), 75-90.
Gaynor. M. (2006) Is Drug Coverage a free lunch? Cross- Elasticities and the Design of
Prescription Drugs Benefits. NBER Working Papers.
Glasgow, L. (2001).Stretching The Limits of Intellectual Property Rights: Has the
Pharmaceutical Industry Gone Too Far? The Journal of Law and Technology, 41(2): 227-258
Kathleen, M. (2008). The Future of Prescription Drug Cost-Sharing: Real Progress or
Dropped Opportunity? Journal of Managed Care Pharmacy, 14(1): 70-82