Pharmaceutical Monopolies
The importance of medical science innovation can hardly be overestimated and is reasonably appreciated by the government of most countries. As a result, when a pharmaceutical company creates a new drug it may apply for and be granted a patent that is a “legal protection that shelters an invention from being used, copied, or traded without permission of the patent holder for a certain period of time” (Schweitzer, 2007, p. 253). It should be pointed out that the patent law of different countries may be different and that to protect its rights worldwide an innovator company needs to be mindful of these differences. For the WTO member countries the patent period, as determined in 1995, equals 20 years (Schweitzer, 2007, p. 256). The starting date is that of an application filing. Besides, for drugs (as well as a number of other products) the period can be extended through additional procedures.
This undoubtedly means that a drug inventor company becomes a monopolist since the date of its patent application filing. Despite the fact that after the patent expires, new participants are most certainly going to enter the market with their “generic products” and make it more competitive, the marketing “leeway”, which an inventor gains through the twenty years of monopoly, is incomparable. It is obvious that the reputation of a product and the trust of consumers are important factors of business success and twenty years are more than enough to build them. As a result, in order to become competitive generic drugs have to be sold at a lower price, while the monopolist, even after becoming a former one, still has the opportunity to charge a cost that is much higher than the marginal one (Mankiw, 2014).
This part of the patent legislation has roused many questions. Apart from the obvious patent drawback, that of prohibiting people from using knowledge and therefore slowing the process of research, the patient rights issues become highlighted when medical patents are discussed (Green, 2008). It is obvious that by using the monopolist’s opportunity of charging a higher price, pharmaceutical companies restrict access to the product that is in many cases vital for the patients. The contradiction between patent rights and patient rights will probably stay acute for as long as pharmaceutical patents exist. At the same time, the reasons for granting patents are understandable, and the primary of them is that of encouraging research. It is well-known that research is an extremely costly activity: the Pharmaceutical Research and Manufacturers of America estimate the costs of drug development to be about $1.5 billion USD (Grayson, 2015, par. 4)
Such a figure is not surprising once we take into account the fact that it is not only the complex scientific process that is so fund-demanding but also the drug regulatory requirements that need to be taken into consideration along with the risks of failure that any kind of research entails. Therefore, it appears to be only fair to encourage drug innovators and allow them to compensate for their possible losses through the granting of a marketing privilege. As for the patients’ rights, one should take into account the fact that even before the cheaper, generic kinds of drugs appear, the price of a drug demanded by its monopolist has to stay reasonable. The reasons for that are not only ethical: in case a drug becomes too expensive, people will be forced to stop buying it, and the deadweight loss of the monopolist will become too great for any efficient business to tolerate.
Marginal Cost of Drugs
It has been pointed out that the marginal cost of drugs tends to be relatively constant (Flynn, Hollis & Palmedo, 2009; Mankiw, 2014). In order to identify the reasons for that, let us describe the notion of marginal cost.
The “marginal cost” is the term that is used to define “the increase in total cost that arises from producing an additional unit of output” (Mankiw, 2014, p. 244). One may conclude, therefore, that marginal cost depends on the changes in the total cost and the quantity of the units produced. However, it should be pointed out that the fluctuations of fixed costs do not depend on the output. As a result, while the changes in the fixed costs do affect the total costs, they do not cause marginal cost fluctuation. It is the variable cost that changes with the number of units produced. Therefore, it can be assumed that the marginal cost of a product mainly depends on the variable costs that first and foremost include the costs of the input.
In relation to this, it should be mentioned that most of the possible drug ingredients, the supply of pharmaceutical companies, are available at the competitive market, their costs being relatively constant and competition-regulated (Flynn, Hollis & Palmedo, 2009). It appears that this is the main reason for the fact that the marginal cost of most drugs is constant and, as a result, may be presented as a horizontal line.
Originally the monopolist drug price does not actually depend on the marginal cost. The standard pricing strategy for monopolies is setting the price for a product unit well above the marginal cost. It has been proved that notwithstanding the ethical issues connected to such a decision, pharmaceutical monopolies are not an exception. Despite the fact that their products are very often literally vital, or that the consumers cannot assess the actual value of the product offered, drug monopolies still have the right to demand a high price which they use (Flynn, Hollis & Palmedo, 2009; Mankiw, 2014). However, even these prices are bound to depend on the demand during the first twenty years (when the patent is still valid) as they are going to reduce slowly.
The situation changes more rapidly once new participants enter the market after the patent expires. It is obvious that the only way in which generic drugs can be differentiated from the original one is the price. By setting the lowest price possible, new market participants do not only secure their position but also have an impact on the market, in general, that is felt by everyone, including the former monopolist. Under the pressure in the market, this company also has to reduce the price until it becomes equal to the marginal cost. After this, the stability of marginal cost will affect the price of the drug much more considerably.
It could be useful to point out that the marginal cost of drugs is only relatively constant; besides, the mentioned tendency cannot be applied to the products that contain some specific, unusual or restricted components, for example, those from rare plants (Flynn, Hollis & Palmedo, 2009). Still, the described specifics of marginal costs are applicable to most pharmaceutical companies. Due to the fact that their supply is present at the competitive market, these monopolies never have to deal with the overpriced products like their own.
References
Flynn, S., Hollis, A., & Palmedo, M. (2009). An Economic Justification for Open Access to Essential Medicine Patents in Developing Countries. The Journal Of Law, Medicine & Ethics, 37(2), 184-208.
Grayson, M. (2014). On Pharmaceutical Innovation, Intellectual Property Rights, Patient Access and Pricing. Web.
Green, S. (2008). Ethics and the pharmaceutical industry. Australasian Psychiatry, 16(3), 158-165.
Mankiw, N. (2014). Principles of microeconomics (7th ed.). Stamford, CT: Cengage Learning.
Schweitzer, S. (2007). Pharmaceutical economics and policy. Oxford: Oxford University Press.