Saturday, August 20, 2011

Generic Drugs and Market Shortages

In today's New York Times there is an article about drug shortages and the impact that is having on patients that cannot get the drugs they need. Normally, I am skeptical when I read a popular press article about a shortage, as it usually ends up being the case that there is not an actual economic shortage, but rather a decreased supply (at higher prices), which is an equilibrium market result. But here is different; and for three fundamental reasons that are inter-related, but in which I will separate in order to make the economics easier to grasp. One is changes in the demand and/or the supply of the generic drug; the second is a change in the market conduct of generic drug firms, and the last is government imposed. Let's take them in order.

First, a little economic revue. The supply and demand model shows us that when both demand and supply are stable then the market will produce an equilibrium price and quantity. If the demand for the product changes then the equilibrium price and quantity change in the same direction (increase in demand leads to an increase in price and quantity), and if there is a change in supply then the equilibrium price changes in the opposite direction and the equilibrium quantity changes in the same direction (increase in supply leads to a decrease in price and an increase in quantity). Economists tend to assume (in a Principles of Microeconomics course) that the changes in quantity are instantaneous, which at the Principles level is a simplifying assumption.

Reality is another matter. The FDA and the ASPH both have lists of current generic drug shortages, where the FDA site states the reason for the shortage on that page, and the ASPH you have to click on the drug to get more information. Most cases are due to increased demand or manufacturing or capacity issues. Both of these are transitory disequilibrium (i.e. shortage) issues, and seem to be resolved within a few months. So the shortage occurs since the physical manufacturing constraints are unable to change as quickly as the market changes.

A related reason for a shortage occurs due to input constraints. Input (called Active Pharmaceutical Ingredients or API) constraints occur when generic drug manufacturers face limitations on the amount of the API they can purchase to produce the generic drug. Like the changes in demand and the manufacturing issues, these tend to be temporary shortages.

A second type of reason is what I will call a market conduct issue, where decisions made by generic drug manufacturers are affecting the generic drug market and either directly or indirectly leading to shortages. The most obvious is exit, where an existing generic drug manufacturer no longer produces a generic drug. For example, here is the press release for Teva's exit for Metoclopramide Injection, USP. Given that an existing firm exits the market, and there is no equal reduction in demand, at existing prices there will be a shortage until either another firm steps up production to meet the supply reduction, prices rise to the market equilibrium price or another substitute generic drug becomes available filling the supply reduction.

Another market conduct reason is generic drug firm consolidation. Economic theory shows us that as firms consolidate, the market equilibrium quantity decreases. In reaction to the existing shortages of generic drugs (and indirectly industry consolidation) a group of oncologists (cancer physicians) are starting a not-for-profit firm to import some of these drugs and eventually manufacture some of these drugs.

A final market conduct reason is profitability. Some generic drugs simply cannot be made profitably here in the United States, and thus potential competitors choose not to enter some generic drug markets.

The last reason is government imposed. Most of these tend to be that a governmental agency has found some type of manufacturing violation (microbial contamination), and thus caused the generic drug manufacturing facility to temporarily cease operations to protect public health. Other governmental issues, such as labeling violations are temporary. Other governmental issues, such as price ceilings or trade bans are more serious economically, as these can have substantially longer delays.

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