South-Western College Publishing - Economics  
AIDS drugs just got more expensive - but only in the US
Subject Drug Firm Increases U.S. Price of AIDS Drug
Topic Equilibrium; Government and the Economy, Elasticity
Key Words

Price; Imports; Market Power

News Story

Pharmaceutical giant Abbott Laboratories has decided to increase the price of its drug Norvir, a critical component in AIDS drug "cocktails," from $1500 annually to $7800. Consumer and AIDS advocates argue that this is price gouging at its most extreme, as other countries face a much lower price. In fact, an annual dose of Norvir in Belgium sells for about US $720.

In 1996, Norvir became the second most commonly marketed protease inhibitor, a crucial component in stemming the effects of AIDS. Then scientists and doctors discovered that Norvir, taken in conjunction with other medications, increases the effectiveness of other protease inhibitors. As a result, AIDS patients typically take Norvir with other drugs.

Abbott Labs spokepeople argue that, because of the presence of price restrictions in other countries and the fact that patients are using smaller doses of Norvir than previously assumed, the firm has decided to reduce production and recoup its research and development costs through price increases of the drug in the U.S. Drug companies, by engaging in price discrimination such as this, are taking advantage of the fact that drug purchases in the US are much more price inelastic than those outside the US. Since insurance pays for most of the drug's purchase price, most consumers do not question how much it costs. In other countries, though, since income levels are not as high as in the US, and since health industries are far more regulated, consumers (and the government) are much more price sensitive, causing firms to lower prices in order to make their drugs attractive to purchase there.

The price increase in the US is causing some in Congress and other groups to consider the possibility of importing these same drugs back into the U.S. from Canada and other countries, a practice that is currently illegal. Drug companies in general are opposed to re-importing drugs to the US, arguing that the U.S. would be importing the drugs at artificially low prices, causing drug companies to continue to lose profit. Further, such a move would force Abbott to lower the price of the drug sold in the US. It will also reduce the incentive to engage in critical research and development, which is considered a fixed (sunk) cost to the firm. Companies argue that rather than using price controls to help patients, government should continue to subsidize research and development in the form of research grants and patent approvals, so that the companies can continue to develop new drugs and therapies.


(Updated June, 2004)

Questions
1.

Besides the presence of drug price regulations in other countries and the absence of such regulation in the U.S., why would drug companies like Abbott Labs charge higher prices in the U.S. than in other countries? How does elasticity of demand play into your answer?

2. Suppose the effect of international drug price regulations was to create a price ceiling in the market for prescription drugs. How would that affect the prescription drug market in the US? Use a graph of supply and demand to illustrate your answer.
3. Is a problem like this an argument for eliminating the use of patents? Why or why not?
Source Gardiner Harris. "Price of AIDS Drug Intensifies Debate on Legal Imports." The New York Times. 14 April 2004.

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