2013 MI H1 Econs CSQ1 Mark Scheme

Question 1 The Pharmaceutical Industry Extract 1: AIDS: Branded and Generic anti-HIV drugs Roche, the pharmaceutical giant, recently announced a price of $20,424 for a year's supply of its anti-HIV drug Fuzeon in U.S. This was almost three times the price of the most expensive AIDS drug. Roche claimed that Fuzeon is more expensive to produce than other anti-HIV drugs, claiming that it spent $600 million developing the drug. However, many HIV drugs that cost up to $15,000 a year in the U.S. can be made for less than $300 a year by generic manufacturers overseas. These generic firms are allowed to enter the market and sell copies of the original drug when the pharmaceutical patent expires. As generic drugs contain exactly the same active chemical substances, these are considered as strong substitutes to the original branded drugs. Figure 1 Sources: World Street Journal, 1 Dec 00 and ACT up press release 13 Mar 03 Extract 2: Regulation of branded drugs In the past year, critics have complained that prescription drugs are contributing to escalating health care costs in the developed countries. Some also assail drug manufacturers, contending that drug prices ar e too high. They propose price controls as a way to lower drug prices. Price controls have a consistent history: they don't work. Whether they apply to air fares, gasoline, teleco mmunications or medicines, they discourage innovation, create shortages and fail to keep prices in check. Further, they harm the poor by making whatever is controlled more difficult and more expensive to obtain. However, according to leading prescription drug price and sales database information company, IMS Health, drug costs are rising primar ily because of rising costs of innovation

that contributed to record sales of new products and a changing mix of available products. Price increases have been relatively modest over the past 10 years. Sources: National Centre for Policy Analysis Policy Report No. 23 Oct 99 and Focus 16 Apr 04 Figure 2: Composition of Drug Costs Sources: National Centre for Policy Analysis Policy Report No. 23 Oct 99 and Focus 16 Apr 04 Extract 3: Under-consumption of drugs in developing countries The major communicable diseases of poverty, es pecially AIDS, TB and malaria, cause over six million deaths annually, with devastating social and economic impacts. The global community has recognised the causal links between ill-health, poverty and weak economic growth. Historically, efforts to tackle the ma jor diseases affecting developing countries have been poorly coordinated, resulting in under-consumption of drugs that can cure these diseases. OECD governments and international bodies su ch as the World Bank have stepped up investments in these areas. In response, new private sector allies– especially the pharmaceutical companies are forging partnerships with governments to undertake a wide range of activities, such as distributing donated or subsidised products, strengthening health service delivery and access to drugs and educating the public. Adapted from http://www.eldis.org

Questions (a) (i) Describe the changes in sales of Glaxo’s AIDS drugs from 1997 to 2000 using Figure 1. [2] (ii) Illustrate, using demand and supply diagrams, how the change in the number of AIDS patients and entry of generic AIDS drug producers affect the market for branded AIDS drugs. [4] (b) (i) Using an appropriate diagram, explain the type of price control that can be used to regulate the price of branded drugs. [4] (ii) Discuss the effectiveness of price controls in the regulation of branded drugs prices. [6] (c) (i) Using relevant economic analysis, explain why the market fails to allocate sufficient resources to the consumption of drugs in developing countries. [4] (ii) Evaluate, with reference to Extract 3, the policies that governments in developing countries have undertaken to address the under-consumption of drugs. [10] [Total 30m]

Answers (a) (i ) Generally, sales of Glaxo AIDs drugs decreased [1]. However, sales for one of the drugs, Combivir rose in 1999 , followed by a fall. [1] (ii) The rise in the number of AIDS patients would lead to an increase in the demand for branded drugs by these patients seeking to increase their life expectancy, causing the demand curve to shift to the right. The entry of generic drug producers will lead to a fall in the demand for branded drugs as price of substitutes (generic drugs) decrease. The entry of generic drugs would increase the number of suppliers in the generic drug market, causing the price of generic drugs to fall. Since generic drugs are substitutes of branded drugs, the demand for branded drugs fall due to the fall in the price of substitutes i.e. generic drugs. The net impact on the equilibrium price and output depends on the relative strength of the two events. 1-2m: Explanation of factors that affect the market for branded AIDS drugs tend to be scanty Max of 3m : Explanation of the two factors that affect the market for branded AIDS drugs, without comment on how price and output depends on the relative strength of demand Max of 4m : With judgement on relative strength of demand or some acknowledgement that price and output depends on the relative strength of demand. (b) (i) Price ceiling+diagram+ references to diagram The type of price control that can be used to regulate the price of branded drugs is the price ceiling. Price ceiling refers to government-imposed price above which firms are not legally allowed to charge. It is the maximum price that the government sets on drug prices, below the market equilibrium price which is deemed too high. The objective of implementing price ceiling is to prevent prices from rising beyond a certain level to ensure the much needed drug remains affordable to the poor patients. This is to achieve equity, i.e. a fairer distribution of goods and services in the country to prevent social instability. With reference to the diagram, the price ceiling is set at Pmax below the market equilibrium price, Pe. 1m: Identification of price ceiling 1m: Explanation of price ceiling &/or objective 1m: Graph 1m: Reference to graph

Figure 1. Price Ceiling b (ii) Price ceiling is desirable because it increases lowers the price of the costly drug resulting in the increased affordability of the drug to lower-income AIDS patients, thus leading to increased equity. This is especially pertinent for the increasing number of patients residing in developing countries. In addition, the market for AIDS drugs is inelastic due to few close substitutes available to the AIDS drugs. Since the branded drug producers who have sole owndership of the patents, are able to pass on high costs of production to consumers in the form of higher prices and hence, price regulation would restrict the monopolists from exploiting the consumers. As a result, the price control would ensure affordability of drugs especially for the needy patients. On the other hand, a maximum price on AIDS drugs may not be desirable as it reduces the incentive of firms to produce and invest in costly innovation. As a result, few new and effective drugs are discovered as a maximum price would reduce the amount of profits earned by the AIDS drug producers and hence, resulting in reduction of profits channeled into research and innovation. Furthermore, according to Figure 2 the percentage increase in drug cost is more than the percentage increase in price of drugs, largely due to rising costs of innovation. This shows that