Monopoly Power under Pharmaceutical Patents

Carlena Ficano, Hartwick College,
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Summary

In this activity, students are asked to identify which among five pharmaceutical patent policy options they believe would be most likely to improve long term societal well being, with the policy options ranging from continuation of the current pharmaceutical patenting system to the extreme stance of complete disallowal of patents. It provides an application of monopoly theory and also forces students to confront the ambiguity associated with appropriate policy action that balances social cost and social benefit in the dynamic and relevant area of health care policy.


Context for Use

This activity can be used in a principles class immediately after covering market structure and monopoly power. It assumes an understanding of monopoly firm P* and Q* relative to the P* and Q* obtained in a perfectly competitive setting as well as familiarity with cost curves and a graphical depiction of economic profit. Familiarity with subsidies and price ceilings is helpful, but not required. I find the activity to be most instructive when coupled with explicit directions that the students must use graphical analysis to justify their decisions and suggest a "gallery walk" activity as an option prior to the start of the open class discussion.

Given the timeliness of patent and drug price escalation discussions in the media, I suggest that students come to class having read recent articles/news releases on this topic to provide them with a real world context in which to evaluate the options provided. I suggest some such articles, below.

This activity requires substantial in-group discussion and time for graphical modelling of the group's final choice as well as time for students to review the graphical modelling of their peers in the class. It is possible to complete the in-group work, gallery walk, and class discussion in a single 80 minute class, but it is better spread across two classes 55 minute classes, if possible.

This activity is appropriate for both large and small class sizes because the open ended nature of the question and options ensures debate.

Overview

This activity has students consider the economic costs associated with patent-granted monopoly power as well as the economic justification for using patents to underwrite the social benefits of research and development. It provides an application of monopoly theory and also forces students to confront the ambiguity associated with appropriate policy action that balances social cost and social benefit in the dynamic and relevant area of health care policy. Specifically, students are asked to identify which among five pharmaceutical patent policy options they believe would be most likely to improve long term societal well being, with the policy options ranging from continuation of the current pharmaceutical patenting system to the extreme stance of complete disallowal of patents.

This activity is most effective after covering market structure and monopoly and can be used in a principles course, a health economic course, or another related upper level elective. While it includes subsidies and price ceilings as options, one could use this question without having formally covered those topics by simply spending a few moments defining each at the start of the class. If this is used in a course in which subsidies and price controls have already been covered, the instructor can require a more in depth incorporate of these topics into the class discussion that follows the group AE choice.

Expected Student Learning Outcomes

In this exercise, students will be able to delineate the economic benefits and economic costs of monopoly vs. competition and evaluate alternative policy options in the context of pharmaceutical patents.

Information Given to Students

Text that students see
Concern over rising drug prices such as the drastic increase in Epi-Pen pricing noted in 2016 and the more recent Humira case described in the first NY Times article read for class has called into question the advisability of pharmaceutical drug patenting given the monopoly power and economic deadweight loss that results from those patents. However, patents can serve an important role according to the second NY Times article on drug shortages read for class. Today we consider the insight that microeconomic theory provides on development of an appropriate policy response to this problem.

Which of the following possible policy alternatives is most likely to improve long term societal well-being?

A. Disallow any further pharmaceutical patenting as patents are allowing pharmaceutical companies to earn economic profits at the expense of those in need of medication.

B. Disallow any further pharmaceutical patenting that would protect innovating firms from immediate competition, but create a system in which the government awards large cash prizes to innovating firms for breakthroughs in treating medical conditions.

C. Allow continued patenting, but force pharmaceutical companies to set fair prices by imposing a price ceiling set at the competitive market price.

D. Allow continued patenting, but force pharmaceutical companies to offer discounted pricing / rebates to low income individuals or individuals without access to insurance.

E. Have the government pay for (fully subsidize) all pharmaceutical research and development instead of providing patents to those companies.

NOTE: Team reporters must be prepared to support their answers with the appropriate graphical analysis (in the framework with market quantity on the x-axis and market price/marginal cost on the y-axis) of the monopoly outcome in their notes.


Student Handout for Patents (Microsoft Word 2007 (.docx) 22kB Jul23 18)
Instructor Guide for Patents (Microsoft Word 2007 (.docx) 23kB Jul16 18)

Teaching Notes and Tips

Prefatory Remarks
Concern over rising drug prices such as the drastic increase in Epi-Pen pricing noted in 2016 and the more recent Humira case described in the first NY Times article read for class (https://www.nytimes.com/2018/01/06/business/humira-drug-prices.html) has called into question the advisability of pharmaceutical drug patenting given the monopoly power and economic deadweight loss that results from those patents. However, patents can serve an important role according to the second NY Times article (https://www.nytimes.com/2016/05/31/upshot/drug-prices-too-high-sometimes-theyre-not-costly-enough.html) on drug shortages read for class. Today we consider the insight that microeconomic theory provides on development of an appropriate policy response to this problem.

Discussion Prompts
I find it important to push students to connect this question with the monopoly graphs covered in the more technical portion of the class and through readings / technical videos and suggest a gallery walk prior to open class discussion. The question lends itself nicely to application of price discrimination, average and marginal cost pricing, and subsidies as well as to a critical evaluation of monopoly power. Further, it works to illustrate that monopolies are not guaranteed profit and that all monopolies have a profit-driven incentive to raise price that derives from market reality and not morality, per se. I often rely on the following questions to guide the student debate that takes place during the report out portion of the exercise:

1. What incentives does the patenting system promote?
2. How/where do we see the firm behavior associated with patenting on the monopoly graph?
3. What is the problem associated with the patenting? (i.e., Is profit the problem, or is it something else?) Who is hurt by the monopoly behavior and how are they hurt?
4. How/where do we see the social problem/negative social outcome associated with patenting on the monopoly graph?
5. Can/will the market correct itself? Why or why not?
6. Why would the government provide patents in the first place? Do they serve any social purpose?
7. What might happen in the industry if there were no patents? Why would this happen?
8. How/where do we see the need for patenting on the monopoly graph? Are monopolists guaranteed profit?

Closing Remarks
Innovation generates a great deal of social value, and in some cases it is important to protect a firm's incentive to innovate through policy such as patents. However, the monopoly power resulting from patents can partially or completely undermine the social value that is created. In the final 10 minutes of class,
  • First, determine which of the question options (A-E) you would select, given what you have learned. This need not be the same as your group choice or what you would have selected before the classroom discussion.
  • Then, write one sentence justifying this choice ("I believe _______ is most likely to improve long term societal well-being because...").
  • Finally, provide a one sentence statement that summarizes what you feel that you learned through the group exercise and class debate.

Assessment

Students are asked, at the end of this activity, to identify their own answer to the activity prompt. This need not be what they originally thought or what their team decided. Then they are asked to justify why they made the choice that they did. Finally, they are asked to provide a one sentence statement that summarizes what they learned through the group exercise and class debate. This material is collected from a sample of students and assessed against a rubric [TBD] to determine if the learning outcome has been met.

References and Resources

Humira's Best-Selling Drug Formula: Start at a High Price. Go Higher: This article speaks to the prevalence of drug price escalation in recent years as well as the impact that price hikes have on consumers ability to access the drugs they need. (https://www.nytimes.com/2018/01/06/business/humira-drug-prices.html)

Drug Prices Too High? Sometimes, They're Not Costly Enough:This article discussed the prevalence of drug shortages driven by pharmaceutical companies not wanting to supply products with relatively low prices and profit margins. (https://www.nytimes.com/2016/05/31/upshot/drug-prices-too-high-sometimes-theyre-not-costly-enough.htm)