In the real world, there seems something counterintuitive about this: One would assume that a firm would maximize its profits by charging the highest price it can reasonably get away with; again, though, this is not the case. (For an illustration of how this works, click here.)
We thought of this today when we read "Drug Makers Raise Prices in Face of Health Care Reform." With the prospect of drug prices being reined in if health care reform passes, the pharmaceutical industry has raised prices by about 9%, which "will add more than $10 billion to the nation's drug bill." So while the pharmaceutical industry has agreed to cuts of approximately $80 billion over ten years, the recent price increases will negate those cuts--indeed, the industry may end up pocketing more money.
But that's capitalism for you. To survive, a company has an obligation to make money. And the marginal-cost curve gets tricky when you start talking about pharmaceuticals. After all, critics of the industry will claim that a pill costs pennies to produce--which is true, to an extent. To be precise, though, it is the SECOND pill that costs pennies to produce; the first one costs millions of dollars. And as for marginal revenue--well, just what is each additional pill worth to a consumer?
All of which is to say that drugs--and healthcare in general--represent another Economics 101 phenomenon: The market failure. All of classical economics assumes a perfect market, but such an animal doesn't exist in the real world. Things like externalities, imperfect knowledge, asymmetrical knowledge, etc., keep popping up. We may not begrudge entrepreneurs their right to make a profit, but when their profit is earned at the expense of sick people, something must be done. What is striking about this case is the egregiousness of the pharmaceutical companies' behavior. And what is sad is that they'll probably get away with it.
Very interesting. Economics seems less of a science sometimes than religion: -- if it were simple and straight-forward, it would not be so controversial (I really liked that bit about the cost of the first pill vs. the 2nd!).
ReplyDeleteI was just reading about Milton Friedman in a NYTimes book review by Paul Krugman (http://www.nybooks.com/articles/19857)
where he likens "The history of economic thought in the twentieth century is a bit like the history of Christianity in the sixteenth century...Keynes played the role of Martin Luther, providing the intellectual rigor needed to make heresy respectable... If Keynes was Luther, then Milton Friedman was Ignatius of Loyola, founder of the Jesuits..."