Price of Prescription Drugs and Oligopoly
"Who's really raising drug prices?" Time, March 8, 1999
Americans spend nearly $100 billion annually on prescription drugs. Consumer demand for the drugs is not significantly affected by their prices, because at the present there are few substitutes for the drugs for treatment of serious pain and sickness, and costs of the drugs are to a great extent borne by insurance companies and the government. Demand for a good that has few substitutes and/or in which the cost of the demand makes up a small portion of a consumer's budget (because of insurance coverage) is price inelastic.
The only competition to prescription drugs is generic drugs, which lowered prices of prescription drugs in general by nearly 40% since 1995. Therefore, makers of prescription drugs have a vested interest in controlling the supply of generic drugs in order to maintain high prices and profits. Over the last several years makers of prescription drugs have resorted to various economic means to control the generic drug supply. The Federal Trade Commission (FTC), which oversees medical drugs in the United States, made the following accusations against some prescription drug companies, although the accused strongly denied the allegations in courts.
In 1999, the price of a tranquilizer called Ativan, manufactured by Mylan Laboratories, jumped from $11 to $85 in one month, because, the FTC alleges, the company restricted the supply of main ingredient of the drug, so that generic drugs could not be produced. In another example, Schering-Plough company enlisted a heavy lobbing effort to extend its patent right three years beyond the normal 20 years of protection from outside competition. Hoechst company, manufacturer of Cardizem CD, a well known chest-pain drug, agreed to pay $40 million annually to Andryx company for its promise not to manufacture a generic drug. And Wyeth-Ayerst company successfully convinced the FTC that its drug Premarin, used for treatment of menopause, is produced from a unique ingredient of the urine of pregnant mares, and a synthetically produced generic drug is unsafe and ineffective.
These are all attempts to suppress the market supply of a competitive product. In the case of prescription drugs, with a very inelastic demand curve (i.e., the slope of the demand curve is very steep), any decrease in the market supply significantly increases the price of the good.