CASE STUDY

MONOPOLY DRUGS’ VERSUS GENERIC DRUGS

According to our analysis, prices are determined differently in  monopolized markets and competitive markets. A natural place to test this theory is the market for pharmaceutical drugs because this market takes on both market structures. When a firm discovers a new drug, patent laws give the firm a monopoly on the sale of that drug. But eventually, the firm’s patent runs out, and any company. can make and sell the drug. At that time, the market switches from being monopolistic to being competitive.

What should happen to the price of a when the patent runs out? Figure 6 shows the market for a typical drug. In this figure, the marginal c;;Srof.l?ro4uc~g ~e drug is constant. (This is approximately true for many drugs.) During the life of the  monopoly firm maximizes profit by producing the quantity at which marginal revenue equals marginal cost and charging a price well above marginal cost. But when the patent runs out, the profit from making the drug should encourage new firms to enter the market. As the market becomes more competitive, the price should fall to equal marginal cost.

Experience is, in fact, consistent with our theory. When the patent on a drug expires, other companies quickly enter and’ begin sealing so-called generic products that are chemically identical to the former monopolist’s brand-name product. And just as our analysis predicts, the price of the competitively produced generic drug is well below the price that the monopolist was charging.

Figure ~ The .Market for Drugs

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