Sat, 12 May 2007

Drug Price Controls

Patrick writes, asking:

I got drawn into an online debate concerning price controls. Among other things, other posters claimed that price controls in other countries would not or could not affect prices here in America. I found his arguments convincing, but part of my mind could not accept it. Somehow, I cannot help but feel that's incorrect.

After a while, I thought about it, and decided that (a) it ignored the factor of time, as price increases again and again, as fewer and fewer economies pay back the prioce of drug development. Simply put, peole get used to paying higher prices. And, (b) companies might actually make more profit with lower prices. If the costs (of drug development) are evened all around, then the drug might cost less that manufacturers can sell more but retain more as profit for th next business cycle.

Still, I admit the issue is very complex. A lack of price controls elsewhere might mean lower prices here, or not, depending on other economic issues. And prices being as high as they are, they probably won't drop immediately, if they do drop. In some ways, an issue like the eternal New York housing crisis is just plain easier.

Without getting into price/demand curves, you can see that there will be a price at which every customer will generate the most profit for a seller. This price is different for every customer. But how to determine the right price (a hard problem in itself) and how do you get that customer to pay that price (a harder problem, since they'd prefer to pay somebody else's lower price). This is called price discrimination.

For books, you get the hardcover first, and then later you get the unabridged paperback. The hardcover is more profitable even beyond the extra cost of the hard cover. They differentiate over time. For movie theatres, the food is wildly more expensive than the food they prohibit you from bringing into the theatre. The ticket is one source of profit and the food is another, so those people who want the full popcorn-cum-movie experience pay the higher price.

For drugs, you have brand names (brands are a form of price discrimination), and you have markets split by countries. It's an imprecise version of price discrimination, but it's better than nothing. Drug companies will set their prices on a per-country basis to try to maximize their profits. This may sound anti-consumer, but profits give them the most incentive to create new drugs.

Price controls have no effect if they're set on the other side of the prices. If a legislator sets the price control at or above what anybody is paying, then they haven't hurt anybody. Only when a legislator sets the price below the natural market-clearing price do they create harm. If they set the price so low that there are no profits, the drug company won't bother selling. If they happen set the price controls such that the profits are sufficient for the drug company to continue selling, then the specific harm will be to cause the drug company to have a lessened interest in any specialized needs of that country. The general harm is that the next generation of drugs is paid-for by the profits from the current generation of drugs. Cut the profits and you eat your seed corn.

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