Supply and Demand - Pharmaceutical Industry

Supply and Demand Ð'- Pharmaceutical Industry

In today's society, a large percentage of the population requires prescription drugs to treat injury or illness. In some cases, the need for drugs may be short term and in other cases, the drugs may be required for the remainder of an individual's life. In all cases, prescription drugs are not free; the individual or his or her insurance company pays. The type of drug and available substitutions generally drive the costs. In this paper, I will summarize a study, "How Increased Competition from Generic Drugs Has Affected Prices and Returns in the Pharmaceutical Industry" and relate the contents of this study to the economic theories described in the fifth edition of the book, Economics by David Colander .

Summary of Article

"In 1984, the Drug Price Competition and Patent Term Restoration Act (also known as the Hatch-Waxman Act) created an abbreviated approval process for generic prescription drugs and at the same time extended patent terms for innovator drugs" (Cook, 1998). The Chairman of the Senate Committee of the Budget authorized an analysis of the impact generic drugs had on brand-name drugs as a result of this act. The study had two objectives Ð'- examine the extent to which competition has increased and how that competition has affected the returns from developing a drug (Cook, 1998).

In the study, the author compares the economic impacts of two drug categories: the innovator drug and the generic drug. Break-through and brand-name are acronyms for an innovator drug. As long as the patent has not expired; an innovator drug cannot be duplicated in a generic fashion. However, an innovator drug faces competition from Ð''me too' drugs because the Ð''me too' drug uses the same functional mechanisms as an innovator drug but with a slightly different chemical combination. The generic drug is a low cost substitute for a brand-name drug (Cook, 1998). With the introduction of Ð''me too' and generic drugs as competition, the classic supply and demand theories come in to play. "When quantity demanded is greater than quantity supplied, prices tend to rise. When quantity supplied is greater than quantity demanded, prices tend to fall" (Colander, 2004, p. 97).

Supply and Pricing

The government plays a large role in controlling the economic market for pharmaceuticals. "By extending patents on brand-name drugs while making it easier for generic drugs to enter the market after patents expire, the Hatch-Waxman Act aimed to benefit consumers by increasing the supply of generic drugs while preserving drug companies' incentive to invest in research and development" (Cook, 1998. p. 4 ). Because manufacturing costs for generic drugs are less, the prices are lower. The introduction of generic drugs has kept the overall price of prescription drugs down which is beneficial to the consumer. Cook (1998) states:

Economic theory and various studies suggest that the presence of several therapeutically similar drugs limits manufacturers' ability to raise prices as much as would otherwise be the case. In addition, brand-name manufacturers are more likely to agree to give purchasers a discount if those purchasers have the option of switching to a generic or me-too competitor.(p. 2)

In contrast, the increased sale of generic drugs reduces the returns that pharmaceutical companies earn from developing brand-name drugs (Cook, 1998). The extended patent time period for a brand-name drug provides the manufacturers with an opportunity to charge higher prices. These higher prices translate to greater earnings which enables the manufacturer to recover its' development costs.

Demand and Pricing

According to economic theory, both demand and production costs play a role in determining the price of a drug (Cook, 1998). The market is seeing a greater increase in the demand for generic drugs because the costs are lower than innovator drugs. However, the increasing demand for generic drugs continues