Exploiting the Elasticity of Demand – The Sovaldi Debate

Recently, a new drug to treat Hepatitis C (HCV) called Sovaldi (sofosbuvir) was introduced to the marketplace by Gilead.  With impressive clinical trial data significant high cost drugs - artisticenough to dramatically change the standard of care for HCV infections, Gilead has set the price tag for this drug at $84,000 for the 12 weeks of therapy, or approximately $1,000 per day.  Sovaldi is not alone, Johnson & Johnson released the drug Olysio (simeprevir) to treat HCV for about $67,000 for 12 weeks of therapy.  While pharmaceutical companies have released expensive treatments before, these HCV drugs have sparked more debate than other specialty drugs in the past.

Back to the Basics

In order to better understand how the United States has reached the $1,000/day pills for HCV, we need to take a short trip back to basic economics.  Market economics suggest that the price for a good or service is established at an equilibrium where supply meets demand.  A basic supply/demand concept in Microeconomics is “price

Basic Supply and Demand curves

Basic Supply and Demand curves

elasticity of demand” which describes the rate at which the quantity of a good demanded changes as price increases or decreases.  When the price of a product raises slightly and the demand for the product drops quickly, the product is said to have a relatively elastic demand.  In contrast, when the demand for a product barely changes as prices rise substantially, then the product demand is said to be relatively inelastic.  In the latter case, consumers are “price takers” as the suppliers are able to set higher prices and can expect little changes in demand.  This creates an environment in which it is in the supplier’s best interest (ie: most profitable) to raise the price.

Inelastic Demand for Healthcare

While in pharmacy school, I took night classes to complete my MBA.  This experience had me mixing business and healthcare early in my career.  I remember during the Iraq war as gas prices skyrocketed, many people raised the question about oil companies price gouging American consumers who had almost no substitutes for their gas-powered vehicles.  The market for gas was a common example in business school economics courses for a market with an inelastic demand.

What was really mind-blowing to me was how healthcare prices continued to rise and no one seemed to ask the question, “Are we price gouging patients?”

One of the amazing phenomenons that occur in healthcare markets, is the change in demand based on how sick a patient is.  When a patient is in good health and is prescribed a low cost medication for blood pressure or cholesterol, the demand for this preventive therapy is relatively elastic.  This means if the price of this preventive therapy jumps from $10/month to $20/month, we could expect demand to drop more dramatically resulting in lower compliance.  However, when the patient suffers a heart attack and is rushed to the hospital and requires a double bypass surgery, the price could theoretically be raised to any infinite amount and the majority of patients would agree to pay the price to prevent almost certain death.  So you can see how the demand for healthcare services dramatically changes based on the patient’s severity.

This demand elasticity phenomenon is so ridiculously obvious that anyone who managed to stay awake in microeconomics in college would be able to put the pieces together to create an extremely profitable business.

The Macroeconomic Implication

The pricing of pharmaceuticals like Sovaldi or Olysio is but one area of concern for healthcare pricing in the United States.  Every provision of care to a sick patient should be reexamined for pricing fairness.  The lack of controls on prices in healthcare has helped balloon US spending on healthcare to nearly 20% of GDP.  “But Joey, price controls hurt the free market right?”  Yes.  Price controls do risk inefficient allocation of goods, however to suggest that critically ill patients experience anything that resembles a “free market” is absolute insanity.  I would argue that continuing to treat healthcare decisions for sick patients as any other market opportunity will eventually crash our healthcare system.

 

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Joey
Joey Mattingly, PharmD, MBA is an assistant professor at the University of Maryland School of Pharmacy located in Baltimore, Maryland. Joey has managed retail and long-term care pharmacy operations in Kentucky, Illinois and Indiana. Leading Over The Counter is a blog of Joey's views and opinions on the topics of pharmacy leadership and management and do not represent the University of Maryland, Baltimore. Joey can be followed on Twitter @joeymattingly.

2 Responses to “Exploiting the Elasticity of Demand – The Sovaldi Debate

  • Ralph Gardner
    3 years ago

    There is lots and lots of new biology coming out of the universities and other basic research institutions and the drug companies need lots and lots of money to turn the basic research into cures. How do we finance the whole system in the best way? What financing options do we have?

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