South-Western College Publishing - Economics  
At the Heart of the Matter
Topic Monopoly ; Market Failure, Regulation and Public Choice
Key Words drugs, Canada, patents, generic, price, profit
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Reference ID: A149610558

News Story Canada seems to be determined to continue its war against drug companies. Just when pharmaceutical firms thought they had prevented Canada from supplying U.S. citizens with cheap drugs from across the border, a Canadian firm ignored a patent and issued a generic drug on its own. The companies owning the patent were not happy.

Sanofi-Aventis, a French firm, and Bristol Myers-Squibb, an American firm, jointly market Plavix, a blood-clotting preventative drug. Their patent on the underlying active compound, which allows them to be the sole seller of the compound, ends in 2012. With sales of $6 billion globally last year, the two companies were counting on the large monopoly-generated revenue streams from this compound for a few more years. But that was before the Canadian firm Apotex defied patent laws and introduced a generic version of Plavix on its own.

First, the two firms cried foul. But Apotex continued selling its own generic. Then the two firms tried to get Apotex to voluntarily stop selling the generic until 2011 in exchange for a financial incentive. Apotex continued to sell its generic version. At primary issue is whether the patent is defendable, and from Sanofi-Aventis' and Bristol Myers-Squibb's actions, it doesn't appear that patents-a form of intellectual property-apply worldwide.

Issuance of generic medications is widely popular in the U.S., because it helps contain skyrocketing health care costs. Generics are a small total of total spending on drugs (because they're so much cheaper), but are about half of all sales by volume. And their use is growing, not only because of the need to contain costs, but because by 2009, 12 of the top 35 drugs by sales will lose their patent protection. Those 12 drugs make up about $307 billion in sales over the next five years, by some estimates.

But Sanofi-Aventis and Bristol are not finished. They've recently dropped their price below the cost of the Canadian generic, hoping to maintain market share. With this action, whatever they maintain in market share, they'll lose in sales. What's the point of having a patent if you can't use it?

Questions
Discussion Questions:
1. What are the economic reasons for issuing patents to firms, especially to drug companies?
2. Is there a better way of helping firms undertake research and development costs without the use of patents?
3. In this example, are Sanofi-Aventis and Bristol Myers-Squibb better off reducing its price to compete with Apotex, or should those companies maintain their high price on Plavix? Why?
Multiple Choice/True False Questions:
1. True/False. By being issued patents, drug companies considered to be natural monopolies.

2. Part of the reason drug companies want patents is because their
  1. Fixed and variable costs are both high.
  2. Fixed costs are high, but variable costs are low.
  3. Fixed costs are low, but variable costs are high.
  4. Fixed costs and variable costs are both high.
3. True/False. From the firm's perspective, and from the content of the article, the absence of a patent forces drug companies to a Nash equilibrium-type pricing solution: an equilibrium, but not an optimal one.

Source "Heartburn." The Economist. August 17, 2006.
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