Drug Industry Dynamics, Essay Example

Market approval in the US for new pharmaceutical products is a long, arduous, and expensive process. Once approved, patent protection keeps close substitute products from entering for some years. If the demand for a particular product is stable, what would you predict for the profitability after approval and before patent expiration?

During the period between approval and expiration of a patent, the patent-holder firms get a monopoly market power since as long as the firm holds the patent, no other firm can manufacture the same product. Therefore, the company can set its price to earning profits more than all costs incurred to the production of its commodities. Undeniably, the firm receives a supernormal profit during this period. Being a monopolistic market structure, the company enjoys a purely zero market competition and makes the decision of setting prices and output. Therefore, before the expiration of the patent, the firm will determine the quantity of output or price level required in maximizing its profit. This period is associated with supernormal profits for the company due to higher prices that would not have existed in a perfectly competitive market.

When a brand name drug’s patent protection expires, many generic producers are usually ready to enter the market. These firms’ products are close substitutes; they have similar production technologies, the regulatory hurdles to join are not so great, and, within a few months, there are plenty of rivals. What would you predict for the profitability during these first few months after generic drug entry?

After the patent expires, the barrier to entry is broken, making it possible for other firms to join the industry, as well as to reverse-engineer the patented product (called a “Generic” version of the product) and subsequently, they enter the market with the cheaper generic version. Their entry increases the supply of the product to the market, and as a result, the product price plunges. The patent holder’s monopoly power gets eroded, and the market share of his company starts dropping, and the excess profits are eroded until he earns only an ordinary profit at par with the new entrants. The entry of other pharmaceutical companies into the market will eliminate the monopoly. Thus, the prices established during this period reflect a perfectly competitive industry. Besides, it is not his decision to determine prices at this stage and the revenue of the company are normal like those of other firms.