Price Controls and Pharmaceutical Drugs

It is no secret that drug prices are on the rise. Pharmaceutical companies across the nation are gaining large profits through their hold on such a vital resource. Due to the qualities [m1]that characterize pharmaceutical drugs, companies are able to drive up prices without fearing sufficient decreases in profit. Corporate leaders are aware of their position because drugs are an inelastic good. Therefore, they are able to increase their total revenue by increasing the price of their good. The situation becomes more complex, however, because people on the other side of the equation are lashing out against the high prices cast on consumers by urging the government to enact interventions that will help to allocate the good to those who need it most.

Due to the inelastic nature of the demand for  prescription drugs, companies are able to drive up prices without fearing a drastic decrease in demand. When the price elasticity of a good is low, a change in price results in only a minor change to quantity demanded. Mathematically, this is true because the formula for determining price elasticity involves finding the change in percent quantity demanded, and dividing it by the percent change in price. If the result bears a number less than one, the good is considered inelastic.

Inelastic Good

Price

P2

P1 D

Q2 < — Q1 Quantity

Graphically, this phenomenon would result in a steeper demand curve as the price offered by producers moves along the demand curve. Thus, By increasing the price of a medication, drug companies can reap a greater profit as they know that consumers will continue to purchase the good even at a higher price. Drugs are an inelastic good because typically there are no close substitutes. If an individual has a certain illness or disease that is treatable by taking a certain drug, the individual will have little choice but to become a consumer of the good. In addition, because drugs are a necessity and not a luxury: if you need a medication, you literally can not go without it.

In theory, companies producing an inelastic good have the flexibility to increase prices because, in accordance with any market structure, those who have a willingness to pay that sustains the market price will consume the good, and those who don’t, will not consume the good. The picture becomes more complex, however, because need is not always represented by willingness to pay, especially in the case of healthcare. Intervention may be necessary to ensure that people receive goods that are vital to their health even if they are not in the financial position to afford the drug. Thus, as highly beneficial as the inelasticity of a drug is to the financial interest of pharmaceutical companies, American society is presently debating over how to set the welfare of americans in balance with the behavior of the industry.

Although it is important to provide incentives – a driving factor behind the productivity of an economic structure, equity must also be considered. Equity is based off of principles of morality held by a society. There are necessary trade offs between equity and efficiency in society because acting in the utmost efficient way can sometimes harm members of society. Advocates in favor of lowering pharmaceutical prices argue that the high prices charged by companies violate society’s [m2]standards of equity, and therefore, fairness and equality must be considered as well when companies decide on pricing strategies. If a good has the potential to save lives, how can economic interest supersede that?

For corporate leaders, increasing the price of a drug is done to drive incentive for innovation. The more profitable the industry becomes, the more likely they will be to improve the quality of drug, and therefore, they are pushing back against intervention. However, many Americans are urging the government to intervene and adopt price controls for the pharmaceutical industry. They specifically advocate for the institution of a price ceiling, which would set a maximum price by which companies are able to price their good.

Supply and Demand with a Price Ceiling

Price

E

Price Ceiling

Quantity

Although this method would be effective in making drugs more affordable for consumers, it will require a sacrifice in efficiency. A price ceiling results in a deadweight loss resulting in a decrease of total surplus due to transactions [m3]that no longer occur following intervention. Companies worry that by instituting a price ceiling, drug manufacturers will be less motivated to engage in innovation. Those in favor of price ceilings respond through openly supporting governmental driven incentives for innovation alongside the price control policies, although there is not a lot of transparency as to how those incentives would appear. A price ceiling, in the eyes of some Americans, will be greatly beneficial because it will help to balance the welfare of individuals with medical need and those seeking to gain profits from their good. In contrast, others argue that by instituting a ceiling, profits along with efficiency may be a byproduct, and therefore in their eyes price controls will do more harm than good.

Bibliography

Bernstien, Jared. “The New York Times Company.” The New York Times. The New York

Times, n.d. Web. 03 Mar. 2017.

Ramsey, Lydia. “Drug Companies Are Reeling after the Martin Shkreli Incident – and It Could

Shake up the Entire Industry.” Business Insider. Business Insider, 30 Sept. 2015. Web. 02

Mar. 2017

3. This is a tough topic since these are monopolies granted by patents. Prices can be regulated in monopolies but it doesn’t really work like a price ceiling. In general the debate is about how much profits do you want to give to these firms for research purposes.   If you give me a word file I can do a better editing job on it!

[m1]It is their monopoly from the patents.

[m2]Since they are monopolies they are inefficiency. The debate is about how much monopoly profits do you need to give to an inventor.

[m3]So the efficiency argument kind of works the other way. The monopoly is inefficient but we feel we need  if to get the research done.