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Supply and Demand

Matthew, J. Pool

American Public University

ECON101/B005/Fall 2020

Prof. Medani Adhikari

November 15^th, 2020

Supply and Demand

Supply and Demand can simply be defined by stating; There is a supplier of a resource and there is a buyer for said resource. The relationship between the two is the desire, or demand, for the product and the effect on the products price. As demand of a product increases so does the supply, increasing the price. However, as demand of a product decreases so does the supply of said product, decreasing the price. Also, if the demand of the product from consumers is high but the supply is low due to lack of resources or manpower to produce the product, prices will decrease. Throughout this paper I will attempt to outline the relationship between consumers and providers for prescription drugs.

Prices for prescription drugs throughout the United States is an issue of such concern that Congress and state legislatures are involved. The law of one price is said to prevail for the pricing of medication however comparing the United States, Canada, and Western Europe conclude that the United States prices are higher. This shows that the Law of one price is invalid and not applied when charging for medication within the United states. This creates issues for the different classes of citizens within the United States. People who purchase with cash and buy retail are charged the highest in price. Many of the individuals who purchase in this manner are the lower-class citizens who are poor and sick. These citizens in many cases cannot afford the healthcare coverage and are forced to pay the highest price for prescription drugs. In further examination of why one would pay more for the same pill comes down to location of purchase. "These vary according to one's insurance coverage, place of purchase (drugstore versus mail order), and the organizational arrangements under which a pharmacy benefit is administered." (Frank, Cubanski, & Kleinke, 2001)

The difference in the price paid for prescription medication has many different reasons like classes, cash vs third party, location, and rebates. All in consideration multiple studies have been conducted which resulted in the individual paying cash will pay more then the individuals who are medically covered sometimes over 14 percent more. The pharmaceutical industry is responsible for the pricing differences. "Cash payers (the vast majority) who purchased their prescription drugs at retail pharmacies have paid higher prices than institutional purchasers since the 1950s. During the late 1950s the Senate Antitrust Subcommittee studied differences between prices of brand-name prescription drugs in the United States and abroad. In attempting to make price comparisons, the subcommittee observed that institutional buyers frequently paid less for prescription drugs than did retail outlets." (Frank, Cubanski, & Kleinke, 2001)

Health care becomes more of a priority for individuals needing prescription drugs. Many studies have been preformed and support the ever-growing enrollment into government assisted medical plans like Medicaid, and managed care plans. Managed care plans and Medicaid seeing over a 50 percent growth since the mid-1980s. The growth of addition care plans changes the cost of prescription drugs. These providers administer their own drug benefit in the form of formularies. "Formularies are typically tied to a set of administrative processes and financial incentives aimed at encouraging adherence to the formulary by clinicians" (Frank, Cubanski, & Kleinke, 2001) In other wards a formulary is a list of medication approved by an administration to treat medical patients. The formulary strives to keep costs of prescription drugs low for the consumer enhancing bargaining power.

"congressional investigators long ago recognized the role of institutional structure, buying power, and market forces in explaining the price structure for prescription drugs."(Frank, Cubanski, & Kleinke, 2001) This is done in the form of formularies having the buyers best interest in the form of negotiating prices from manufacture. This creates the opportunity for the drug manufacturer with price-elastic demand. A Buyer will have more options in purchasing prescription drugs from a variety of sources creating a price competition. Manufacturers goals are to have their products as the preferred drug on the formulary. "The implication is that buyers that can present profit-maximizing manufacturers with the greatest price-sensitivity in sales through strong management and high adherence to their formulary will realize the largest price concessions. Thus, the price concessions are responses by profit-maximizing manufacturers to demands by price-sensitive buyers. Hence, price differentials are not related to recouping losses by shifting costs. Rather, they represent unequal bargaining power across different classes of purchasers reflected by their ability to shift purchases in response to price." (Frank, Cubanski, & Kleinke, 2001)

In 1987 The Prescription Drug Marketing Act was signed into law by President Ronald Reagan. This act set guidelines for reselling prescription drugs and directs states to set regulations on wholesalers and record keeping of wholesalers and their licensing. This act limits the resale of prescription drugs also stating that nonprofit providers are not allowed to resale. This is important because of how it limits the parties from being involved in the resale of drugs which ultimately effects the price. The distribution of drugs is complicated and there are a lot of different ways it is done. Most of the distribution comes from full-line wholesalers or warehouses meaning that sales are not directly to end users. Resulting in the requirement for a third party to negotiate prices. Most health plans obtain their drugs from chain and independent pharmacies or by mail. While there are a few things that effect the concession price of prescription drugs like charge backs, rebates and discounts the end result is that 74 percent accounts for manufactures retail price and 23 percent to retail pharmacy and the additional 3 percent wholesalers cost. Two things worth noting is one that the generic dispense fees are higher for insurers and two networks of pharmacies are established by care providers and PBMs which negotiate dispense fees. Thus, creating purchaser-manufacture dealing that consist of promises to increase demand for price concessions. This contributes to the different in prices that are seen amount the classes of buyers.

In conclusion the suppliers where able to capitalize on the needs of the buyers by charging them more because they where cash buyers. The market for prescription drugs was shifted when more citizens started to get medical coverage to assist them with prescription drugs. Thus, creating a middleman from the manufacture to the end user. The result of creating the middleman would be that managed care plans and PDMs can redirect in a price-responsive manner based off the demand for a medication that is on the formulary list. The issue is that the bigger organizations have the greater effect on prices creating an issue for the organizations that represent the cash payer and retail drug stores who have limited bargaining power. Simply to put this the pharmaceutical companies have the market cornered it could be stated that they have the market in an economic monopoly. There are still that some individuals who cannot afford medical care and pay the higher cost because they are using cash. The cost comes down to the need for the medication. The demand for the drugs will always drive the cost unfortunately corporations profit at the expense of someone's health.

References

Frank, R., Cubanski, J., & Kleinke, J. (2001). Prescription Drug Prices: Why Do Some Pay More Than Others Do?: Health Affairs Journal. Retrieved November 15, 2020, from https://www.healthaffairs.org/doi/10.1377/hlthaff.20.2.115