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Home Publications Blogs Beat the Press If Drug Companies Could Charge Higher Prices, Why Aren't They?

If Drug Companies Could Charge Higher Prices, Why Aren't They?

Friday, 15 February 2013 06:14

Economists usually believe that companies try to make as much money as possible. This is why readers of an NYT article on plans to reduce Medicare payments for drugs might have been surprised to see the comment:

"Some have speculated that other consumers could end up paying for the cost savings if drug makers raise their prices to account for the lost revenue. 'That money has to come from somewhere,' said Douglas Holtz-Eakin."

This statement implies that drug companies have a group of customers from whom they could now be making more money, but for some reason are choosing not to. This is not consistent with how economists think the economy works. It is difficult to imagine that Pfizer, Merck or any of the other big drug companies are voluntarily choosing to forgo profits. If it is possible for drug companies to get more money by raising prices, then it would be expected that they would have already raised prices.

The piece also includes speculation on why the Medicare drug benefit cost less than had been projected. The main reason is that drug costs in general have risen much less rapidly than had been projected.

Comments (9)Add Comment
Dean Baker Puts Another Nail in the Coffin of Pricing Myths
written by Last Mover, February 15, 2013 6:48
Exactly. The way to think about drug pricing is to look at health care provider and insurance pricing in general. Whenever possible, providers, insurers and big pharma practice third degree, or "perfect" price discrimination designed to extract all consumer surplus under the demand curve.

That's why prices are near impossible to figure out in the first place. It's complicated by design in order to maximize price gouging, but not so much to drive customers or insurers away, thus the constant back and forth dance with fine print and constantly changing terms, conditions and charges, including btw low prices designed to recover otherwise lost revenue from those determined to have true low willingness to pay.

This also puts the lie to bogus claims mindlessly repeated in media about "cost shifting", supposedly the ability to raise prices in one area to make up for losses in another, as if the original prices were mysteriously kept lower than what could have been a higher price without losing the sale. It doesn't happen among predatory prices already set at a highest possible maximum.
Why can't Medicare be like Medicaid
written by Jennifer, February 15, 2013 7:45
To follow up with @last mover the health care pricing game is exactly that, a game to extract as much money from all concerned without looking bad. It's why I can't take seriously anybody who talks about "free markets" and medicine. There is a lot about economics that I do not understand but for a "free market" approach to work I do believe you have to know what things actually cost. Nobody plays the pricing game better then the drug companies, who charge astronomical prices to the government and insurance companies but are sure to give the same drug for free to the uninsured. The difference at the government level for pricing are astounding too, I confess I did not know until now the drug companies had to sell Medicaid drugs at a lower cost although I do know the VA is allowed to bargain. There is no reason why Medicare and Medicaid can't be run the same way, and that Medicare MDs utilize a formulary--a list of preferred medications, I.e. the cheaper generic ones--like Medicaid.
written by Kat, February 15, 2013 9:33
Yes, to keep up the artificially inflated prices of the drugs the money will have to come from somewhere. They see the writing on the wall. Seniors don't have a spare hundred or two sitting around so squeeze the government. It's a one in two shot, but with friends in congress, their crazy plan to stop this proposal might just work!
What would be really great would be lowering the payments enough to wipe out entire classes of worthless/harmful drugs marketed to seniors.
But I'm betting on Pharma.
This is actually a really good question
written by Brett, February 15, 2013 10:20
And it applies to a lot more than drug companies. You get that talking point all the time -- if we regulate the banks, or we pass this environmental legislation, the companies are just going to pass on the cost to other consumers. But is there any validity to that?

In the case of banks, I think there is. Banks are so anti-competitive, and the nature of the business is that once people get set up with a particular bank, it's extremely difficult to get them to switch or leave, that they can raise fees to absorb costs imposed elsewhere and they won't lose many customers.

I use Wells Fargo, and I've noticed since the financial crisis they've raised all sorts of fees. There is a minimum balance fee on savings accounts -- used to be $3, now it's $5 a month. I'm sure they can raise interest rates on credit cards whenever they want. They can freely set overdraft fees and "other ATM" fees, etc.

All that is an argument that the banks are too big that the market isn't functioning properly. There is no competition to reduce fees and gain customers, in fact it's the opposite. They seem to be competing with who can charge the biggest fees to make the largest profits.

But definitely an interesting question, especially regarding drug makers.
written by watermelonpunch, February 15, 2013 11:27
The piece also includes speculation on why the Medicare drug benefit cost less than had been projected. The main reason is that drug costs in general have risen much less rapidly than had been projected.

What is the reason for this discrepancy?
written by ljm, February 15, 2013 12:30
Maybe the drug companies are aware that people on medicare know they are being gouged by drug prices in the US and are willing to pay for drugs from Canada, Mexico and other countries that are cheaper for the same drug. The drug companies already charge much to much for medication and reap huge profits.
written by liberal, February 15, 2013 5:04
watermelonpunch asked
What is the reason for this discrepancy?

IIRC Dean has said in the past that it's because the projections assumed a constant rate of new drug innovation. What happened is that pharma drug pipelines have been drying up, so there's not as many new expensive drugs coming out (as was projected) to replace the ones going off patent.
written by watermelonpunch, February 16, 2013 12:42
Thank you for responding to my question. That sounds like an interesting topic I'd like to learn more about.
Why drug costs increased less than projected
written by Procopius, February 17, 2013 6:15
@watermelonpunch: "What is the reason for this discrepancy?" I have read elsewhere, and maybe here, the biggest reason for the slowdown is that big pharma have hollowed out their R&D to the point they are not finding new drugs to patent, and many older drugs are losing patent protection and being produced at a much lower price as generics (if they have any value at all). I haven't done any research but there's a blog (Carroll Avedon's Confluence?) written by someone with a background in pharmaceutical research which has been very critical of the way the big companies have destroyed their research labs in a search for more profits through "standardization" and general downsizing. Sounds likely to me but I don't have any data.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.