Microeconomics Commentary

Less competition, demand-supply gap push US drug prices
Generic drugs are a medicine which dosage and performance functions, are similar to a patented/branded FDA (US Food and Drug Administration) approved drug. Supply-restricting and cost-inflationary factors in the market has prompted an increase of "390-8,200" per cent increase across 10 products.



Market share of generic drugs in the US market has expanded in the last years, leading to more competition resulting in the exit of distinctive medicine manufacturers. Abounding competition in the market provoked lower prices. This pushed away suppliers from the low-margin industry, causing supply shift to the left, which is the total amount of a specific good or service producers are willing and able to supply at a given price (Se to S1). Likewise, increasing government regulation and legislation targeting foreign and domestic generic drugs competitors caused significant increase in the compliance costs of firms and investments to meet FDA requirements, even provoking factories shutdowns. Again this contributed to a bigger shift in supply to the left (Se to S1). This shrink in the market producing a "gap" (Qe to Q1) between demand, the consumer willingness to buy a good or service at a given price, and supply. Consequently, there was a price hike (Pe to P1) in medicines.

Inelastic demand is when a change in price of a product leads to a proportionally smaller change in quantity (value of PED is smaller than value of PES). Considering ceteris paribus the demand for medicine in the market has become more inelastic (De to D1). Less competition in the market means there is fewer number of close substitutes provoking more inelastic demand, not to mention, medicine is a necessity so price changes have low response of demand. Assuming demand for generic medicine is relatively inelastic a price increment benefits producers. Therefore there is an increase in revenue as price soaring takes place (Pe,Y,Qe,0 to P1,X,Q1,0). However, how much or if PED of medicine lowered is arguable. The value of PED isn't equal at across any point of the curve, when price increases demand becomes more elastic and vice versa. So demand inelasticity may possibly be equal or more elastic at point (X) than point (Y) because there was a price rise (Pe to P1). If this is the case then an increase in price would lead to a decrease in revenue for producers. Yet this is unlikely because prices of generic drugs still remain lower than patented drugs, which still generates an incentive in consumers to buy them.
The FDA introduced a user fee in drugs, again this increase in costs contributed to a further shift to the left in supply (S1 to S1+Fee). The price equilibrium now stands at (P2) from (P1). The fee burden becomes bigger for consumers (P2,F,W,P1) than producers (P1,W,G,A). Inelastic demand enables this as consumers demand is less sensitive to an increase in price, so few consumers would stop buying medicines when price rose. Therefore, producers will pass most of the burden to the consumers causing a price increase (P1 to P2) and a cut in quantity from (Q1 to Q2). This fee will create a revenue loss for producers from (P1,W,Q1,0) to (A,G,Q2,0). Moreover, profit maximization is a viable possibility. This could be a scenario of excess supply (Q2), happens when the amount supplied of a good or service exceeds its demand, at point Z. Producers would try to pass all the costs towards consumers and minimize revenue loss achieving this by raising price to (P3).
This FDA fee had a higher impact on consumers because demand is inelastic. The price of generic drugs has a dependence on FDA regulation and fees, if fees increase price will increase and if lowered price will follow. Withal, investment is increasing by firms to match FDA requirements so compliance costs will decrease in the future lowering price of medicine. The market price of generic drugs is at its peak. It could be said that price of generic drugs has a ceiling because if the price equals the price of patented drugs then the demand for them will fall drastically as patented drugs are substitutes goods that are a lot more attractive for consumers. Moreover the market of generic drugs is a cycle; due to the decrease in market concentration the few participating firms could be experiencing short-run abnormal profits. In the long term this would change as other firms will re-enter the market because it's profitable again. Perhaps, if this doesn't occur the market will be inclining towards an oligopoly making it less efficient. Finally if the price rise is consequence of excess supply, it will be temporal as it would return to equilibrium.