Balancing Regulation and Innovation: A Comparative Analysis of Pharmaceutical Markets in Australia and the United States
1. Introduction
The presence of a monopoly aspect characterises pharmaceutical markets due to the patenting of medications. According to economic theory, the pricing guidelines for a monopolist would result in the price being set much above the marginal cost from the firm’s viewpoint. The monopolistic nature is due to pharmaceutical medicine’s patent holder having the sole authority to sell the drug on the market. Countries have different approaches to dealing with this concentration of power. This is done in Australia through the Pharmaceutical Benefits Scheme (PBS), the legal framework regulating pharmaceuticals’ costs. However, in the US, the pharmaceutical market is left unregulated. The microeconomic impacts will be analysed to better understand each approach’s strengths and weaknesses.
2. Does the Government need to regulate the pharmaceutical industry? Comparison between Australia and U.S
For the past few years, the impact of pharmaceutical price limits on patient health outcomes and social welfare has been a contentious and hotly disputed policy issue. These laws could reduce prescription prices, potentially enhancing access to affordable pharmaceuticals, increasing patient adherence to medication, and ultimately improving treatment (Miller, 2020). Other arguments caution against having significant unanticipated adverse effects. The stifling of pharmaceutical research and development is of considerable concern (Miller, 2020).
Developing novel drugs is inherently costly, time-consuming, and hazardous, and this fact is frequently cited to explain the cost of branded drugs (Kakkar, 2021). Numerous studies have repeatedly demonstrated that declining pharmaceutical sales and profitability cause drug R&D expenditures to decrease, resulting in the launch of fewer novel compounds each year (Vernon, 2004). According to recent estimates, just 47% of novel drugs launched between 2011 and 2018 were available in other wealthy nations with price control mechanisms, compared to roughly 90% in the US (Badger, 2019). Furthermore, compared to the US, the release of these novel drugs was frequently postponed in the latter country by more than a year (Kakkar, 2021). According to Golec and Vernon’s analysis, EU pharmaceutical companies significantly cut their R&D spending between 1985 and 2004, which led to the release of 46 fewer medications (Kakkar, 2021). While the EU spent more on medication R&D than the US did at the beginning of this period — by about 24% — it fell behind the latter by 15% by 2004 (Golec & Vernon, 2006). A similar occurrence could be seen unfolding in Australia (Beecroft, 2007). Additionally, the PBS places price controls on drugs, which can make it less profitable for pharmaceutical companies to release new drugs in Australia (Beecroft, 2007). This can also discourage investment in research and development in the Australian market. However, It should be noted that the US market is much larger than the Australian market, so it’s more attractive for pharmaceutical companies to release their drugs in the US first.
It has been demonstrated that the effects of pharmaceutical price limits grow with time, can stifle generic competition, and cause medicine shortages in regulated markets (Sood et al., 2008). Existing businesses may stop producing a specific product category, reduce production, or lower quality in response to declining profit margins. The pricing limitations may also present a significant barrier to entry for new competitors. The two groups in these contexts with the least access to healthcare, the poor and rural consumers, have been demonstrated to be disproportionately affected by these drawbacks (Guenette, 2020). Price limits can, ironically, negatively influence the availability of medications, even though they are intended to increase access and affordability (Khanijo et al., 2020). The PBS attempts to counteract this through the provision of grants and subsidies; however, it is clear that more action is necessary as current regulation practices stifle innovation and perpetuate shortages (Australian Government, 2023).
3. How does the PBS affect outcomes in the market for a pharmaceutical drug?
Monopolies are typically discouraged in free-market economies as they limit alternatives and impede competition. Therefore, developing strategies that can effectively control monopoly power is important. In Australia, this is done through the PBS (Australian Government, 2023). Because of the regulation enforced, the Australian market functions differently from the unregulated pharmaceutical monopoly that exists in the US. Unregulated markets enable the US to raise drug costs above inflation rates, irrespective of demand. The different approaches to the provision of pharmaceuticals are demonstrated.
Firstly, the difference in profit generated by the regulated and unregulated monopoly market structures is prominent. The change in the area of producer surplus demonstrates this significant difference. Graph two shows a larger producer surplus, indicating that the US generates greater profit when operating under an unregulated market. The unregulated market produces more profit as the pure monopolist is a ‘price maker’ — has direct access to the demand curve and, therefore, chooses a price (Krugman & Wells, 2015). The price is chosen at the profit-maximising output (where MC=MR) (Krugman & Wells, 2015). The profit-maximising price set by the unregulated monopoly is much higher than the Australian market price. Consequently, the quantity consumed in the US is much lower than Australian consumption, hence the smaller consumer surplus attributed to the US outcome. The regulated market is favourable from the consumer perspective because of the lower prices and ability to consume more.
4. Analysis of the impact of the Pharmaceutical Benefits Scheme on consumer and producer surpluses
Table 1 depicts the market demand schedule and total costs schedule of a monopolistic medical company.
Profit maximising point:
MR = MC=$40
Graphically this will occur at P=$130 & Q=4.5
Total revenue:
$130*4.5 = $585
Total cost:
$150
Economic profit:
$580 — $150 = $430
Consumer surplus:
0.5*(4.5–0)*(200–130) = 157.5
The monopolistic market structure has been graphed to depict the profit-maximising outcome.
The point of interception between marginal revenue and marginal cost indicates the point of profit maximisation. This graph is representative of an unregulated monopoly in which the firm is a price maker (Krugman & Wells, 2015). However, the firm is no longer a price maker when considering the effects of PBS regulation. Due to price caps, a regulated market is made to operate in perfect competition (MC=D) (Krugman & Wells, 2015). from graph 3, it can be interpreted that if the market price was dictated by the point at which marginal cost and demand intercept, then the corresponding area of consumer surplus would be considerably larger. The increased consumer surplus in a regulated market occurs as price caps force the firm to lower prices, consequently increasing the product’s accessibility and hence, consumer welfare. A regulated monopoly is therefore preferable for a consumer when exclusively considering consumer surplus.
However, while the regulated market structure is preferable to consumers, an unregulated monopolistic market structure is preferable to producers (Krugman & Wells, 2015). When firms are allowed to act as price makers, a firm will set a profit-maximising price (as demonstrated in graph 3) (Krugman & Wells, 2015). Increasing the price and consequently restricting the quantity demanded to a point where marginal revenue equals marginal cost (Krugman & Wells, 2015). In graph three, the producer surplus is represented by the area below the red dotted line and above the marginal cost line. When considering that a regulated market would establish a price at the point where demand intercepts marginal cost, it can be interpreted that producer surplus would be considerably smaller when operating in a regulated state.
It is also important to note that when the firm is unregulated and can act as a price setter, the total surplus is not maximised. Because resources are distributed differently in a monopoly and perfect competition, monopolistic price and production are inefficient. Results in a competitive market are economically advantageous when the overall surplus is maximised. A monopoly market does not maximise overall economic well-being since it is an imperfect market. Due to the concentrated market power created by an unregulated monopoly, the market has failed to allocate resources efficiently, and market failure has occurred (Krugman & Wells, 2015).
5. Benefits and costs when dispensing generic drugs
Switching from branded to generic medications is a typical practice across all therapeutic fields with the primary goal of cost reduction. After a patent expires, generic drugs can be quickly substituted. Although generics can often be a good choice, transitioning to generic drugs could have unforeseen repercussions.
Psychological
Patients’ worries about generic substitution may make it difficult to take their medications as prescribed. The research under consideration shows that a sizable percentage of patients (33%) have unfavourable attitudes regarding generic drugs (Himmel et al., 2005). Some patients believed that lower pricing meant poorer quality, while others thought that accepting the generic version was due to cost savings (Himmel et al., 2005).
Performance
With regard to switch-back rates, overall healthcare expenditures, the occurrence of side effects, toxicity, and efficacy, there are undoubtedly changes depending on the therapeutic class of the drugs being switched. For instance, after switching to a generic version of a drug used to treat epilepsy, serious problems such as breakthrough seizures were observed(Kesselheim et al., 2010). However, it is to be noted that the majority of generic drugs have proven to function efficiently with no adverse effects (Straka et al., 2017).
Cost of performance
For branded drugs, consumers must pay exorbitant rates (Australian Government, 2023). However, based solely on this observation, it is impossible to say whether costs are excessive. That judgement depends on whether customers receive a reasonable value given the prices paid for these goods. However, numerous studies reveal branded pharmaceutical treatments to be generally priced below the value of the health benefits achieved when compared to commonly recommended threshold monetary values of additional health benefits (Frech et al., 2022). In terms of economics, the outcome shows a willingness to pay for extra QALYs over the average or standard cost of the QALYs obtained (Frech et al., 2022).
Financials
When prices decline, so do profits for manufacturers. The supply chain is complicated for generic pharmaceuticals that aren’t marketed in large quantities (Helmers et al., 2010). As a result, manufacturers could decide not to invest in the market and withdraw, leaving one business in charge of producing a specific drug (Helmers et al., 2010).
Generic drugs can be sold at a lower price than brand-name drugs because the manufacturers of generics do not have to invest in research and development. As a result, generic drugs can make medication more affordable and accessible to a broader range of people (Australian Government, 2023).
Stifle innovation
Regulations on the pharmaceutical industry can limit profits for companies, which may decrease investment in research and development (Kakkar, 2021). This can slow the pace of innovation as companies may have fewer resources to invest in new drugs and treatments (Kakkar, 2021).
Net benefit conclusion
Significant costs are associated with the distribution of generic drugs, including psychological barriers, side effects in specific drug therapeutic classes, and the slowing of innovation. However, a greater consumer surplus is generated by the reasonable cost of performance and accessibility of generic brands, which outweighs the small population of negative surplus associated with the costs.
6. Product innovation
Product innovation, which is time- and risk-consuming, is the most significant contribution made by the pharmaceutical business. The following R&D model has been generated based on a sample of 10 pharmaceutical companies over 14 years.
This model estimates the marginal effect of NR, DVR, and CFM on R&D intensity. An assessment will be done at a 5% significance level (t-stat = 1.96). There is relatively strong evidence that both NR and CFM have a strong effect on RDS (3.81>1.96 and 6.07>1.96, respectively). Therefore, the null hypothesis that both NR and CFM have no significant effect on RDS can be rejected.
However, DVR does not significantly influence RDS as 1.76<1,96. Therefore, the null hypothesis that DVR has no significant effect on RDS can not be rejected.
An R² value of 0.49 indicates that only 49% of the variation in RDS is explained by the variables included in the model. This is not ideal and indicates that further explanatory factors need to be included in the model. Factors to be considered include, time in development, number of researchers, trade openness, education of researchers and technology use. However, further testing of models is required to determine the significance of additional explanatory factors.
7. Conclusion
From the evidence discussed, it is clear that the regulation enforced by the PBS has both strengths and weaknesses. Throughout the report, Australia’s provision of pharmaceutical regulation was analysed against the unregulated US pharmaceutical monopololy. It was revealed that, on the positive side, regulation could prevent a monopoly from exploiting consumers through discriminatory pricing and other anti-competitive practices. Additionally, regulation maximises total welfare and ensures that the public interest is protected by ensuring that the monopoly provides essential services at a reasonable cost. Conversely, regulation can discourage innovation and efficiency by imposing bureaucratic rules and procedures on the monopoly. Additionally, regulation can be costly to implement and administer, leading to higher consumer prices and reduced monopoly profits. In conclusion, while regulating a monopoly can have benefits, it is important to balance preventing anti-competitive behaviour and fostering innovation and efficiency. However, it is clear that providing affordable essential services is critical; hence, more must be done to counteract the negatives. Given the advantages mentioned above and the disadvantages of direct pharmaceutical price limits, a one-size-fits-all strategy is unlikely to answer the complex dilemma of high prescription medication costs. Promoting competition in the pharmaceutical industry is a practical method to advance medicine access and affordability while encouraging innovation. Allowing additional businesses to compete can significantly improve market competition for both generic and branded drugs. Additionally, it is recommended that further research is commenced into a model that more accurately gauges the contributing factors to R&D intensity. Only with this knowledge will individuals effectively distribute funds to receive maximised returns.
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