Yves here. This post serves to illustrate how “economics says” has become a magic talisman in political discourse. Invoking it generally results in the audience accepting what follows, even when it is patent nonsense. Here we see how an editorial writer abjectly misapplied economic theory to justify super-high drug prices. Another argument against exploitative pharmaceutical pricing is that in the US, the industry benefits from extensive Federal R&D support. Mariana Mazzucato in her book The Entrepreneurial State, has determined that 3/4 of significant drugs (as in the “new drug applications” that were not mere modifications or reformulations of existing drugs) were Federally funded. So there’s a much bigger issue that the pharmaceutical companies get ample state support, yet are allowed to act as if they are purely private entities when it comes to price setting.
By Spencer England, an economist and investment strategist. Originally published at Angry Bear
Jeff Jacoby had an interesting article in the Boston Globe on Sunday where he argue that if the demand for something doubled the price must increase—it is basic introductory economics. What price is too high for a miracle drug?
His argument is so typical of how so many columnist and/or bloggers demonstrate that a little knowledge is a dangerous thing.
In basic theory many economist draw supply and demand curve that show if demand doubles the price will increase. But most are aware that this is actually a special case where all the assumptions of the perfect competition model hold. But, practical economists realize that this is a special case and that there are many exceptions to this theory.
Specifically, Jacoby writes that a doubling of a demand for a medical drug must lead to a price increase.
But the drug industry is a clear case where introductory economic analysis does not work because the drug industry is one of those industries where much of the cost of bring a new product to market is sunk or fixed cost. The specific sunk or fixed cost in the drug industry is the fortunes spent on research, development and testing before a new drug can be brought to market. These expenses are capitalized and incorporated into the price of a drug. The rough and ready rule of thumb is that these sunk or fixed cost account for about half of the price of a new drug. Exactly how much of this sunk cost is incorporated depends heavily on the estimate of how large the market for the drug will be. For example, if a drug firm has $1 billion in these sunk cost and they expect to sell two billion units of the drug they can assign $0.50 to the price of each pill for the sunk cost and another $0.50 for other costs of manufacturing, distribution, advertising, profits, etc., etc., so the final price is $1.00 per pill. But if the demand suddenly doubles, as Jacoby writes, the price does not have to increase. Rather the $1billion in fixed or sunk cost can now be spread over four billion units rather than original two billion units so the cost per unit falls from $.50 to $0.25. Consequently, the drug firm can cut the price of the drug from $1.00 per pill to $0.75 per unit and still make more profits than they did when the price was $1.00.
Jacoby’s analysis is a classic example that if so many bloggers or public pundits knew half as much as they though they knew, they would be geniuses. But the real problem is that the Globe editorial staff allows such shoddy analysis to gain the credibility it gets from being published in a highly regarded paper like the Boston Globe.
Jacoby claims that the doubling of demand for the drug Maloxone completely justifies the more than doubling of the price from $19.56 to $41.43 and that state officials should not investigate that increase. But maybe, just maybe, the state officials know something that Jacoby does not know.
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Warren Mosler has said before that the only part of econ that is relevant, anywhere, is the study of monopoly/oligopoly.
It works a hell of a lot better than anything else econ offers up as a model.
The pretty much non-existent “marginal” cost of producing more drugs is just the beginning of how this “law of supply and demand” breaks down. Completely irrelevant.
Keeping with the law, lets apply the law of gravity. Beat that, murphy!
re monopoly and oligopoly in the pharma sector, a more relevant article in the last few days comes from the WSJ, entitled “Pharmaceutical Companies Buy Rivals’ Drugs, Then Jack Up the Prices” http://www.wsj.com/articles/pharmaceutical-companies-buy-rivals-drugs-then-jack-up-the-prices-1430096431
“highway robbery”
I always love when an author uses soft, euphemistic words like “misapplies.” Personally, I prefer the pejorative “fucks up.”
But that’s the thing. This isn’t a mistake. It is purposeful deception.
It’s not an accident. It’s public policy.
Not so sure…I know plenty of otherwise intelligent people who not only think like this, but also actually believe that anyone who doesn’t is the equivalent of a climate-change denier.
I think that’s a great insight into differences in approach. There seems to be a vocal group that suggests any time people in power do something bad, it’s an error. It’s a logical defense mechanism for handling cognitive dissonance, since errors don’t negate the larger premise of good faith.
The trouble with bringing up fraud is that once it enters the picture, now you can no longer view leaders as acting in good faith. The issue is no longer a lone fuckup, but rather a systemic, institutionalized management philosophy of deceit.
The error view strikes me as particularly odd in drugs because drugs are so heavily regulated, from the prescription system to controlled substances scheduling to IP laws to international trade laws to research subsidies to tax breaks for non profit medical schools and hospitals to the way that Medicare, Medicaid, and other programs spend money. None of this is accidental. It’s not a fuckup that we run the largest prison system on the planet. It’s simply an unavoidable byproduct of keeping the legal drug trade distinct from the illegal one.
Never ascribe to avarice that which can be explained by incompetence.
Weather they are lying or not is actually besides the point. What we need to focus on is the fact that what they are saying is simply not true.
“Never ascribe to avarice that which can be explained by incompetence.”
Corollary: To conceal avarice, demonstrate the appearance of incompetence, and all those authoritarians who pledge allegiance to Hanlon’s Razor will eat right out of your hand.
This is one of the major changes happening beneath the surface in American society and a significant difference in intergenerational communication. Appeals to authority have lost all meaning for younger people. You have to earn trust through authentic dialogue. Credentials no longer confer that because it is precisely the people with the credentials that have been in positions of power over the past few decades.
Nobody is mistaking the economics here. The economics of drugs are, shall we say, patently clear. High initial investment, low marginal cost of production. The market cost of doubling the production of most drugs is quite low. It is that very clarity that requires the predatory class to create a facade of academic complexity. But it’s all a show, a sham, and I would suggest most of the audience knows that.
The only people who still seem to be suckered by the deception are older, more educated liberals who benefit from the extreme waste of resources in education and healthcare and so forth. After all, one man’s wasteful spending is another man’s salary.
It wasn’t anti-science Republicans that vetoed national health insurance. It was the educated Democrats.
This gratuitous generation bashing is unseemly and most likely very inaccurate. Are you really claiming that no younger people or conservatives buy into the arguments for pharma price gouging? What’s your evidence for this extraordinary claim or are you just expressing bigotry or generational self-loathing? Most of the “waste of resources” in health care is due to profit gouging by corporations that is either supported (see Medicare Part D) or at least not opposed by government. Blaming patients for seeking the care they need is unwarranted. Its the profit-driven healthcare system not the patients that produces waste.
The delicate sensibilities of the overpaid, control-obsessed, drug-war supporting, auto-centric, don’t-challenge-me police chiefs, prosecutors, judges, professors, doctors, deans, hospital administrators, civil engineers, journalists, bankers, politicians and all the other professions trained in our nation’s universities are so fragile that to point out that an overwhelming majority of the positions of power in our nation are held by people significantly older than the median age is generation bashing?
And at anyrate, I’m not generation bashing. If anything needs bashing, I’m bashing higher ed. The intergenerational comment is about communication. I’m not saying Millennials are better than Boomers. I’m observing that they are different in important ways. Younger Americans have experienced a very different world, one where the silliness of everyday authoritarianism has reached such extremes that large numbers of people can’t help but notice. Just Say No is embarrassing. The OFA bus tour that excluded national health insurance is embarrassing. The corporate media is embarrassing. Trickle down economics is embarrassing. The TSA is embarrassing. The treatment of sex and sexual orientation in our society is embarrassing. The lockdown of our nation’s schools and the embrace of testing is embarrassing. People have individual issues that matter more than others, but in the big picture, the aggregate spewing of our nation’s Serious People is comical – and comically out of touch.
I’m not predicting where things will change, merely pointing out that the elites have run out of capacity to buy off the younger folks. There just aren’t enough positions of privilege to hand out. So we don’t know what’s going to happen exactly, but something is happening. Once you stop buying the spin, everything falls apart that the pundits are trying to proclaim.
When a patient transports drugs across the Canadian border, I’m not blaming them for seeking affordable healthcare. The government run by aging college graduates is blaming them. When a patient uses marijuana as a cheap, safe, effective drug, I’m not blaming them. The government run by Democrats is blaming them.
Its not generation bashing to point out that positions of authority are mostly (but clearly not all) held by older people but 1) that was not your original argument and 2) even if it was being older implies nothing about one’s servility to authoritarian power structures since those in positions of authority are a minority of all older people.
Yes, all the things you decry (trickle down, TSA, OFA bus tour, Just Say No, etc.) were all backed by many young people. Who were bigger supporters of Obama than millennials? Reagan, in his day (as well as Nixon) had as many young supporters as Obama does today.
The bottom line is that you can’t generalize based on age. Elites and their courtiers come in all ages. Plenty of us older folk are as disgusted as any one and as victimized as any one by the outrages you cite. MIllennials are no different than their predecessors, either for good or for bad, no matter what your pretensions about them are.
Good, I think we largely agree. That’s right in line with the original comment.
On minority of people:
On positions of authority:
But we don’t completely agree, because here, you seem to be hesitant to really call out hospitals, universities, law enforcement, banks, media, and other actors to the degree I do.
I would propose that the willful blindness to injustice is stronger amongst age groups that benefit more and suffer less from this system. Wage stagnation and the drug war and so forth have disproportionately impacted younger Americans. Younger Americans, in aggregate, are living fundamentally different lives, from education to housing to marriage to kids to careers to driving to prison to poverty. Younger people (especially younger men) have experienced a system that views them as criminals first, valuable citizens second only after proving your worth. I’m not just talking black men although they experienced it the worst. Teens of all colors were increasingly targeted as problems rather than people, from petty things like age limits at malls and the removal of the facade of Constitutional rights in schools to major changes like extending driving restrictions and trying teens in adult courts.
I think age does matter. Not for everything. It’s not the only variable. But I think there is a lack of understanding among Americans born before about 1970, give or take, about how different growing up in the US was in the 1980s and 1990s. Not a lack of understanding by everyone, a general lack of familiarity in aggregate. And the new millennium is even more different, but we may not know exactly how for a few more years. Experiential learning leaves deep marks. It colors how we view things. In aggregate, this has left meaningful differences on everything from perspectives on cars to perspectives on drugs to perspectives on family. DARE alone did enormous damage to the reputation of police, and that’s just one specific program.
And so when you have different experiences and perspectives, communication gaps arise. Or to put it differently, you have Zuccottis and Fergusons and Baltimores and all the rest, with older Americans telling people to calm down and younger Americans begging to be heard.
Washunate,
Very well said, and I agree with everything you are saying.
My take isn’t just about an age gap. There is the first sin of personality types.
I remember reading a study # citing that @ 1/3 of the population had “authoritarian” tendencies. Either the few percent who were prone to want to be “the leaders” or the rest who tended to be the followers. These percentages SEEM right to me. In all generations. Those who prove they will bow down to “the powers that be” get ahead. They then become fearful of losing that advantage and become even more “conservative”.
It seems with age comes the legacies of everything that has had to be compromised thus far to survive, and then throw in what people will do “for their children”, and the lock is in. People are stuck. Until they are not.
So in a world where the ones with the money and power allow themselves even greater advantage by cheating and lying, The “newbies” you speak of are just as screwed as everyone else. And Here in the south, a large chunk of that demographic is closer to fascist faithful, “wrapped in the flag and carrying a cross”, and all that.
Everyone alive is the product of an age of propaganda.We have all been exposed to different strains, and some reinforced with lucrative situations, others reinforced by struggle.
The problem is that too many believe “the hype”, and know of nothing outside.
But, I agree with everything you are saying. here.
P.S., thought you might like a few quantitative ways of seeing differences over time.
http://www.gallup.com/poll/19561/who-supports-marijuana-legalization.aspx
http://www.gallup.com/poll/165539/first-time-americans-favor-legalizing-marijuana.aspx
http://www.journalism.org/media-indicators/newspaper-readership-by-age/
http://www.pewsocialtrends.org/2014/09/24/record-share-of-americans-have-never-married/
http://www.gallup.com/poll/169640/sex-marriage-support-reaches-new-high.aspx
I am the author of the article on drug pricing.
I’m also a 73 year old liberal.
Hi! So do you disagree with what I wrote? It was the Democrats who have prevented national health care. And affluent intellectuals who proferred justifications along the way. Media and Healthcare are just two of many areas where younger people look at credentials and fancy suits with wariness and disagreement. Things are changing; the present social arrangement is unsustainable.
I’m also very curious about your thoughts on John Hall and Northeaster’s comments. Jacoby is describing textbook economics. Odd price behavior is exactly what one would expect in markets where government grants monopolies through patents, especially when those markets also tend to have consolidated suppliers and disorganized buyers.
The question is not whether Jacobys economics is wrong. The question is whether we should have intellectual property laws, drug laws, trade laws, and so forth that create these economic situations. And whether healthcare should be allocated based on employment or based on citizenship.
There is no economic answer to that question because it depends upon one’s personal preferences.
At 26 sadly I can tell you young people aren’t looking period. They’re too busy with League of Legends and music videos.
Well, that’s certainly not true for many young people in Ferguson and Baltimore and New York and Chicago and Oakland, and I’m not talking about anybody whose picture got splashed all over the papers (or screens).
“Appeals to authority have lost all meaning for younger people.”
You mean those critical thinking courses have actually been working? Wow!
Two questions: younger than whom? ALL the “younger” people? I know quite a few in their late 20s-early 40s and plenty of them still fall for appeals to authority–especially if they have no particular background in the matter at hand.
indeed, appeal to authority still works for anyone who consults a doctor, hires a lawyer, or a skilled craftsman… so much for ‘no one is looking to any authorities anymore’
There is incredible skepticism in our society of those areas. Just google Citizens United. You get over 300 million results.
Appeal to authority is a logical fallacy and rhetorical tactic. Retention of professionals is an economic exchange with an enforced monopoly. I think many of the youth of today are living with a foot in both worlds, and while they may outwardly appear to defer to mainstream rulers on matters, I get the sense that most of it’s not particularly sincere.
They actually have to take courses for critical thinking now? Wow.
Some time ago I became aware that medical costs in the US as a fraction of GDP were in line with those of other advanced economies until around 1980, when they began to pull away from the pack. So I asked, what happened around that time to change the trajectory of medical costs in the US? One thing that happened is that Federal law was changed to allow pharmaceutical companies to patent drugs that had been developed with Federally funded research. Tilt! Is that not part of the problem?
Pretty much all the roads to ruin lead to the election of Ronald Reagan.
Pretty much. But I would also contend that this same philosophy has been true since the beginning of time. If you had money, you lived well and could afford doctors and medicine. If you didn’t have money you died unless you had a strong enough constitution to overcome. That was reality even in devoutly Christian societies all through the ages. Changing that equation is going to take a social shift much like the one we’re seeing towards marriage equality, driven by young people who reject the social system of their elders. Will the kids get riled up about healthcare? How about jobs?
It takes a movement and I don’t see one brewing just yet.
Wait a minute here. This post does not make any sense. In the perfect competition model, the supply curve is horizontal. It is perfectly elastic. If demand shifts right, then the price does NOT change. That’s the whole essence of perfect competition. No one firm has the ability to raise prices. Prices equal marginal costs.
Now instead, let’s think about the drug market. Specifically, due to the impact of patents, drug makers have limited time monopolies. This means that the supply curve is more or less vertical over the course of the patent. Prices are set such that marginal revenue equals marginal cost. Increasing demand (shifting the demand curve right) leads to higher prices in this model.
Nevertheless, Jacoby’s article notes that monopoly will not last forever. Eventually the drug will go off patent. While the drug in the article might retain some benefit from being a leading brand, it will still face significant competition from generics. Leading to falling prices.
The economics is textbook. However, that does not necessarily mean that the economics leads to the public policy implications that Jacoby’s article implies. Your point would be stronger if you attacked that aspect of it.
Forget your elastic and inelastic BS, this is as simple as a capacity issue which Spencer points out.. It is a cost issue and not a pricing issue. If capacity, materials, and labor exists; there is no reason for pricing to go up and the cost of introduction to the market is spread over a larger quantity and paid off sooner. If this is truly the issue, there is a problem of ethical behavior on the part of the manufacturer price gouging.
BS? He’s pointing out this is textbook economics. What you call price gouging the government calls patents.
Are monopoly rents in textbooks these days? And is someone entitled to a rent stream just because they push a sufficient amount of paper?
Ha, yeah.
For myself, I wasn’t an econ major, and haven’t been in school for awhile now anyway, but I figure if Gregory Mankiw talks about monopolies, it’s pretty mainstream:
http://gregmankiw.blogspot.com/2006/06/textbook-economics.html
“Prices are set such that marginal revenue equals marginal cost.” No. Not in the patent/monopoly market model. In that model a patent holder seeks to maximize his/her revenues while the patent provides market power. If there are therapeutically similar drug courses (that is, there are substitutes), the patent holder would seek to differentiate his/her product from the substitute through marketing. The availability of substitutes of similar therapeutic value constrains the patent-holder’s market power and thus, the price. In the event the drug has unique therapeutic value, pricing becomes a revenue maximizing exercise. For example, Rituxan is a highly effective cure for non-Hodgkin’s lymphoma. 20 vials of Rituxan cost about $15,000. I have no idea of what it cost Genentech to develop the drug, but there is very little likelihood that the marginal cost to produce 20 vials is $15,000, even if you include the pro-rata sunk costs. I suspect that the price of Rituxan will decline precipitously once the patent expires in Sept. 2016. I also suspect that the individuals who actually developed the drug (the lab rats the so-called free market wishes to incentivize with lucre) have made far less from their discovery than the principals of the company, who mostly play golf.
I might give Genentech a break were the drug its own creation, free of external support. But federally-funded research goes into 3/4 of all new drugs. I also might accept as rational pricing aimed at paying the company back for research cost for other drugs that didn’t make it into production. But $15,000 for a curative drug seems exorbitant to me. It bears no resemblance to a supply and demand meme.
You entire analysis is bunk because naloxone has been off-patent for decades, yet the current lone producer of the nasally administered dosage of naloxone still enjoys a monopoly because the profit margins on old, commonly-used generics have for many years been tiny compared to newer off-patent drug opportunities. Unless this producer can make the very far-fetched argument that its marginal costs more than doubled at the exact same time as demand for the drug increased, they are increasing the price because they -can-, not because they -must- by whatever version of the laws of economics you subscribe to.
But the reason we have consolidation in drugs is because of intellectual property laws, trade laws, lax enforcement of anti-trust laws, laws preventing buyers from negotiating volume discounts, lack of universal health insurance, consolidation in hospitals, and so forth.
Increasing the price because you can is the textbook definition of having market power (ie, oligopoly or monopoly pricing).
Sorry, that was meant for John Hall, not you.
Biologics have a barrier to entry beyond patents: being generally sourced from GMOs fermenting in a vat at such a rate as won’t kill themselves, they are in fact expensive and time-consuming to produce. I wouldn’t bet on a massive price decline. Genentech still has the machinery in its possession. Even if someone else has engineered their own organism to produce the same substance, the learning curve is steep and the ability of the second source to leverage the trial efforts of the first isn’t that high.
It should be the case that anyone with an appropriate laboratory could call the NIH and get a starter on agar for any such organism that was developed with government money.
Prices vary all the time in a perfect competition model, that’s the whole point: prices instantaneously adjust to equilibrate supply with demand because everyone is a price-taker.
Stand-up philosopher
I coalesce the vapors of human understanding into a logical and viable comprehension.
….OH, you’re a bullshit artist.
Did you bullshit anyone today?
The part of the Jacoby article that I’m mystified by is the idea that “supply” is restricted or “inelastic” as they like to say in the profession. How can supplies of a drug be inadequate for more than a few months? Those who demand the drug can just get on a waiting list until production can catch up. No price increase needed.
What if auto manufacturers did the same thing? What if they refused to produce more cars when they got popular and instead just jacked the price up? It would rightly be seen as a bizarre, short-sighted move. But, of course, the difference is that of monopoly, as “bob” points out right in the first comment.
If capacity or materials do not exist, chances are and just like making flu vaccine; the materials take months to produce. Sodium-levothyroxine which I used to schedule for Thyroid took months to make also and was expensive at $5000 / kilo but would make millions of tablets at various dosage.
Getting on a waiting list does not improve delivery or lead time and only increases the backlog or orders. The only solution is to increase capacity the same as in automotive to produce more product. This too does not happen overnight. Tooling for automotive molds, the same as pharma has to be made, then qualified, and approved by the OEM or USDA/FDA.
This drug is a life saving drug, getting on a waiting list means the patient dies. It is needed immediately to impact a drug over dose. Narcan reverses drug over dosage. “Naloxone is a medication used to counter the effects of opioid especially in overdose. It will usually reverse the depression of the central nervous system, respiratory system, and hypotension. Naloxone may be combined with opioids that are taken by mouth to decrease the risk of their misuse. http://en.wikipedia.org/wiki/Naloxone
Remember when they miscalculated which flu strains to use? They had to start them over again and delivery was months out for them. In automotive to make a new tool to increase capacity, it takes 16 -18 weeks, qualification/testing is another 4 weeks of repetition for life experience, and then the OEM has to approve it. If I miscalculated on making sodium-levothyroxine for Synthroid tabs, the lead time was 20 weeks to make more. In the case of Narcan (which this is) , creating a backlog of customers waiting does little good as the customer dies. “Narcan among others, is a pure opioid antagonist. Naloxone is a medication used to counter the effects of opioid especially in overdose. It will usually reverse the depression of the central nervous system, respiratory system, and hypotension. ” If you do not have it, the customer dies.
Capacity and materials may be the issue.
Capacity and materials are issues intermittently as only two manufacturers currently produce naloxone (and only one produces the nasal dose), but you’re wrong about the potential benefits of a customer backlog. This is not just because we’re mostly talking about hospitals as opposed to individuals as the customer base, but also particularly because the newest “customers” for naloxone are state and city health departments who are outfitting beat cops with the nasal form of the drug – many of whom will likely never even use it. Since these institutional customers do not “die” if there are shortages, squeezing buyers who have large budgets and inelastic demand makes perfect sense from a monopoly producer’s standpoint. Charitable outreach groups do not have the same resources, but will probably still buy naloxone for their programs no matter what the cost as there is no good alternative for acute opioid overdose – they will just be forced to purchase less, and more will die for the sake of Mr. Market. Intermittent shortages have been going on for years, so if generic naloxone manufacturers are unable to produce adequate amounts and are honestly worried about their limited supplies of drug being given to law enforcement and outreach programs who are less likely to use the medication compared to paramedics and hospitals, they could prioritize or restrict sales instead of doubling the price. But they do the latter because the US pharmaceutical market (and its apologists) allows them to get away with it.
Bart:
I am going to disagree on backlog as most manufacturers use it as an excuse to increase lead times which is false. What you are describing is a time phased rollout of a product to meet demand. You just do not dump it in the 1st week expending the plant to have a capacity in that week to build it. You phase the manufacture of it in or as you suggested in your plan, you lie to the customer on delivery.
LoL! Great sense of humor.
Couldn’t agree more. I lived in boston in the early 00’s, and I could never understand their reputation. They’d never be bothered to cover anything local, and anything above that level was straight neo-con orthodoxy, written by and for people who are from boston, but live in, ahem, Cambridge.
I think they used to call these types of people, locally, Loyalists.
Jacoby was an idiot when I used to read the Globe regularly. Nice to know he hasn’t changed…consistency is the virtue of small minds.
“economics says…” and every word that follows is a lie. It is called media framing or framing bias. In Framed! Labor and the Corporate Media, Christopher Martin identified five dominant frames in the media coverage of labor disputes:
The complicity of economists themselves with these frames, imposed on economics by corporate media, is especially troubling. Economists parrot the media frames as if they were endogenous products of economic analysis, which they are not. Even those economists who disagree do not directly challenge the legitimacy of the frames — instead they pretend they arise from methodological, interpretive, ideological or analytical differences between economists. When an “outsider” does challenge the legitimacy of the frames, the response from economists is stony silence followed by the continuation of business as usual.
Economics is NOT a science or even a distinct scholarly discipline. It is a wholly-owned subsidiary of the corporate mass media.
Hi Sandwichman:
I will but that one. Anything which can be explained easily, clutter it with BS. This ne sounds like one of my throughput consulting gigs where I have to explain increasing a lead time does not improve delivery.
Naloxone (not maloxone) was developed in the 1960s and is off-patent, currently being produced by generic drug manufacturers. The issue of massive sunk R&D costs thus don’t really apply in this scenario as the original patent holder stopped producing the drug long ago. However, this is a monopoly scenario because only one manufacturer (Amphastar) makes the drug at the concentration used for nasal administration, while another (Hospira) makes the drug at a lower concentration that can only be used for IV administration. The reason for the present de facto monopoly is that the profit margins on naloxone and many other older generics shrank drastically during the 90s and 00s when compared to newer off-patent drugs, such that many manufacturers stopped producing older, dirt-cheap generics for reasons of profit margins. We have reached the point where in many cases, only 1 or 2 companies produce the national or even global supply of pharmaceuticals that serve as irreplaceable cornerstones of modern healthcare. This has led to a rash of intermittent shortages – and there have indeed been shortages of naloxone for IV use in recent years. Jacoby seems hopeful that this situation will encourage new producers to enter the market, but in the case of naloxone the only new entry on the horizon is an auto-injectable form of the drug that costs $700 per dose. So Jacoby can wave his hands in textbook arguments all he likes but the truth is new producers have yet to volunteer to bring the price of naloxone back down, despite shortages and price increases that have been ongoing for years.
On the demand side, in addition to the increase in deaths from heroin use over the past three years (likely due to the crackdown on prescription painkiller availability – I mean, what did authorities think addicts would switch to if not even more dangerous street drugs?), there have been efforts in many states and cities to put nasal formulation naloxone in the hands of outreach/advocacy groups who distribute it in OD kits to users, as well as in the hands of law enforcement who can use it when needed on the job. These buyers, unlike hospitals and patients, do not work with insurance plans to pay for these medications, and the dramatic spike in prices corresponds exactly to the arrival of these new buyers in the market. Considering this timing and the de facto monopoly on nasal formulation naloxone, AGs have every reason to look into exactly how and why the manufacturer decided to increase prices so drastically and suddenly. The elevated price for naloxone is helping to save lives as Jacoby would have it, but rather making it much less affordable to charitable outreach groups who are trying to implement harm reduction programs in the community. There is no good substitute for naloxone in acute opioid overdose, and so reducing availability of the drug due to cost leads directly to increased overdose deaths.
Extra reading:
http://www.medpagetoday.com/Psychiatry/Addictions/48829
http://www.nytimes.com/2014/12/01/nyregion/prices-increase-for-antidote-to-heroin-overdoses-used-by-police.html
Monopoly, oligopoly. Even the most orthodox economist admits that the “law” of supply and demand does not apply in either of these situations.
It’s the only topic worth anything in most econ textbooks, and its usually given just a chapter, if that.
I can tell you that profits are not being made at the point of dispensing. The average price per script is five bucks. Many insurance companies often reimburse less than the price of the drug. All the profits are going to big pharma–which has layed off half of its employees since 2000. Pfizer doesn’t even have a marketing dpt., much less R&D, anymore; it’s all off-shore. Even big drug chains, (there are only 5 main ones now. Where’s the antitrust!) while providing dangerous, speed-up service, make half of their income on front-end sales.
If the demand for a drug doubles, of course there will be upward pressure on prices. I don’t care if it is in a perfectly competitive market, or an oligopoly. Then there is also the elasticity of the demand. Drugs tend to be pretty price insensitive. A diabetic will pay just about anything for insulin. As far as the government subsidizing the R&D of drugs, my guess is that these must be a specific class of drugs that have a low payout. If you have ever looked at the Income Statement of Big Pharma, you will note that R&D chews up most of the revenue. And most of these new drugs being expensively developed never make it to market.
You’re talking about fixed costs. The price of the drug is a variable cost; the initial price set by the manufacturer is one estimated to recoup the development and manufacturing costs. Unless there is a diminishing marginal productivity associated with increased drug production (costs increasing faster than profits) or gross negligence in planning drug prices there is no particular reason for prices to rise significantly.
Re-read my post. I said nothing about costs. That is the supply side. I am only talking about the demand side.
No, Jack. You discussed both, although you were obviously unaware of it.
You’re right…I did mention R&D costs. But the thrust of Jeff Jacoby’s article was only about how demand affects price levels. Did you read it? Here is a snipit which I completely agree with. Don’t you?
“Of course, with demand for the medication skyrocketing, the price has climbed as well. The workings of economics apply to pharmaceuticals just as they apply to housing, bourbon, iPhones, or tickets to NFL playoff games. When demand for a product or service rises, the price of that product or service can’t help but rise in response. That is especially true when the growth in demand has come about quickly or in unexpectedly short order.”
but it is supply AND demand that affects the price of a good.
IF the supply of the good cannot be increased without incurring additional fixed costs, then you may or may not be right.
IF the supply of the good cannot be increased quickly you are right.
but IF the supply of the good can easily be increased, then the price of the good should drop because of economies of scale.
and Jeff Jacoby is saying that ‘thanks to the workings of the market, more lives are being saved”
How does raising the price of a drug save lives?
Using your supply and demand curve, if prices rise, what happens to the demand of the drug? It falls, am I correct?
If the demand falls, then less of the drug is being used. If less of the drugs is being used, the LESS lives are being saved.
So it would appear that, thanks to the market, less lives are being saved and more profits are going to the maker of the drug, do you agree?
The supply of a drug is a bit more complex, because we are generally talking about industry supply with substitutes….viagra, cialis, levitra, generics. But in Jacoby’s example, there were no substitutes and the demand for a specific drug (to help heroin addicts detox) increased exponentially very quickly. The obvious result is upward price pressure.
and of course an increase in the demand for a good doesn’t force an increase in price, it enables it.
I am confused on why we want drugs sitting on shelves because of high prices. It certainly isn’t saving more lives.
You can be sure that if product is priced so high that it is not selling, the price will be lowered. Take Rogaine, for example. The price is pretty high. But the user needs to use it for the rest of his life for it to be effective. With repeated use of a product like this, you could certainly leave units on the shelf with aggressive pricing.
False. Supply, or apparent supply, can also be reduced.
If you believe that business is altruistic, you’re beyond the help of any legal substance.
Hunkerdown…where did I say business is altruistic?
Jack,
everything you are saying is hogwash.
The pharma industry as a whole has reliably spent as much if not more in some years on marketing, rather than R&D. The last time I saw actual numbers (5 years ago) the national institute of health regularly had done all the research in creating @ 1/3 of the drugs patented each year, and then GAVE these drug formulas to various drug companies, for them to patent.
Before the oil companies conspired to tighten the fuel supply,making them the most profitable companies in the early part of this century, the drug companies were the most profitable. In their time off the throne of the biggest crooks in the room, they have been manipulating “medicare part d” compensation negotiation rules. Bill moyer’s had a great special about “the state of Maine vs. the pharma industry”, where they had leveraged their Medicaid expenditures , so as to have a better negotiating position in getting cheaper prices on drug purchases. They did so. The pharma industry sued in maine. and lost. And kept losing all the way up the maine supreme court. They lost there too.
Then came the lobbying for a national medicare drug plan restriction which specifically denied the federal gov’t from using the heft it had (@ 52% of the market), from negotiating for better drug prices. And now we have shortages, insane prices so companies can make more money and sell/make fewer/less drugs.
So , Please,
Leave your market force factors garbage in the can where it belongs. This is the pharma industry, not some fictional company you are teaching college freshmen about.
I say the gov’t ought to let the NIH patent all their drugs they create as belonging to the people, and build an infrastructure to research, develop and manufacture and distribute needed safe drugs for the population, for pennies on the dollar of what it costs people now.
Let’s look at Merck, a typical example of Big Pharma. In 2014 they spent $7+ million on R&D. That is 17% of sales…far from chump change.
“Then came the lobbying for a national medicare drug plan restriction which specifically denied the federal gov’t from using the heft it had (@ 52% of the market), from negotiating for better drug prices. And now we have shortages, “
I assume by “better drug prices” you mean lower prices to the consumer, and because of the drug companies getting higher prices there are shortages. Is that correct? If I’ve got it right, it makes no sense since it is prices that are set too low, NOT too high that bring about shortages.
Nonetheless, if the NIH develops a drug, and gives it to big pharma to market, that private company should have little to say about the price. But, the drugs they produce on their own should not be price controlled. If it is, that’s when you end up with shortages.
I know former phama execs. They use every accounting trick in the book to allocate overheads to R&D. That number is exaggerated.
Moreover, it no doubt includes the cost of “new drug applications”. Over 85% of FDA “new drug applications” in the last decade have been for minor reformulations, like an extended release version (so you take the drug only once a day as opposed to 3X a day) to extend patent life.
And Big Pharma does spend more on marketing on R&D. Tell me how many industries are so profitable that they can afford to do in-person selling to small businessmen (which is what doctors are).
“R&D. That number is exaggerated.”
So would you call it tax avoidance or tax evasion? Either way they are inviting an audit.
“And Big Pharma does spend more on marketing on R&D”
Really?! OMG! How horrible! How dare a private company spend so much on marketing. They need to be punished for that. Maybe a boycott. Hmmm…no…people may need the drugs. Since we are into anecdotal examples, I have a close friend who has Parkinson’s. He takes two dopamine based drugs that keeps him out of a wheelchair.
tax evasion
And I am a cpa and we once did a study for a pharmaceutical company. Advertising was 30% of their sales
It was their biggest cost factor with r and d running a close second.
Huh? Merck’s sales in 2014 were $10.3 billion with a nominal research budget of $1.5 billion. Rule of thumb is half of what a business claims to spend on research is real, but let’s be generous and assume they spent $1 billion. That’s less than ten percent of total revenues.
Here is where I am get the 2014 data:
http://finance.yahoo.com/q?s=MRK
Then on the left side of page click “income statement”.
$42 million revenue with $7 million spent on R&D.
Where are you getting your data?
Jack, have you looked at Merck’s website? They average quarterly revenues in the range of $10 – $11 billion. So multiply times four.
So in your original post you stated their ANNUAL sales was $10.3 billion. Now you are saying they make that much per quarter. Which is it?
Never used the word annual, I just didn’t put in “Q4” because I was in a hurry. Did you check the site?
“Never used the word annual”
Really?! Then how am I supposed to interpret the following:
“Merck’s sales in 2014 were $10.3 billion”
Dunno. Everyone else gets it. Try reading the preceding comment rather than getting defensive?
Oh: Did you check quarterly earnings reports on Merck’s site?
With all due respect Jack, you are not reading that statement correctly. The numbers given are in thousands. Note the sentence above the chart on the right. Add three zeroes and you get very close to Ben’s figures.
if prices are set to low, demand increases, causing a shortage of the INVENTORY of the drug.
there is a shortage of the drug because MORE OF IT IS BEING CONSUMED.
Drugs sitting on shelves because of high prices don’t really help sick people.
Yes jack,
from a consumer point of view, a lower price is a better price. The gov’t buys these drugs for people to use. Therefor they are a consumer, and to get lower prices means that there will be more money left in the budget to buy more things people need.
as far as merck is concerned, they are trying to rig the markets like all the rest of the drug companies, by creating an environment where economic standards(volume price discounts,economies of scale,negotiation for prices,etc.) don’t interfere with their monopolistic/oligopolistic desires to have their cake and eat it too.
The real problem is that these companies are still making a profit. So they can’t really say they are not “making money”., as a reason for cutting back on anything. And really, it is this type of pig headedness that is the problem washunate was talking about ,up thread. People with their heads so far up their asses, they can disregard this entire industry SHOULD be nationalized for the sake of national security, and also for the sake of making healthcare dollars go as far as possible and healthcare needs being met.
as we have it now, we have people needing drugs which were invented years ago, losing access to drugs because privately controlled companies say they can’t make enough profits, when they are already making profits and are receiving welfare from the state(NIH research,tax breaks, sweetheart gov’t contracts,etc) .
That is why these companies are stupid. They deserve the wrath of the people whom they are gouging, which is everyone. And should have many and any of their patents confiscated by eminent domain, just like any private property that can be taken for a greater public good. And the fact is we are left in an unsafe position to leave these drug companies alone, for they have demonstrated their inability to do what is best for society.
Shortages are caused by lack of will. Not anything to do with a marketplace. If there was a will, there would be a way. I don’t know, but Ive never heard of a shortage of Viagra or of oxy contin . The pharma industry can flood the streets with anything it wants, even if most of those sales are going to kids in high schools. The shortages are just the industry trying to put the consumer over the proverbial barrel to show whose boss. And we all know it. And if you don’t, you are not thinking about it very clearly. There was even a congressional hearing about the overpresciption of these “party” drugs, which the company knew were making them extra billions per year, and were not used by sick people, but the demand was there, so they gave the supply to the pill pushers in white coats and kept the supplies on the streets. This is now resulting in the number one cause of hospital visits and death in young people.
So while these pharma execs choose not to make drugs for people who need them, they sell the hell out of drugs for people to party with. And people like you go to bat for them? nice try at pretending to be conservative on this issue.
Jack:
Forget elastic, and inelastic pricing and price sensitivity as it has nothing to do with manufacturing the drug and costs. What you propose is price gouging by believing the price/cost goes up if demand increases. It doesn’t. If the capacity and the materials exist, there is no reason for costs to increase forcing a pricing increase and indeed the overhead, fixed costs, and R&D are spread over a broader amount of product. The other exceptions are just that . . . exceptions.
People will pay just about anything to be well again; which does not mean, we should profit excessively off their disorders and illness.
You are making the same mistake someone else did above. I said nothing about costs. I, as well as Jeff Jacoby, the author of the Boston Globe article, am simply talking about demand. To deny the fact that a rapid increase in the demand for a life saving drug should have no affect on price is to deny the most fundamental laws of economics.
“People will pay just about anything to be well again; which does not mean, we should profit excessively off their disorders and illness.”
Then why not just have the government nationalize the drug companies….kind of like what Chavez did with the oil companies. And, hell, why stop there?
Reductio ad absurdum only works when your confrère agrees with your concept of absurdity.
What we are saying is that there is no reason for basic needs to be subject to the laws of economics, where they will inevitably be corrupted, degraded and captured by those at the top who least need or deserve it. What’s so wrong with a society that says no dessert until everyone’s had dinner?
Absurd indeed. Food is a basic need. When China under Mao began his “Great Leap Forward” program, the ultimate result was mass starvation. Then Mao died and Deng Xiaoping took over. He decided to reduce quotas for Chinese farmers. Once modest quotas were met, they could keep the surplus and do with it what they pleased. Food production exploded. The rest, as they say, is history. Those greedy selfish farmers.
It has reduced poverty, while incomes and income inequality have increased, which is leading to a resurgence of the new left.
Its a dynamic process and one would be remiss to claim victory on such a small slice of time.
Skippy… Do rats and mice claim victory at the hieght of a population explosion – plague?
Isn’t it interesting that as the poverty rate decreases, income inequality increases. Would you prefer it be the other way around?
No, it isn’t interesting as assuming a causative relationship is a logic failure.
Since 1820 the global Gini Coefficient has risen 30%. During the same period, however, global poverty has fallen drastically. The two are tied to the hip in an inverse ratio.
The point of the article was that his “economics”explained why the government should not ask for information explaining why the price more than doubled.
Do you agree with that?
I think everyone but me has said this on here before.
The price doubled… because of markets.
no further explanation needed.