Controversy surrounds health care. Daily, news reports on television, in newspapers, and the Internet discuss the rising cost of healthcare in the United States. The delivery and utilization of healthcare is a complex process. James and Stokes (2006) indicate “the process of healthcare includes diagnosis, treatment, prevention, rehabilitation and palliative care” (p. 1).
Multiple entities help deliver healthcare – physicians, nurses, therapists, hospitals, insurance providers, government agencies, and commercial companies such as pharmaceutical and medical equipment suppliers. The aging population is placing increased demands on the healthcare system. The increase in co-morbidities associated with obesity is also testing the ability of health care systems to control costs.
Overuse of antibiotics leading to drug resistance and the decrease in research and development of these drugs by pharmaceuticals is causing concern among epidemiologists. Resources are scarce and with newer technology and treatments the health care system must evaluate constantly and determine how to allocate effectively these resources.
The Economics of Health Care
Health economics is a discipline that “measures the costs and benefits associated with healthcare” and “seeks to achieve efficiency in terms of competing healthcare options” (James & Stokes, 2006, p. 2).
The efficiency of resource allocation has three focus areas: “Getting the greatest output from production inputs (a problem for suppliers). Product choice – determining what goods and services should be produced (meeting consumer demands). Product distribution (who gets the products produced)” (Scott, Solomon, McGowan, 2001, p. 282).
Resource allocation is complicated because the health care market is different from the competitive market. In health care the patient can experience a range of outcomes, health insurance covers direct medical expenses, and there is no set market price that indicates the value of resources used (Scott, Solomon, McGowan, 2001).
The interests of the Pharmaceutical manufacturers is the cost of research and development as well as the effectiveness, safety, acceptability, and cost effectiveness of new drugs (Walley, p. 68). This paper will focus on the economic tools and concepts of marginal cost, demand curve, and elasticity as it relates to pharmaceuticals.
Marginal cost is the increase in total costs triggered by the manufacture of one more unit of output. Pricing medication is dependent on which pharmaceutical company manufactured the drug. A patent gives a drug company monopoly power, and they can set the price above marginal cost (P>MC).
The price is higher so the company can reap the profits. Although there is no chemical difference between the generic equivalent of a name brand drug, consumers may continue to purchase the name brand drug because they are familiar with the name. Once other drug companies start manufacturing, the price of the drug will drop.
When the consumer has to pay higher out-of-pocket costs for prescription drugs they use less. In standard economics the reduced use of prescription medication because of the higher out-of-pocket costs would be seen as efficiency (Chernew & Fendrick, 2008). The less medication consumed used would mean less cost for the consumer, thus cost sharing would indicate an efficient health care system.
Unfortunately, standard economic reasoning does not always apply to health care. According to Chernew & Fendrick (2008), “The price of prescription drugs generally exceeds marginal costs” and “when faced with cost sharing consumers reduce consumption of both high-value and low-value services” (p. 1).
The demand curve is a graph that depicts the relationship between cost of a medication and the consumers are prepared to pay. Demand curves are used to assess activities in the competitive market. In the case of medication, the competitive market would commence when name brand drugs patent expires and the generic versions of name brand medication hits the market.
Before research and development of new medication can begin, pharmaceutical manufacturers dedicate large capital outlays. They also undergo “regulatory scrutiny and scientific credibility related to the safety and efficacy of the new drug” (Openshaw, 2005, p. 1). According to Openshaw (2005), the estimated costs related to new drug development ranges from $230 million to $500 million before the drug can be presented in the market.
The manufacture of a new drug allows pharmaceutical manufacturers to take out a patent. This patient provides protection of the drug so the company can set a price without the worry of competition. This “monopoly power gained from patient protection provides incentives for drug companies to invest the large amount of capital needed for research and development” (Openshaw, 2005, p. 1). This allows the pharmaceutical manufacturer to earn more than they would in a competitive pharmaceutical market.
The drug patent is in effect for 20years. Once the drug is put on the market, there is usually less than 20 years because of the amount of time taken from research and development to introduction of the drug. Once the patient expires, other pharmaceutical manufacturers can begin production of a generic equivalent of the drug.
Introduction of generic drugs on the market are lower cost than the name brand drugs. There is conflicting evidence regarding the cost decrease of brand name drug with the introduction of the generic equivalent. Studies have indicated that name brand drug rise in cost when generics are introduced but their market share decreases. This increase in price can be attributed to brand name loyalty.
The pharmaceutical patent law creates:
Comparable markets are deficient in price competition. Each market has its own inelastic demand curve. In the United States raising the elasticity of the demand curve with increased medication copayments will decrease insurer’s costs but will increase the costs of medication and in turn decrease access for the consumer.
Importing cheaper drugs from countries with fixed price controls will not work in the United States because it is the pharmaceutical manufacturers that set the price of the drug in this country and elsewhere (Stein & Valery, 2004, p. 5).
The increasing costs of medications and other goods and services are placing pressure on the consumer, insurer, and pharmaceutical manufacturers. There are limited pharmaceutical resources the world over. Improving the efficiency of allocation of scarce resources through economic evaluation will help relieve this burden. Cost-effectiveness and affordability are becoming the determinant for reimbursement of new medication in some countries (Brodogi & Kalo, 2010).
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