Because they can, but should they?

Mylan is the company that produces the EpiPen, a device that injects a measured dose of epinephrine when someone has a severe allergic reaction. Mylan didn’t invent the drug or device. The company acquired it in 2007 from Merck, which bought the rights for the drug years earlier from another company. By some estimates, Mylan’s EpiPen controls roughly 90 percent of the market for epinephrine injection devices. When Mylan purchased the rights to the EpiPen in 2007, the drug cost about $100 for a two-pen set. It currently retails for more than $600.

Mylan isn’t the only company to buy a drug and then dramatically increase its price. Earlier this year, the Wall Street Journal (as well as other news outlets) reported on pharmaceutical companies that buy rival’s drugs and then jack up the prices. A noteworthy example is Martin Shkreli, a hedge fund manager and CEO of Turing Pharmaceuticals, who bought the drug Daraprim and raised its price from about $13 a dose to $750. The drug is used to treat a variety of infections and other diseases. Turing bought the rights to the drug from a company, which bought the rights to the drug from another company, which bought the rights to the drug from another company, …

Why did Mylan increase the price of the EpiPen? Why did Turing increase the price of the drug Daraprin? Because they can. The companies control exclusive rights to the drug and the demand for the drugs are highly inelastic. First, by having exclusive rights over the drugs and with little if any competition, they possess monopoly power. This means they can act as price makers rather than price takers. Second, as I explained to my microeconomics students today, demand for the drugs is inelastic because there are few substitutes to them and they are necessary. This means that consumers will not (or cannot) be very responsive to large changes in prices. If you are subject to severe allergic reactions, you probably will not forgo the drug if its price increases. You will grumble and complain but buy it anyway. Thus, the combination of monopoly power and inelastic demand makes raising prices economically rational.

The drug companies and other commentator point to other reasons for high drug prices. Some argue that the patent system and long and costly regulatory approval processes are to blame. While these affect the initial costs for many drugs, they don’t explain why the price rose so quickly years after the drug has been on the market. If Daraprim was profitable at $13.50 a dose, then patenting and regulatory costs won’t explain the 5,000 percent increase in its price after Turing bought it.

According to an article in today’s Wall Street Journal, drugmakers are pointing a finger at middlemen for rising drug prices. Drug company executives say that the system is to blame. Everyone has to take a cut, such as pharmacy-benefits managers. Drug companies say that they have to offer increasingly larger rebates to pharmacy-benefits managers to induce them to accept their drugs as part of their company’s health plans. These benefits managers, in turn, are blaming drug prescription services and health insurers. While there might be some merit here, it’s hard to believe that middlemen and insurance companies are largely responsible for the dramatic increases in drug prices. I can’t imagine that a benefits manager will say “no” to the only drug that is available to treat severe allergic reactions or some infections. Drug companies won’t have to offer large rebate inducements if their drug prices were not already very high.

To be sure, the problem is complicated. Should we force drug companies to price their products “reasonably”? What is a reasonable price for a life-saving drug? Who’s to say that $20 or $30 or even $50 is unreasonable for Daraprim? These companies also employ thousands of workers and their stocks are part of savings, retirement and other investment portfolios for many people. If we mandate lower prices for drugs, then what happens to drug company employees and investors?

If drug companies can raise prices, and justify the price increases on economic grounds, then should they? Economic considerations are important, but they are not the only values that matter. Fairness matters too. Is it fair to ask patients to pay 5000 percent more for a lifesaving drug?

Fairness can be more difficult to justify than economic rationale. But we can simplify things. While there are many bases for arguing “fairness,” all of them are grounded in expectations. When our expectations are met, then we have little grounds for arguing unfairness. However, when expectations are not met, people typically feel justified in claiming unfairness. Consumers with a history and experience in paying $13.50 for a drug to treat infections will continue to expect that prices will be about the same the next time they buy the drug. While most people can expect gradual increases in prices, for instance due to inflation, there is no reasonable argument anyone can make that would convince me that consumers would expect a 5000 percent increase for Daraprim or a 500 percent increase for the EpiPen in a relatively short period of time. If drug companies want to increase prices more than what consumers expect, then the companies need to speak directly to consumers and change their expectations. That is fair. But I expect that will be quite a challenge for drug companies.

 

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Author: Harvey James

Professor, Agricultural and Applied Economics, University of Missouri Editor-in-chief, Agriculture and Human Values

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