1、IntroThe pharmaceutical industry got its start in 1899,when Bayer,a German chemical company,introduced a painkiller called aspirinToday,the pharmaceutical industry is massive but tightly regulatedThis industry is an ideal setting to study both the economics of innovation and the economics of regulat
2、ion.Ch 12|Pharmaceuticals and the economics of innovationTHE LIFE CYCLE OF A DRUGThe life cycle of a drugFind chemical compound that might treat a diseaseThen,test it on animals to show it is not toxicThen,test on humans in three phasesPhase 1:low dose to healthy individuals(2 years)Phase 2:dose to
3、unhealthy individuals(2 years)Phase 3:test effectiveness in preventing disease or medical conditions(3-4 years)Get approved for sale by FDA or similar bodyThe life cycle of a drugOnce the drug is approved for sale,the drug company has a temporary legal monopoly protected by a patent(17 years in the
4、US)This is the companys chance to recoup the millions of dollars spent on testingAfter that time is up,other companies can produce the same drug cheaply and profits decrease sharplyCh 12|Pharmaceuticals and the economics of innovationDRUG DEVELOPMENTDrug development is costlyHard to find a promising
5、 chemical in the first placeOnly 21.5%of drugs that enter Phase I pass to Phase IIIThe whole process can cost$500 million or more to bring a drug to the point of approvalCh 12|Pharmaceuticals and the economics of innovationPATENTSHow do we induce companies to make these costly investments?Patents cr
6、eate a legal monopoly and hence the opportunity for monopoly profitsIn practice,only the top 30%of drugs pay for themselvesHow strong should patents be?Downside of stronger patentsCustomers have to pay monopoly prices for a longer periodLess incentive for further innovation by same companyLegal barr
7、iers to subsequent innovation by another companyBut if patents are too weak,no incentive to develop new drugs!Patents in developing countriesLow-income countries think about this tradeoff differentlyMonopoly prices weigh more heavily on low-income populationsFree rider effect:if the US has patent pr
8、otections,companies will develop new drugs even if there are weak patent protections in IndiaWe will see this effect again when we talk about price controlsPrice discriminationIn theory,drug companies could sell their drugs for different prices in different countriesIn practice,black-market importat
9、ion makes this impossiblePrice controlsPrice ceilings set or negotiated by the government Example:Italian government publishes list of maximum permissible prices for each drugExample:NHS in UK sets the price at which they are willing to purchase drugs(monopsony power)Controls reduce incentive for re
10、searchTradeoff between access to existing drugs and incentives to develop new ones,same as patent tradeoffUS has no broad price controlsOther countries free-ride on US market for future innovationDrug companies count on making their money off US consumersCh 12|Pharmaceuticals and the economics of in
11、novationINDUCED INNOVATIONInduced innovationDefinition discoveries that result when innovators change their research agenda in response to profit opportunitiesExample:changing demographicsAs the US population aged between 1970-2000,drug companies turned their attention to drugs for the elderly(glauc
12、oma medication,etc)Induced innovationAcademic and public institutions also engage in induced innovation,even though they do not usually profit directly from their discoveries.Examples:Large-scale production of penicillin during WWII by US Department of AgricultureIn recent years,academic researchers
13、 have focused more on obesityUS Army ceasing malaria research after Vietnam War ended and troops came home from malarial regionsWho is harmed by induced innovation?Diseases that are rare(orphan diseases)or that mostly occur in developing countries(tropical diseases)receive less attention from resear
14、chers,because there is less profit to be made.Governments have tried to harness the power of induced innovation to fight these diseasesOrphan Drug Act in the USAdvanced purchase of yet-undiscovered vaccines for HIV,malaria,TBCh 12|Pharmaceuticals and the economics of innovationREGULATION OF THE PHAR
15、MACEUTICAL INDUSTRYFDA regulation ensures safety of drugsBefore 1930s,no safety or testing regulations for drugs in the US“magic elixirs”Thalidomide&Europe(1960)Prescribed to pregnant women with morning sicknessCaused birth defects in over 10,000 newbornsPulled from shelves and promoted stricter dru
16、g regulation throughout the worldKefauver-Harris Amendment in the US(1962)Companies must prove new drugs are safe and efficacious through clinical trialsStricter regulations led to a lower number of new chemical entities on the market(Peltzman 1973)Type I and Type II errorsThe FDA has to decide how
17、restrictive to be when approving new drugsRestrictive vs.Permissive regulationsType I error=bad drug is approved(e.g.Vioxx)Type II error=good drug is rejected or delayed(e.g.beta blockers)Phase III trials do not have complete information about a drugThere is a tradeoff between rejecting good drugs a
18、nd approving bad drugsChoosing T*will always lead to some errorROC plots the tradeoff between Type I and II errorsRegulators balance social welfare and potential harmMore incentive to avoid type I errors because of media attentionType II errors rarely get in the media because they are hard to catchO
19、ther regulationsDoctors have prescription powerTrue in most countriesbenefit:less intentional and unintentional abuse of drugscost:time,inconvenience,expenseBans on direct-to-consumer(DTC)advertisingBans in place in most developed countries except USbenefit:prevent moral hazard,reduce strain on doct
20、or-patient relationshipscost:customers may not find out about new drugs that will benefit themConclusionTradeoffs Patents incentive for innovation vs.affordable prescriptionsGovernment price controls innovation vs.affordabilityFDA Regulation more new drugs vs.fewer dangerous drugsType I and II errors approve bad drugs vs.decline good drugsDoctor prescriptions increase safety of drug use vs.expensive drugs
