Congress is discussing the possibility of removing patent protection for life saving drugs in order to reduce the cost of the Medicare and Medicaid systems. Discuss both the short-run and long-run implications for the economic situation of the drug industry. Include in your answer the impact on prices, new development, etc. of drugs. Include appropriate graphs showing the difference between monopoly pricing and competitive pricing.
The drug industry currently takes on both monopolistic and competitive market structures. When a drug company develops a new drug, there are patent laws that allow the company to have a monopoly on selling the drug. In the short-run, the company is able to charge the monopoly price (above marginal cost) and maximize profit by producing the quantity where marginal revenue equals marginal cost. Once the patent runs out, other drug companies have an incentive to enter the market causing it to become more competitive. These new companies produce generic versions of the drug and charge a price below the monopolist’s price. As more and more competitors enter the price is driven down to marginal cost.
If congress were to remove patent protection on life-savings drugs, drug company’s profits for life saving drugs would decrease. More companies would be able to begin producing the drugs without waiting for the patent period to end therefore, the original drug maker would not be able to charge the monopoly price for very long because competitors could quickly engineer generic versions. The original producer would no longer be a price maker and instead need to follow profit maximization rules of a competitive market by producing the quantity where marginal revenue equals marginal cost and charge a price equal to marginal marginal revenue.
Since the original drug maker will not be able to benefit from monopoly pricing during the patent period, there will be less incentive for them to create lifesaving drugs. A part of the benefit of higher profits during the monopoly period is the ability to recoup some of the research, develop, and testing costs of producing these drugs that the generic makers do not incur. Consumers on the other hand would benefit from competition in the market which prevents a single drug maker from dictating the market price of these newly developed lifesaving drugs.