Economic Concepts in

Pharmaceutical Industry
Vinod Chaturvedi 1402212
Vinod Kumar Maliya 1402213
Vinti Dhawan 1402214
Vipul Thapa 1402215
Viresh Yadav 1402216

Introduction
The economics of the pharmaceutical industry right now is doing very well in particular.
According to George Cressanthis in, the article, now that the baby boom generation is
becoming older, more drugs are needed. Spending on pharmaceuticals represents around
11 percent of total healthcare spending, which in turn is over 14 percent of gross
domestic product (GDP) and rising (Cressanthis). The pharmaceutical industry is also
expected to grow in the years and according to the article, it is on an upward trend. This
industry makes their money mostly on a buyer-to-buyer market. The article also says that
the main way drug companies make money in the pharmaceutical industry is in the
science and manufacturing operations areas. According to Cressanthis, Drug discovery
and research and development (R&D) will always represent the life-blood of a
pharmaceutical company. Recently, the pharmaceutical industry primarily spends their
money on marketing the drugs. With the recession, drug manufactures are putting
more efforts are being placed on novel ways that these new drugs can be commercialized
in the marketplace (Cressanthis). The pharmaceutical industry also spends money on
analyses of the market. The role of the government in regulating pharmaceutical
activities, both at the federal and state levels, is growing. Numerous companies hire
economists to conduct analyses on the expected impacts of proposed governmental
policies and develop analyses to propose policy directions of interest and importance to
individual companies and the industry (Cressanthis). Pharmaceutical industries also
have excellent working conditions and environments. This affects the income and cost of
the company because the drug company initially spends money to make their employees
happy and comfortable. The combination of highly competitive compensation and
benefit packages and overall high-quality work environment (opportunities and resources
for research, computer programming, software, and technology, and well-trained staff
with advanced degrees operating in a collegial work place) attract and retain top talent
(Cressanthis). This helps with their overall GDP and having the best talent will set
them apart from other drug companies. Finally, drug companies spend their money on
increasing Drug discovery and R&D costs. as investments in drug pipelines require
ever greater resources to generate differentiable and novel approaches to treat diseases
(Cressanthis). The drug industry is on an upward trend and had a larger GDP than they
are spending. This is because of the drug companies spending on ways to move product,
employees and data analysis. The drug company relies heavily on the time period and the
economy and must change their strategies and spending accordingly.

Supply and demand in the pharmaceutical industry

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The supply and demand graph for the pharmaceutical industry works differently than a
normal supply and demand graph. This is because the pharmaceutical industry works
differently than others. Medicines are always in demand. People will always need
medicine to cure their illnesses. Sometimes people need drugs for a short period of time
and other times they need it for life (Lgriffith, 2008). There will never be a time or period
of the year where drugs and medicine are not in demand. Therefore, no matter what the
price is or how much of the drug is supplied, there will always be a high demand for it.
This is different than a normal supply and demand curve. In a normal curve, as the price
goes up, the supply of it goes up but the demand for it goes down (Heakal, 2003). This is
normally because people are less willing to pay more for a product, however, when it
comes to medication for their health, they tend to be more willing to pay more for it.
Everyone needs medicine at some point in their life. Many people rely on certain
medications more than others. When a doctor prescribes a drug, people have to pay it, or
at least their health insurance providers do. Medications are a necessary component of
life. They help people stay healthy. In this case, the supply and demand curve for the
pharmaceutical industry is not going to look the same as the supply and demand curves
for other industries. The demand curve is always going to go up and never down.
Medicine is always going to be in demand. My company, Novo Nordisk, has the same
supply and demand curve as its industry. Novo Nordisk sells drugs relating mostly to
diabetes (Novo Nordisk, 2012). There are always going to be people with diabetes in the
world. This way, there are always going to be people that need medicine to help them
with their diabetes. Their products are always going to be in demand for people suffering
with diabetes. The demand for their product is never going to go down. The supply and
demand curve for my company behaves the same way as the supply and demand curve
for the industry as a whole. Medicine is always in demand. That is something that will
probably never change.

Price and income elasticity of demand

There is some empirical evidence on the price elasticity of demand, at least for the U.S.
and Canada. After analyzing the before and after data of a study of Mississippi Medicaid
recipients for the effects of insurance on pharmaceuticals, the price elasticity is
approximately 0.4, signifying a 0.4% decrease in demand if price increase by 1%.
Lacking empirical evidence on the income elasticity of demand for pharmaceuticals by
specific countries, cross-country regression analyses for OECD countries indicated that
the income elasticity of demand for health care expenditures ranges from 1.3-1.8,
meaning a 1% increase in per capita income in these countries is likely to result in a 1.31.8% increase in health care spending
Evidences suggest that pharmaceutical demand is price inelastic but income elastic. This
explains the price discrimination between countries (108). For countries with higher per
capita income, drugs are much more expensive because people are willing to pay more
for medication whereas medications in poorer areas are lower Priced.
Both the demand theory and available empirical evidence showed that pharmaceutical
prices pl ay a significant role in the health care system; however, as the prevalence of
health insurance for pharmaceutical purchase increases, the out-of-pocket price at the
time of purchase become less important as a decision variable .
It has usually been observed that the rural demand curve for pharmaceuticals is much
more elastic than the urban demand curve. This is perhaps due to the fact that rural
income is less than urban income. Producers use this fact to determine their marketing
strategy and manipulate price accordingly. These aspects should be regulated by the
Government, so as to ensure uniform supply geographically.

Differentiation
One of the biggest differentiations of pharmaceutical companies are their patents. Their
patents hold the most value when it comes to product distribution, but when the patents
begin to expire; competition heightens when generics appear on the shelves. A battle
between brands versus generics ensues and differentiation becomes extremely important
for the companies.
Product strategy is a way which companies help their products have a longer market
life. When a companys products sales begin to slow down due to generics coming out,
the company will find other clinical usages for the drug, thus strengthen its market life.
Also, advertising directly to consumers helps to promote the product so that patients
would be encouraged to ask their physicians to prescribe them that product. For example,
my company, AstraZeneca, has a drug called Nexium which topped advertisement to
consumers at about 255 millions of dollars, increasing public awareness and sales.
Altering product form can also differentiate companies, just by simply changing the
form of the medication; like from a liquid to a tablet. Giving consumers a variety of one
product can help differentiate a company from a generic, as well as brand loyalty. Brand
loyalty stems from experience of using a product and having a good reaction toward it.
This gives the consumer a tendency to buy from the brand rather than the generic, in fear
of the generic not having the same effect.

In the end, pharmaceutical company differentiation is really based on how the companies
promote and differentiate their products. The more they make their drugs have more
benefits, the more likely consumers will buy that drug.

Perfect Competition and Monopoly in Pharmaceutical

Sector
Brief Information:
1. The growth Indian Pharmaceutical industry has been characterized by
Extensive Governmental control and
Absence of strong patent protection before 2005.
2. Grant of product patent became one of the necessary conditions in order to become a
member of World Trade Organization. There were almost fifty developing countries
which did not exercise product patent in the pharmaceutical sector during the Uruguay
round of GATT and actually resisted introduction of product patent in this sector for
the fear of increase in drug prices.
3. Indias advantage remained in formation of generic drugs and it remained
competitive in the world pharmaceutical market in terms of price mainly
through reverse engineering and advantage of process patents.
4. It was the developed countries that feared their monopoly rights and profit margins
might get affected from low price drugs supplied by countries like India. Thus these
developed countries were keen in implementation of product patent for all WTO
members.
5. In the TRIPS (Trade Related aspect of Intellectual Properties right) agreement, more
than 100 countries have agreed not to free-ride on invention efforts of others. Impact
on prices of drugs:

Economics Concepts (Impact on price of drugs):

1. Impact of TRIPS on prices of drugs:
It is true that under any kind of intellectual property right, the price of that
particular commodity will be high. This is due to the reason that monopoly price is
always higher than perfect competition prices.

1.1 Producer and Consumer Surplus:

Though producer surplus increases under monopoly, consumer surplus is less under
compared to perfect competition and there is a net deadweight loss in the former case.
This is illustrated in following figure.

Figure: Comparison of perfect competition and monopoly market structure in terms of

Consumer Surplus and deadweight loss

We are usually more concerned about increase in consumer surplus than producer surplus
as it is assumed that consumer surplus indicates better welfare situations.

1.2

Effect of Patent :

By introducing patents, a monopoly situation is created. So this is going to

result in a rise in price for obvious reasons, at least in short run.
But benefits are expected to follow in the long run when after discovery,
diffusion of knowledge occurs. The process of diffusion would include adapting

the product to local conditions, obtaining market approval, introducing it to

physicians and other distribution chains.

2. Why perfect competition is not attainable in this sector?

An important factor regarding pharmaceutical sector is that this sector is
characterized by information asymmetry.
The consumers do not have the perfect information and knowledge, and the
information is mainly in the hand of producers and doctors.
The law of one price is basically not at all a law in this sector and often users
go by brand name and use high priced products even though generic versions
which are low priced are available.
So in this kind of sector it is very difficult to attain a market structure near to
perfect competition and only can be done by sets of regulations like drug price
ceiling.

Marketing Segmentation
The pharmaceutical industry can be divided into multiple segments. First of all, the
pharmaceutical industry is segmented by customers. This is not difficult to guess, since
not every medicine is designed for every customer, and customers have varying needs.
Some medical products have warnings labels alerting consequences of consumption
towards pregnant women or children, or even customers which health problems (Smith
2012). Some companies, like Teva, make products pandering to the needs of different
types of consumers, whereas other companies make products for specific consumer
needs. For example, Novo Nordisk makes products for patients with diabetes, including
growth hormone therapy and hormone replacement therapy. Additionally, another
important part of the pharmaceutical industry is the cost of the product. Pharmaceutical
products are always in high demand because people are always sick. For brand name
products, this can lead to price inelasticity, in which they raise the price of their product,
knowing that the consumers will still purchase the product. However, in order to reach a
targeted market (and to compete with generic products at cheaper price points), products
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must be maintained at an appropriate price. Another segmentation in this industry is the

geography and product distribution. Products should be readily accessible to consumers.
The United States is one of the worlds top leading competitors in product distribution,
along with Europe and Asia. United States used to be the lead competitor of product
distribution, but in recent years, Europe and Asia have been dominating the market.
These segmentations continue to morph and expand the pharmaceutical industry.

Future Predictions
Over the next few years, the global market for pharmaceutics is expected to make a
recovery from the recent sales slump due to expiring patents on some of the biggestselling medicines (Silverman).
According to an annual report from IMS Health, global spending is forecasted to grow
from $956B (2011) to $1.2T (2016), reflecting a compounded annual growth of 3-6%.
This increased spending reflects an increase in global demand as people are spending
more on pharmaceuticals. Thanks to expansion in emerging markets, the growth in
annual global spending is predicted to more than double by 2016; however, the disparity
between nations is striking. In developed markets (U.S., Europe, and Japan) spending
will drop to 57% of the global total due to expiring patents of popular brand name drugs
and increased cost containment measures. Japan, however, proves to be different as it is
achieving emerging market growth rate due to its aging population (Health Care in
Japan).
Sales growth for the top 8 multinational pharmaceutical companies in Japan in 2011
ranged from 12-31% (Health Care in Japan). The Japanese government is also
deregulating in areas of new drug reviews, pricing system, and generics. The expanded
Pharmaceuticals and Medical Devices Agency has cut review time since 2008 and
increased the number of new approvals; previously the price of new drugs in Japan would
be lowered every 2 years, now the price of new medicines will be upheld through the
patent, making drugs much more profitable; and lastly, the authorities have set the goal of
generics taking up 30% of the market in volume (Health Care in Japan). This series of
actions helps to increase supply and lower prices to a certain extent. The maintenance of
price throughout a drugs patent keeps the price high, but the greater volume of generics
will help lower the prices of some other medications.
Emerging markets, on the other hand, are expected to reach 30% of global spending by
2016 as both population and economic growths contribute to higher demand for drugs.
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These nations are predicted to double the spending on pharmaceuticals over the next 5year period. Compounded annual growth spending in emerging markets is forecasted to
reach 12-15%, compared to global rate of 3-6% (Silverman). From 2011 to 2016,
spending on brand names is anticipated to increase from $596B to $615B, mostly in
developed markets; global generic spending is projected to increase from $242B to
$430B (2016), of which $224B $244B is expected to come from emerging markets
(Silverman). These facts further emphasize the significance of emerging markets,
especially for the generic drug industry.
For the big brand name firms, developed markets remain their target consumer base since
they are the ones able to and willing to purchase the higher priced medications. In the
U.S., patent expirations will save consumers $127B in the next 5 years, a number that
will be offset by $21B of projected spending on generics, resulting in a $106B patent
dividend in 2016 (Silverman). As for the price, the IMS believes that discounts and
rebates will represent an estimate of $180B $190B in 2016 and would lower estimated
global spending by 15-16%. Drug makers are anticipating an improved market thanks to
a new wave of blockbuster medicines for cancer, diabetes, heart disease, multiple
sclerosis, and hepatitis (Hirschler). As companies emerge from the patent cliff of 2012,
a number of crucial R&D bets on potential multibillion-dollar-a-year products are
expected to play out in 2013 (Hirschler). Simon Friend, global pharmaceutical leader at
PwC, warns that as Productivity is starting to turn the corner the other big issue is
whether the industry can get the prices it needs for new products, hinting further at price
as a major challenge for both the sellers and the buyers as the pharmaceutical industry
expands (Hirschler).

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References
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<http://intl-mmj.sagepub.com/content/9/2/104.full.pdf html>.
Behner, Peter. "2012 Healthcare - Pharmaceutical Industry Perspective."
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Smith, Brian. (April 2012). Super segmentation in pharmacy marketing. Retrieved
from
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http://www.ohio.edu/people/paxton/webpage/103/Chapter%205%205ed.htm
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