Reflection Paper on these two chapters
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Chapter12.pptxCHAPTER 12 PHARMACEUTICALS AND THE ECONOMICS OF INNOVATION
Bhattacharya, Hyde and Tu – Health Economics
Intro
The pharmaceutical industry got its start in 1899, when Bayer, a German chemical company, introduced a painkiller called aspirin
Today, the pharmaceutical industry is massive but tightly regulated
This industry is an ideal setting to study both the economics of innovation and the economics of regulation.
Bhattacharya, Hyde and Tu – Health Economics
Ch 12 | Pharmaceuticals and the economics of innovation
THE LIFE CYCLE OF A DRUG
Bhattacharya, Hyde and Tu – Health Economics
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The life cycle of a drug
Find chemical compound that might treat a disease
Then, test it on animals to show it is not toxic
Then, test on humans in three phases
Phase 1: low dose to healthy individuals (~2 years)
Phase 2: dose to unhealthy individuals (~2 years)
Phase 3: test effectiveness in preventing disease or medical conditions(~3-4 years)
Get approved for sale by FDA or similar body
Bhattacharya, Hyde and Tu – Health Economics
The life cycle of a drug
Once the drug is approved for sale, the drug company has a temporary legal monopoly protected by a patent (17 years in the US)
This is the company’s chance to recoup the millions of dollars spent on testing
After that time is up, other companies can produce the same drug cheaply and profits decrease sharply
Bhattacharya, Hyde and Tu – Health Economics
Ch 12 | Pharmaceuticals and the economics of innovation
DRUG DEVELOPMENT
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Drug development is costly
Hard to find a promising chemical in the first place
Only 21.5% of drugs that enter Phase I pass to Phase III
The whole process can cost $500 million or more to bring a drug to the point of approval
Bhattacharya, Hyde and Tu – Health Economics
Ch 12 | Pharmaceuticals and the economics of innovation
PATENTS
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How do we induce companies to make these costly investments?
Patents create a legal monopoly and hence the opportunity for monopoly profits
In practice, only the top 30% of drugs pay for themselves
Bhattacharya, Hyde and Tu – Health Economics
How strong should patents be?
Downside of stronger patents
Customers have to pay monopoly prices for a longer period
Less incentive for further innovation by same company
Legal barriers to subsequent innovation by another company
But if patents are too weak, no incentive to develop new drugs!
Bhattacharya, Hyde and Tu – Health Economics
Patents in developing countries
Low-income countries think about this tradeoff differently
Monopoly prices weigh more heavily on low-income populations
Free rider effect: if the US has patent protections, companies will develop new drugs even if there are weak patent protections in India
We will see this effect again when we talk about price controls
Price discrimination
In theory, drug companies could sell their drugs for different prices in different countries
In practice, black-market importation makes this impossible
Bhattacharya, Hyde and Tu – Health Economics
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Price controls
Price ceilings set or negotiated by the government
Example: Italian government publishes list of maximum permissible prices for each drug
Example: NHS in UK sets the price at which they are willing to purchase drugs (monopsony power)
Controls reduce incentive for research
Tradeoff between access to existing drugs and incentives to develop new ones, same as patent tradeoff
US has no broad price controls
Other countries free-ride on US market for future innovation
Drug companies count on making their money off US consumers
Bhattacharya, Hyde and Tu – Health Economics
Ch 12 | Pharmaceuticals and the economics of innovation
INDUCED INNOVATION
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Induced innovation
Definition– discoveries that result when innovators change their research agenda in response to profit opportunities
Example: changing demographics
As the US population aged between 1970-2000, drug companies turned their attention to drugs for the elderly (glaucoma medication, etc)
Bhattacharya, Hyde and Tu – Health Economics
Induced innovation
Academic and public institutions also engage in induced innovation, even though they do not usually profit directly from their discoveries.
Examples:
Large-scale production of penicillin during WWII by US Department of Agriculture
In recent years, academic researchers have focused more on obesity
US Army ceasing malaria research after Vietnam War ended and troops came home from malarial regions
Bhattacharya, Hyde and Tu – Health Economics
Who is harmed by induced innovation?
Diseases that are rare (orphan diseases) or that mostly occur in developing countries (tropical diseases) receive less attention from researchers, because there is less profit to be made.
Governments have tried to harness the power of induced innovation to fight these diseases
Orphan Drug Act in the US
Advanced purchase of yet-undiscovered vaccines for HIV, malaria, TB
Bhattacharya, Hyde and Tu – Health Economics
Ch 12 | Pharmaceuticals and the economics of innovation
REGULATION OF THE PHARMACEUTICAL INDUSTRY
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FDA regulation ensures safety of drugs
Before 1930s, no safety or testing regulations for drugs in the US “magic elixirs”
Thalidomide & Europe (1960)
Prescribed to pregnant women with morning sickness
Caused birth defects in over 10,000 newborns
Pulled from shelves and promoted stricter drug regulation throughout the world
Kefauver-Harris Amendment in the US (1962)
Companies must prove new drugs are safe and efficacious through clinical trials
Stricter regulations led to a lower number of new chemical entities on the market (Peltzman 1973)
Bhattacharya, Hyde and Tu – Health Economics
Type I and Type II errors
The FDA has to decide how restrictive to be when approving new drugs
Restrictive vs. Permissive regulations
Type I error = bad drug is approved (e.g. Vioxx)
Type II error = good drug is rejected or delayed (e.g. beta blockers)
Phase III trials do not have complete information about a drug
Bhattacharya, Hyde and Tu – Health Economics
There is a tradeoff between rejecting good drugs and approving bad drugs
Choosing T* will always lead to some error
ROC plots the tradeoff between Type I and II errors
Regulators balance social welfare and potential harm
More incentive to avoid type I errors because of media attention
Type II errors rarely get in the media because they are hard to catch
Bhattacharya, Hyde and Tu – Health Economics
Other regulations
Doctors have prescription power
True in most countries
benefit: less intentional and unintentional abuse of drugs
cost: time, inconvenience, expense
Bans on direct-to-consumer (DTC) advertising
Bans in place in most developed countries except US
benefit: prevent moral hazard, reduce strain on doctor-patient relationships
cost: customers may not find out about new drugs that will benefit them
Bhattacharya, Hyde and Tu – Health Economics
Conclusion
Tradeoffs
Patents incentive for innovation vs. affordable prescriptions
Government price controls innovation vs. affordability
FDA Regulation more new drugs vs. fewer dangerous drugs
Type I and II errors approve bad drugs vs. decline good drugs
Doctor prescriptions increase safety of drug use vs. expensive drugs
Bhattacharya, Hyde and Tu – Health Economics
