Econ 201

Steven Schell, in his letter to today’s Wall Street Journal, attacks a previous letter writer for his ignorance of economics, and then goes on to display his own lack of sophistication:

The [letter-writing] congressman is lacking in basic economic knowledge. What does he propose American pharmacists, wholesalers and consumers do when multinational pharmaceutical companies merely stop selling their drugs to small-market, single-payer government purchasers that demand below market prices for prescription drugs? When that happens, Americans will go back to paying exactly what they do now, and access to lifesaving drugs won’t be available to patients in Third World countries at any price. The more I read comments like this, the more I’m convinced there should be prerequisites for running for Congress — Economics 101, for example.

The writer assumes that companies will stop selling their drugs in low-price markets and that the US price for drugs is the “market price.” In fact, pharmaceutical companies have been able to practice price discrimination –selling their products for lower prices to customers who are less willing or able to pay while maintaining higher prices in other parts of the world, especially the US. This is a profit-maximizing strategy for the pharma companies, who can capture a greater portion of the area under the demand curve (i.e., generate more revenue) than they could if they priced everywhere at a high or low level.

With gross margins often reaching 80 or 90 or even 95 percent, companies have an incentive to sell as much product as possible even at low prices. That’s why the drug companies have been willing to give in to countries that demand lower prices. It worked for them pre-internet, pre-reimportation and as a result they let prices diverge greatly among countries. Now that the internet has brought price transparency and enabled online pharmacies, the gap in prices has become unsustainable.

The inevitable result is that prices will eventually converge around the world, although it will take a while and won’t happen completely.

Drug companies don’t want to pull their drugs out of markets. It makes them look mean, they lose profits, and they may end up having their prices regulated in the US as the public turns against them.

Let’s also not forget that patents –granted by government– enable the companies to charge high prices in the first place. The patent regime can be modified if prices get too high.

January 10, 2006

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