Populist politicians and "consumer" activists get really upset when they discover that pharmaceutical companies often charge more for a drug sold on the American market than they do for the same drug sold abroad. They demand that the sales price be equalised – under the implicit, but erroneous, assumption that the lower price will prevail.

Economists say those politicians and activists need a lesson in the cost structures of pharmaceutical manufacturers and how companies set up their price schedules.

To begin with, it can cost many millions of dollars to research, develop, test and market a new drug – but the cost of manufacturing the actual dose is cheap. Companies must charge more for drugs in rich countries in an effort to recoup their Research & Development costs – then, in an effort to increase the volume of sales, sell them for less in poorer countries at a price the market will bear.

Take, for example, the AIDS drug PLC, a daily dose of which sells for $18 in the U.S. and $9 in Uganda. What would happen if the manufacturer were required to charge only one price?

  • That uniform price would be closer to $18 than $9 – because the revenue loss from charging $9 in the U.S. would far exceed the cost of lost sales in Uganda at the higher price.

  • So mandating a fixed price makes the Ugandans a lot worse off, while doing little for American consumers.

    But the outcome of one mandated price could be different. What about an anti-malarial drug selling for $10 a dose in the U.S. and $2 a dose in Uganda?

  • With malaria occurring in Uganda at a rate of, say, five times the rate of the U.S., the manufacturer would make more revenue by charging $2.

  • But that would only occur if the price of manufacturing the drug were small enough for $2 to cover the cost – yet it is likely that the incentive to research and develop drugs aimed at diseases affecting poorer, tropical countries would suffer.

    Experts point out that differential pricing – not flat-rate pricing – leads to more people getting the drugs they need.

    Source: Hal R. Varian (University of California – Berkeley), Economic Scene: A Big Factor in Prescription Drug Pricing: Location, Location, Location, New York Times, September 21, 2000.

    For more on Health issues http://www.ncpa.org/pi/health/hedex1.html

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