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Pharmaceuticals

Pharmaceuticals. Econ 737 11/11/10. Outline. I. Introduction II. Research and development III. Regulation IV. Patents V. Pricing VI. Direct to consumer advertising. I. Introduction. Pharmaceuticals: mostly medicines and vaccines

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Pharmaceuticals

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  1. Pharmaceuticals Econ 737 11/11/10

  2. Outline • I. Introduction • II. Research and development • III. Regulation • IV. Patents • V. Pricing • VI. Direct to consumer advertising

  3. I. Introduction • Pharmaceuticals: mostly medicines and vaccines • Share of health care spending: 8.3% in U.S., 15.4% in France, 18.5% in Germany, 29% in Japan • In absolute terms spending is higher in the U.S. than most countries, but less than Japan

  4. I. Introduction • Why are pharmaceuticals unique? • Prescription needed (except for OTC); physician’s role as agent even more explicit • Insurance historically less pervasive than for other medical services (why might this be?) but expanding • Share of drug costs paid out-of-pocket dropped from 82% in 1970 to 34% in 1995; has continued to drop since Medicare began covering drugs in 2006 • Role of R&D => patent protection => market power • Large profit margins (61% compared to 31% average for manufacturing industries) • International trade issue • Imports 8% of consumption in developed countries and 20% in developing countries • In the U.S., should importation be allowed? • More spending could mean less spending

  5. II. Research and Development • Success of a few drugs in mid-1900s (i.e. penicillin) led to an explosion in R&D spending • $263 million in 1951 to $8 billion in 1990 (1990 dollars) • Gradual movement from no science to “try everything and see what works” science to “rational drug design” rooted in biochemistry • R&D subsidized by government (is this appropriate?) • Grants ($4.8 billion in NIH funding in 1991) • Financial aid for prospective scientists • University funding

  6. III. Regulation • Most developed countries have regulatory institutions to ensure safety and efficacy (Food and Drug Administration in US) • Leads to huge time and money costs with testing • Average amount of time to go through testing and regulatory process: 9.1 years in 1990s • What is “optimal” level of regulation?

  7. III. Regulation • FDA regulation in its current form began in 1962 and has drastically limited the amount of new drugs since then. • Is this good or bad? • “Compassionate use” began in 1980s to allow patients with life-threatening illnesses access to not-yet-approved drugs.

  8. IV. Patents • As a result of the costliness of R&D and the approval process, most drugs are money losers.

  9. IV. Patents • Given the large time costs and risks, some type of patent protection to ensure drug companies can profit from their successful innovation is generally considered desirable. • But what is the “socially optimal” level? • In US, currently 20-year patent protection but clock starts at time of discovery, not approval, so in practice much less than this.

  10. V. Pricing • Under patent protection • Differentiated oligopoly: monopoly over the compound but other compounds can treat the same condition • Of 148 patent-protected compounds studied by Lu and Comanor (1998), 135 had at least one close substitute and the average number of substitutes was 1.9. • Price depends on the degree of improvement over the substitutes (Lu and Comanor, 1998) • Important gains: 3.2 x price of substitute • Modest gains: 2.2 x price of substitute • Little of no gain: about same price as substitute • Tort liability matters: Manning (1997) found half the difference in the prices of selected drugs between US and Canada was due to differences in tort liability risk

  11. V. Pricing • After patent protection • Now face competition from generics • 1984 law allowed generics to have an abbreviated approval process • Generics saved US consumers an estimated $8-10 billion in 1994 (CBO, 1998) • Generics’ share of prescribed drugs rose from 18.6% in 1984 to 44.3% in 1998 • Generics enter at prices 40-70% of original

  12. V. Patents • Incumbents often respond by raising prices. • They face two groups of patients/doctors – price-sensitive and brand-sensitive – and found it more profitable to ignore the price-sensitive group and just milk the brand-sensitive group.

  13. VI. Direct to consumer advertising • Historically marketing directed to physicians, through pharmaceutical sales reps, advertising in medical journals, etc. • As of 1997, laws on direct to consumer advertising relaxed to allow companies to mention drug name and discuss benefits => explosion in TV ads, etc. • Is this good or bad? • Empirical evidence on effects mixed, although clear physicians don’t like it

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