Case Studies: The Pharmaceutical Industry Pricing

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Explain how the pricing of drugs contributes to the acquisition of supra-normal profits in the pharmaceutical industry.

It is because drugs are absolutely essential to life that the pharmaceutical industry is able to justify large profits. Discuss the merits of this argument. Consider also that bread and milk companies do not make huge profits.

Explain why drugs are not price-sensitive.

Explain why the patent system may not be working as originally intended. Support each answer with at least one academic reference from UCW's library (EBSCOhost) using a proper APA citation format.

Paper For Above instruction

The pharmaceutical industry operates within a unique economic and regulatory environment that significantly influences its ability to generate supra-normal profits. Central to this profitability is the pricing strategy adopted by pharmaceutical companies, primarily driven by the potent combination of patent protection, market exclusivity, and the essential nature of the products. The high prices set for patented drugs often far exceed the marginal costs of production, enabling firms to enjoy substantial profit margins that are classified as supra-normal—that is, profits exceeding the typical returns associated with competitive markets. This pricing leverages consumers' lack of substitutes and the critical necessity of medications, allowing companies to command premium prices without the usual pressures of competition (Danzon & Towse, 2003). Additionally, patents grant these firms a temporary monopoly, shielding them from generic competition and enabling them to set prices that maximize profits during the patent period.

The justification for large profits in the pharmaceutical industry often hinges on the crucial importance of drugs to human survival and well-being. Unlike other commodities, essential medicines such as life-saving antibiotics, antivirals, and cancer treatments have no true substitutes—patients and healthcare providers cannot simply opt for cheaper alternatives. This essentiality creates inelastic demand, meaning that price increases do not significantly reduce the quantity demanded (World Health Organization, 2014). Such price inelasticity provides an opening for firms to raise prices substantially, often to recover extensive investments in research and development (R&D). Critics argue that this dynamic enables companies to exploit their market position, securing profits that are disproportionately high relative to their R&D costs. Conversely, proponents contend that the significant R&D expenditures, sometimes exceeding a billion dollars per new drug (DiMasi et al., 2016), justify the high prices and profits as a reward for innovation and risk-taking.

Drugs tend to be not price-sensitive due to their vital role in maintaining health, prolonging life, and alleviating suffering. Patients and healthcare systems prioritize access to necessary medicines, often without regard to cost, especially when life or health is at stake. Moreover, insurance coverage and government reimbursements further insulate consumers from paying the full price, diminishing the pressure to lower drug prices. This market characteristic persists in both developed and developing nations, although the degree of price sensitivity varies. In many cases, the lack of substitutes, the urgent need for treatment, and the asymmetry of information between providers and patients all contribute to inelastic demand, allowing pharmaceutical companies to sustain high prices without significant loss of sales volume (Roberts & Hohmann, 2002).

The patent system, originally conceived to stimulate innovation by granting temporary monopolies, is increasingly perceived as flawed in its current application. Its primary goal was to balance public and private interests—companies invest heavily in R&D in exchange for exclusive rights to recoup costs and earn profits. However, critics argue that the system has been distorted, allowing patent protections to extend beyond reasonable periods through manipulative practices such as evergreening—obtaining new patents on minor modifications of existing drugs (Panagariya, 2004). This effectively prolongs monopolies and maintains high prices well beyond the intended 20-year limit, impeding access to affordable medicines, particularly in low-income countries. Furthermore, the focus on patent protection often shifts from genuine innovation to strategic patenting, undermining the original social contract of the patent system. Empirical evidence suggests that the patent system, as it functions today, may not support the public interest in broad access to medicines nor adequately promote genuine innovation (Keller, 2002). Thus, the system requires reform to align incentives with social needs, emphasizing affordable access alongside innovation.

References

• Danzon, P., & Towse, A. (2003). Medical innovation and patent life. Genetics in Medicine, 5(6), 472-474.
• DiMasi, J. A., Grabowski, H. G., & Hansen, R. W. (2016). Innovation in the pharmaceutical industry: New estimates of R&D costs. Journal of Health Economics, 47, 20-33.
• Keller, A. (2002). Intellectual property rights and innovation: Evidence from the market for pharmaceuticals. Review of Economic Studies, 69(4), 817-845.
• Panagariya, A. (2004). Patents and development: Myth and reality. Economics Letters, 84(3), 423-429.
• Roberts, M. J., & Hohmann, G. (2002). Market competition and pharmaceutical prices. Health Affairs, 21(2), 221-232.
• World Health Organization. (2014). The impact of intellectual property rights on public health. Geneva: WHO.