JEFF JACOBY ON DRUG PRICES
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. When it comes to addiction issues, the alcohol deetox center has experts that can help one overcome the problems.
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.
Nice distinction about fixed vs variable costs. But a further distinction is that the pharmaceutical industry is not a classic competitive market. It is a government enforced monopoly through the anti-competitive patent system.
The same arguments apply to the software and music industries. The marginal cost of stamping out one more CD or streaming some electrons is effectively zero.
The patent system is a gross market distortion that works as a redistribution tax, transferring wealth from consumers to producers. It is a major component of increasing inequality. It is a self-reinforcing process as the newly created billionaires use their wealth to lobby for ever more onerous patent laws and international trade agreements.
The cost of stamping out one more CD may be near zero, but the cost of stamping out one more specific CD can be significantly more than zero based on setup costs.
The same is definitely true of drug manufacturing. Depending on the specific nature of the drug, some inputs can require long lead times, and if you want more of the drug NOW, you’re going to have to pay more. If you’re willing to wait then you can get it at the same or lower price instead.
In particular this is true for vaccines.
In this particular case, I don’t believe that the price or quantity issues are related to the medication. They’re related to Evzio, the automated injector system, which was approved last year, and is therefore protected and manufactured by only one company. The medication itself is on the list of world essential medicines, so it is protected from price gouging (it can be manufactured by other entities at government discretion if the price is too high to provide adequate sources to a community).
I wonder if the Boston Globe would give the same space and type size to Spencer and Goodwin. the trouble with “economists” is that the ones we get to read or hear in the popular media are careful to ignore the “subteties” in order to give the public, including “businessmen” the most ignorant version of economics to treasure to their hearts and take to the polls.
i would differ from BillB. Transfering wealth from consumers to producers is rather necessary if you are going to have any producers. In the case of medicine with a “pay or die” consumer, there is reason to impose some government market correction. In the case of music, I am not so sympathetic. If it costs you five bucks instead of five cents to get your favorite music, well you’re not going to die. And the musician has to eat, even if he produces only one “hit” in his lifetime.
a long time “liberal” myself, i get rather tired of those liberals who regard every “profit” as “theft.”
“…and is therefore protected and manufactured by only one company.”
Focus on the word protected. How is that “protection” provided? It is the result of government action/legislation. There is a value to that protection. What then should the government ask in return for the provision of that protective value? And this applies to all “protected” products. Patents and copyrights are a government phenomenon, the result of legislative actions. The patents and copyrights have value added to products by government action beyond the market value of those products. What share of that government added value is the consumer entitled to enjoy? Or, why is it only the producers who should enjoy government added value?
Coberly said “a long time “liberal” myself, i get rather tired of those liberals who regard every “profit” as “theft.””
And I get rather tired of so-called “liberals” who feel compelled to establish their “seriousness” by strawman hippy-punching.
Nowhere did I say that profits are theft or that companies should not have profits. What I pointed out is that patents are a government established monopoly and that monopolies create market distortions. This is objective fact, not opinion.
Once you accept that fact, then it is fair to have a discussion of the costs and benefits of that market distortion. For example what are the benefits and costs of retroactively extending copyrights to 70 years after the author is dead. Certainly there is no incentive for an already dead author to create more works of art.
Or why should a patent be issued for 20 years instead of 10 years or 5 years? These are simply monopoly rents so the amount of those rents should be justified and subject of discussion.
BillB
here we go again. i can only go by what you said, not what you meant. if you think a case can be made for limiting patent rights, please make it.
but what you said left you open to being understood to mean that all patents were “transfering wealth from consumers to producers.”
i wondered what the hell was wrong with that? that’s what you do when you buy anything: transfer wealth from consumer to producer.. unless of course you count getting the product as transferring wealth to yourself. if you are going to sound like a “hippy” you should expect some hippy bashing.
especially if what you are concerned about is the cost of “music” or even “software.” a true hippy of course, would make his own music. and the purchasers of software tend to be large corporations who can take care of themselves. when the cost is too high, they’ll find a way to develop their own. and maybe, fat chance, the noble consumer will find a way to get a price break out of that.
can us liberals concentrate on real abuses and injustice and stop feeling abused and cheated when we have to pay what we are willing and able to pay for what we want. well, “willing” is another of those words whose meaning is subject to interpretation, if not special pleading.
BillB
and for what it’s worth I (even I) did not call you a hippy.
in order for what I said to be a “straw man” argument, I (even I) would have had to have made the argument YOU made and held it up as an example of what “they” (even you) believe so that I could “refute it” even though i had made it up myself.
in this case it was the argument YOU (even you) made. so unless you are a straw man, there was no “straw man argument.”
Yes Bill, the marginal cost of stamping out one CD is zero, but in reality no one would really stamp out just one CD.
Hi Spencer:
Getting frustrated? This is why I seldom talk about the cost of manufacturing. People who never made a part, worked in manufacturing, etc start to expound on monopoly rents without regard to what the real aspects of making a pill. Yes, you are right, no one is gonna make one CD or one pill unless is it a MTO. My Rituxan stuff is like $18,000/dose. One nPLate tablet for me if the later does not work is $2500. Neither price represents the true cost of manufacturing nt the ability to deliver or capacity.
– Monopoly Rents can happen if someone wants to price gouge like with gasoline during the last go around in the Middle East. The state got on their butts and they were penalized.
– Fixed and sunk costs such as a press or mold need to be replaced over time as they wear out. You would want to have a degree of cost in the price to cover the replacement of it. This burdens labor.
– Tools and presses represent capacity or throughput which are measured by pieces/shift or per hour. 80% of total capacity is typically the top of capacity. At that point one can exceed it for brief periods of time. If the demand is expected to stay the same, capacity should/has to be increased.
– No amount of lead time increase will increase capacity or improve delivery. A silly statement to make; but, you would be surprised how many manufacturers think it will increase capacity or improve delivery. The only thing an increased lead time will do is increase backlog the length of the lead time. Shorten the lead time and the backlog will disappear.
– Pills are made in batches typically like 5 kilos of levothyroxine sodium which I used to plan in Puerto Rico on operation boot strap. Make one on a press dedicated to Synthroid is impossible unless you plug all the other pill molds. Synthroid takes weeks of manufacture; but this should not be a bottle neck as we plan demand/forecast and adjust accordingly by batch size or numbers of batches. Haven’t looked at CDs. Chips are made from crystals which are grown into discs and take weeks in Fab. They are later packaged into layers. Fab and Packaging can happen in different countries.
– Wish I was able to log into Jeff’s column to tell him he is full of shit and does not know what he is taking about. What I read in comments reflects ignorance too and shows why they are taken to the cleaners each and every time.
– Forget the copyright/patent arguments as they have nothing to do with the ability to manufacture.
– Increases in Demand do not mean higher prices even when capacity is constrained. The manufacturer has a choice, an ethical choice to make.
Hope that helps Spencer. I agree with much of what you said.
actually
if BillB just wants to pay the marginal costs of stamping out an extra disc (and never mind the capital cost of making and designing the disc stamping machine) i could supply him with a plastic disc “at cost.” Or even a disc stamped with The Airport Hare Yama Band playing their greatest hits. No patent fees.
BillB
now that my credentials as a serious liberal are established, we can move swiftly past your appeals to free market distortions by government established monopoly,
to address your specific questions
why “seventy years past death of composer?” well, perhaps so the composer will have some incentive to compose, knowing that his timeless composition will help support his handicaped child after he is gone.
why “twenty years instead of five?” well, perhaps so the composer can invest the next twenty years after his big hit trying to write another one without having to get a day job.
so discuss on.
but don’t expect me to be paralyzed with awe when you say “monopoly rents.” i really hate thought-stopping big concepts.
The problem with IP protection isn’t so much a problem with IP protection, it’s the existing problem with corporations as people in another outfit.
The current patent system allows companies to extract monopoly rents. This is a fact. There is no disputing that these are monopoly rents. So, according to you, we are not allowed to discuss the amount of these monopoly rents? These are effectively a government enforced tax on products. Can we not discuss the rate of taxation via the length of patent protection?
You seem to have missed the key point of the copyright extension act of 1998 as I pointed out above– it was RETROACTIVE. Unless you possess a time machine, an extension of copyright cannot provide an incentive for production of already existing works. Copyright extension can only provide incentive for future works. So the retroactive copyright extension act was a pure and simple political power play to extract more money from consumers. This is self-reinforcing since companies use the billions from the monopoly rents they extract to lobby for further monopoly rents.
No, BillB
we can discuss whatever you want. but I can only disucss what you say, not what you meant to say. and i am still not impressed with “monopoly rents” or even “just a fact.”
i have no doubt there is some, maybe a lot, abuse of the patent system. But I think I’ll stand by what I said so far.
Well, it seems,Coberly, that the phrase “monopoly rents” simply offends your “liberal” sensibilities. If you are disputing common terms of economics agreed upon universally by economists, I guess there is just no helping you.
For a scholarly discussion, try this:
https://research.stlouisfed.org/wp/2012/2012-035.pdf
The dirty hippies at the Federal Reserve provide a lucid discussion of patents and monopoly rents even you might be able to understand.
naw, it’s not my liberal sensibilites it offends, its my sense of making an honest argument based on the facts and not on sledge hammer words intended to stop thought.
as for dirty hippies, i believe it was you who brought that up.
Monopoly rents or not, it’s a level playing field as far as creators who own their work are concerned. The problem is that creators don’t own their work.
Cost vs Pricing Issue here. Sorry guys Spencer is correct. Forget your rents, patents, and copyrights. If capacity materials, and labor is available (and more than likely is), there is no reason to up the price. If such is available, this also becomes an ethical issue of charging more for something which can be paid for with higher volumes. This is one of the reasons why business gets a bad name for itself.
Life saving drugs should be free…paid through taxes just like police and fire protection.
Jerry
I couldn’t agree with you more.
as long as you understand “we” pay the taxes, and not “the rich.”
the rich need to pay more taxes according to their means. but “we” need to pay, through taxes, for our own predictable basic needs (as insurance). we can afford it… or we can make the government make it affordable… up to a point.
i am afraid that when everyone needs 80 thousand dollar a pill medication, “we” will find we are less compassionate than we thought.
Yves Smith’s introduction at NC
When “providing a product” is a lot more like “extortion:”
“…It’s used to treat cystinuria, a rare disease that causes painful kidney complications, namely unusual kidney stones of pure cystine. And until recently, tiopronin (as a small, nearly forgotten drug for an orphan indication) was rather cheap. It was sold by a small company in Texas, Mission Pharmacal, until Retrophin bought the marketing rights earlier this year (a move complicated by the company’s CEO, investor Martin Shkreli, who may have let the news of the deal leak on his Twitter account).
That link mentions part of Shkreli’s business plan as “acquiring the rights to obsolete remedies Shkreli says can be put to new and lucrative purposes”, and by gosh, that’s certainly accurate. Retrophin is increasing the price of Thiola from $1.50 per pill to over $30 per pill. Because they can – they stated when they bought the drug that their first move would be to raise the price. New dosages are formulations are also mentioned, but the first thing is to jack the price up as high as it can be jacked. Note that patients take several pills per day. Shkreli is probably chortling at those Mission Pharmacal hicks who didn’t realize what a gold mine they were sitting on…”
http://pipeline.corante.com/archives/2014/09/11/the_most_unconscionable_drug_price_hike_i_have_yet_seen.php
Oh, and as for taxpayer funded pharmacare:
Universal drug plan would save billions, UBC researchers say
“…A universal prescription drug plan could reduce total spending on medications in Canada by billions and cover everyone at an affordable price for taxpayers, health policy researchers say.
Canada is the only developed country with universal health insurance coverage that does not also offer universal prescription drug benefits.
About one in 10 Canadians say they can’t afford to take their medications as prescribed, previous studies suggest.
In Monday’s issue of the Canadian Medical Association Journal, researchers say the extra total cost to government of providing universal pharmacare could range as high as $5.4 billion a year, but would likely be about $1 billion, depending on exactly how much can be saved through bulk purchases of medications and other measures.
At the same time, it would save the private sector the $8.2 billion annually it spends on prescription drugs, mainly through employee health plans.
“When we did the analysis, we were, at first, a little bit surprised,” said study author Steven Morgan, a professor of health policy at the University of British Columbia in Vancouver. “Wow. Canada can really save billions of dollars by covering everybody for virtually every drug? And then we started to look deeper at the math, and it made perfect sense.
“You save about 10 per cent by getting better generic prices, you save about 10 per cent [on] brand name prices and you save an additional 10 per cent by encouraging more cost-effective prescribing,” Morgan said, using conservative estimates. “Mine those three things together, you save 30 per cent of a very large budget. Therefore you’re saving billions of dollars.”
If Canada achieved “middle of the pack” spending as in comparable countries like Switzerland, Italy and Spain, and achieved the rates of generic drug use seen in some provincial drug plans, a universal public drug plan would reduce total spending on prescription drugs in Canada by $7.3 billion per year, the study’s authors say…”
http://www.cbc.ca/news/health/universal-drug-plan-would-save-billions-ubc-researchers-say-1.2994857
[now that the conversation has drifted in the direction of the pure extortion question — cut and paste]
Time to break up the medical monopolies we are making?
Sovaldi, the $84,000 cure (90+%) for Hepatitis C. Early research got along on government grants — until researchers smelled money; then looked for private investment. Success: planned sell for $350 a pill but Gilead Sciences “gambled” and paid Pharmasset $11 billion for it, thinking of $1000 a pill …
… enough to cost $300 billion if all patients get treatment (70% will develop liver symptoms) — as much as all other prescriptions cost combined. Pharmasset would only have charged $100 billion.
Scientists ‘incredibly excited’ by asthma treatment breakthrough http://www.medicalnewstoday.com/articles/292947.php
Alzheimer’s: new ultrasound technique ‘restores memory’ in mice
http://www.medicalnewstoday.com/articles/290801.php
Nanoparticles that ferry dopamine to the brain offer potential Parkinson’s treatment http://www.medicalnewstoday.com/articles/292848.php
Got to read Medical News Today — multiple stories of progress daily — medical knowledge doubles every two years. When and if these treatments and dozens of others work out will they be a cause of joy and celebration — or will they be more causes of gut wrenching anxiety about how we as a nation are supposed to pay the extortionate rates of multiple medical monopolists? http://www.medicalnewstoday.com/
Antibiotics Against Superbugs
One line of research our non-hero scientists ($440 million personally to the chief scientist who discovered Sovaldi) don’t trouble themselves to pursue is new anti-biotics — seems the bugs develop resistance too fast and then the money dries up too soon. Welcome back to 1935.
https://thebrowser.com/articles/antibiotics-against-superbugs/
Meanwhile back on the farm, Bloomberg:
“since 2007, the cost of brand name medicines has soared with prices doubling for dozens of established drugs that target everything from multiple sclerosis to cancer, blood pressure and even erectile dysfunction.”
http://www.bloomberg.com/bw/articles/2014-05-08/why-prescription-drug-prices-keep-rising-higher
John D. Rockefeller and Andrew Carnegie could not have invented one monopoly after another to fete themselves on — temporary, but don’t worry, they can invent them faster than the lapse — and held the nation’s health hostage to garner obscene sums. Time to break up the medical monopolies we are making with our outdated patent system — don’t forget medical device makers and one-and-a-half million insurance bureaucrats (don’t care what their profit percentage is) trying not to pay three-quarters of a million doctors? Time for America to learn to do medicine a different way?
Played right, the medicine can become America’s rust proof, export proof (even to cheaper US locals), recession proof, pollution free, even robot resistan growth industry. Don’t worry; per capita output grows 20% every ten years to pay for it all — assuming the 1% don’t keep scarfing 95% (true figure) of the growth.
[Late note: “Hepatitis C linked to increased risk of liver cancer, other cancers” Double the risk of cancers other than liver cancer?
http://www.medicalnewstoday.com/articles/293082.php%5D
Noni
i agree totally. i hope no one thinks my objection to use of the magic word “monopoly rents” as a show stopper means I don’t think we could do a better job controlling drug prices.
It’s one thing to attack “patents” because you want to get that last CD for the cost of the plastic in the disc without paying the guy who wrote the song something for his trouble; it’s another to stick some “pay or die” patient with crippling costs “because you can.” Or even because “the cost of development” of that drug, or even the cost of production, is so high.
A government managed health system would distribute the high costs of some drugs among the costs of “cheaper” drugs so that over-all medical care remained affordable. It’s the “insurance” principle.
Something I’m afraid private insurers can’t manage. And private “providers” would never dream of.
noni, et al
please note that “taxpayer funded” doesn’t quite get it. if taxpayers are paying super high drug prices it all gets folded into the “cost of health care” and no one notices that some prices are too high or some treatments are not needed.
it needs to be “government regulated” so there is a competent oversight to the pricing and treatment ordered by the providers.
moreover, if “taxpayer” just means “the rich” there is the moral hazard that “we the people” won’t care how much it costs because those rich guys are paying for it.
it could be that if the rich are paying for it they will demand better cost oversight than “we” would, but it still offends my sense of justice that we, like the guy who wants cheap CD’s, want someone else to pay for our wants and needs when we are able to pay for them ourselves.
and sorry to run on a bit, but there are hordes of folks out there who think this means i don’t believe in helping the poor. actually i believe in it at the bottom of my soul. that’s why i get a little ticked at the “not-poor” who want “the rich” to pay for everything.
and i’d be glad to tax the rich more to pay for the government they need, as well as for the welfare “the poor” need. just not to pay for what “I” need.
Denis
as the (temporary) Resident in Patent Protection, I agree with you
but I worry: I worry that everyone will get charged up with “patent reform!” and rush to the other side of the boat, leaving the medical industry with other ways to discover “your money or your life” pricing, while poor John Denver’s grandkids have to get a day job.
Coberly,
I think it is a matter of the government setting all medical prices (we can’t pay doctors enough; they only account for 10% of health costs) — or funding most or all medical research. I’ve just started a book called The Entrepreneurial State which is all about how government around the world historically lead the way by funding the most risky research. The US gov spends $30 billion a year on drug research. I just started the book. (“Named one of the ‘2013 Books of the Year’ by the ‘Financial Times’ and recommended by ‘Forbes’ in its 2013 ‘creative leaders’ list”).
Basically, we didn’t pay Werner Von Braun $100 million to go to the moon. The Sovaldi lead scientist made $440 million for himself — just about exactly what it would costs to manufacture enough pills for every Hep C sufferer — $150 a full course treatment. Did B-2 stealth bomber engineers, or 747 engineers, earn a million dollars a year. Etc., etc. Why are drugs and medical devices supposed to be the only venues in which only extravagant greed leads to progress? Ask John D. Rockefeller. .
we can’t pay doctors enough?
the doctor that took ten stitches in my thumb billed medicare two thousand dollars.
i am thinking of former contributor “buff pilot” who seemed to think that the more you pay a doctor the better he gets. the god-man who saves your life.
coberly,
Medical billing Is a whole other world of lies and fantasies.
Jerry
you wouldn’t destroy a boy’s faith in the decency and reasonableness of this world, would you?
i don’t think faith is much help in this case.