When Drug Prices Exceed Market Clearing Prices
Consumers are feeling the crunch by pharmaceutical companies, as they increase their spending on prescription drugs by 13.1% this year. The $20 billion spent this year on drugs to treat Hepatitis C alone equates to a 5 cent-per-hour tax on every working American. While pharmaceutical companies are rightfully granted a patent to exclusively deliver their drug to users in order to justify the risks they undertook, as one economist told The Economist, there is not an economic theory which could explain drug companies’ astronomical pricing on their products.
There are three tiers of consumers in this pharmaceutical industry—the everyday citizen, these citizens’ insurance companies, and drug benefit management companies which cater to the insurance companies. The everyday citizen is relatively shielded by insurance companies from the astronomical costs of these drugs. However, as the drugs reach astronomical, economically infeasible prices, insurance companies are forced to reevaluate their coverage of these drugs. The drug benefit management companies may even opt out of multiple treatments which they deem too expensive.
The market clearing prices that these companies are willing to pay for each drug are completely dependent on the profit they can still make, while keeping their clients relatively healthy. The most effective drugs for their clients’ illnesses often times have few substitutes. Many are still within their patent period, when generic versions are not offered, which often times grant pharmaceutical companies monopolies, and thus pricing privileges, over certain illness treatments. So in order for insurance companies to continue offering certain increasingly expensive treatments, they must either increase their clients’ premiums, which would effectively increase their funds to pay the market clearing prices, or to simply limit/discontinue coverage, as the drug’s cost would otherwise exceed its payoff.
Given these large prices, market clearing prices are not reached; often times, the drug prices are becoming far greater than what consumers are able to afford. High deductible plans and drug prices have driven many citizens away from seeking medical help or stop life-saving/extending treatments. Yet, as long as there are individuals who can afford the premium and allow the pharmaceutical companies to obtain the financial returns they are aiming for, these companies have no incentive to make their products’ prices market-clearing and thus available to all who need the products. They will continue to raise their prices—they are in the business of making money, and extending people’s lives just happen to be byproducts of their endeavors.
Links: http://www.economist.com/blogs/democracyinamerica/2015/06/pharmaceutical-pricing