Economics Project on Pharmaceutical industry.

Submitted to:
Mam Swaha Shome

Submitted by:
Sameep Verma 0872 Ravneet Kang Sachin Jain Tushar Atray

Acknowledgment

We consider ourselves fortunate to receive the encouragement and patronization of those who helped us in completion of this assignment. This learning exercise would not have been possible without the guidance and support of Mam Swaha Shome, as she has been a great source of inspiration in every phase of the project which gave us this opportunity to learn about Pharmaceutical Industry.

We also extend our sincere thanks to our friends and related members of this project directly or indirectly helping us for successful completion of this assignment.
Warm Regards Yours Sincerely
Sameep Verma Ravneet Kang Sachin Jain Tushar Atrey

ANALYSIS OF THE INDIAN PHARMACEUTICAL SECTOR :

The Indian pharmaceutical industry was estimated at US $16.6 billion (including exports). Indias healthcare spending is around 6 per cent of the total gross domestic product (GDP) of India.

Formulations (drugs) are the end products administered to consumers i.e. the diseased population. Bulk drugs are the raw materials used to make formulations which are ready-to-use forms of bulk drugs and include capsules, tablets, syrups and injections. Bulk drugs or APIs are made of two or more chemicals or intermediaries. Bulk drugs are intended to have a direct effect on the diagnosis, cure, mitigation, treatment or prevention of a disease. Out of the total Indian pharmaceutical market in 2007-08, formulations account for around 70 per cent and bulk drugs for the balance 30 per cent in value terms. India produces 22 per cent of the worlds generic drugs (in terms of value) and is also one of the top five API producers (with a share of about 6.5 per cent). Highly fragmented formulation industry: The formulations industry is highly fragmented both in terms of the number of manufacturers as well as the variety of products. There are about 300-400 units in the organized sector and around 15,000 units in the unorganised (small scale) sector that form the core of the industry. The industry has a wide range of over 100,000 drugs spanning across various therapeutic categories.

Supremacy of the Indian companies vis--vis multinational players: Indian companies dominate the formulations market as seven out of the top ten players are Indian. The formulation market in India is quite concentrated. The top five formulations companies, Cipla, Ranbaxy, GlaxoSmithKline, Cadila Healthcare, and Piramal Healthcare, accounted for about 22.3 per cent of the domestic formulation
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market in 2007-08. The market is concentrated at the top with top 10 players controlling about 36% of the total formulaton sales.

Concentrated Manufacturing : In geographical terms manufacturing operations are largely concentrated in Maharashtra, Andhra Pradesh. However, many players have shifted their manufacturing bases to excise free zones like Baddi (Himachal Pradesh) and Haridwar (Uttaranchal) due to the shift towards MRP based excise duty levy.

In 2006, the per capita annual drug expenditure in India was around $3 as compared to $412 and $191 in Japan and US, respectively. This can be attributed to the huge population in India and the declining health expenditure as a percentage of total government expenditure in India. Unlike US, India does not have a strong health insurance sector to share the healthcare cost with the patient. Consumers do not directly pay for their medicines in the US. Government organisations and managed care organisations reimburse most of the drug cost to the patients in US. However, with rising drug expenditure, patients are being asked to share a large portion of their expenses. This has prompted consumers to choose generic drugs and forego the use of high priced branded drugs.

Market Structure of Pharmaceutical Industry

Demand in pharmaceutical industry

The pharma industry has two types of demands

1. Perfectly Inelastic demand In the case of life saving drugs for eg: atropine (used by patients who suffer from cardiac arrests.) the demand for the drug is completely inelastic as these drugs will be bought no matter what their price is in the market. The demand curve is shown as an vertical line shown in figure below

Price

Quantity

2. Elastic demand In case of OTC drugs such as disprin (an analgesic) the demand is elastic as if the price of disprin increases the consumers will move on to the substitutes of the product. The demand curve is downward sloping shown in figure below

Price

Quantity

Description about The Market Structure

Monopolistic competition is a form of imperfect competition where many competing producers sell products that are differentiated from one another (that is, the products are substitutes but, because of differences such as branding, not exactly alike). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive one where firms cannot gain economic profit. In practice, however, if consumer rationality/innovativeness is low and heuristics are preferred, monopolistic competition can fall into natural monopoly, even in the complete absence of government intervention. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). Joan Robinson is also credited as an early pioneer of the concept. Monopolistically competitive markets have the following characteristics:

There are many producers and many consumers in the market, and no business has total control over the market price. Consumers perceive that there are non-price differences among the competitors' products. There are few barriers to entry and exit. Producers have a degree of control over price.

The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic
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profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule

Major characteristics
There are six characteristics of monopolistic competition (MC):

Product differentiation Many firms Free entry and exit in the long run Independent decision making Market Power Buyers and Sellers have perfect information

Product differentiation
MC firms sell products that have real or perceived non-price differences. However, the differences are not so great as to eliminate other goods as substitutes. Technically, the cross price elasticity of demand between goods in such a market is positive. In fact, the XED would be high. MC goods are best described as close but imperfect substitutes. The goods perform the same basic functions but have differences in qualities such as type, style, quality, reputation, appearance, and location that tend to distinguish them from each other. For example, the basic function of motor vehicles is basically the same - to move people and objects from point A to B in reasonable comfort and safety. Yet there are many different types of motor vehicles such as motor scooters, motor cycles, trucks, cars and SUVs and many variations even within these categories.

Many firms
There are many firms in each MC product group and many firms on the side lines prepared to enter the market. A product group is a "collection of similar products". The fact that there are "many firms" gives each MC firm the freedom to set prices without engaging in strategic decision making regarding the prices of other firms and each firm's actions have a negligible impact on the market. For example, a firm could cut prices and increase sales without fear that its actions will prompt retaliatory responses from competitors. How many firms will an MC market structure support at market equilibrium? The answer depends on factors such as fixed costs, economies of scale and the degree of product differentiation. For example, the higher the fixed costs, the fewer firms the market will support. Also the greater the degree of product differentiation - the more the firm can separate itself from the pack - the fewer firms there will be at market equilibrium.

Free entry and exit

In the long run there is free entry and exit. There are numerous firms waiting to enter the market each with its own "unique" product or in pursuit of positive profits and any firm unable to cover its costs can leave the market without incurring liquidation costs. This assumption implies that there are low start up costs, no sunk costs and no exit costs.

Independent decision making

Each MC firm independently sets the terms of exchange for its product. The firm gives no consideration to what effect its decision may have on competitors. The theory is that any action will have such a negligible effect on the overall market demand that an MC firm can act without fear of prompting heightened competition. In other words each firm feels free to set prices as if it were a monopoly rather than an oligopoly.

Market power
MC firms have some degree of market power. Market power means that the firm has control over the terms and conditions of exchange. An MC firm can raise it prices without losing all its customers. The firm can also lower prices without triggering a potentially ruinous price war with competitors. The source of an MC firm's market power is not barriers to entry since they are low. Rather, an MC firm has market power because it has relatively few competitors, those competitors do not engage in strategic decision making and the firms sells differentiated product. Market power also means that an MC firm faces a downward sloping demand curve. The demand curve is highly elastic although not "flat".

Perfect information
Buyers know exactly what goods are being offered, where the goods are being sold, all differentiating characteristics of the goods, the good's price, whether a firm is making a profit and if so how much.

Market Structure comparison

Number of firms

Market Elasticity of power demand

Product differentiation

Excess profits

Efficiency

Profit maximization condition

Pricing power

Perfect Competition

Infinite

None

Perfectly elastic

None

No

Yes

P=MR=MC

Price taker

Monopolistic competition

Many

Low

Highly elastic (long High run

Yes/No (Short/Long)

No

MR=MC

Price setter

Monopoly

One

High

Relatively inelastic

Absolute (across Yes industries)

No

MR=MC

Price setter

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Inefficiency
There are two sources of inefficiency in the MC market structure. First, at its optimum output the firm charges a price that exceeds marginal costs, The MC firm maximizes profits where MR = MC. Since the MC firm's demand curve is downward sloping this means that the firm will be charging a price that exceeds marginal costs. The monopoly power possessed by an MC firm means that at its profit maximizing level of production there will be a net loss of consumer (and producer) surplus. The second source of inefficiency is the fact that MC firms operate with excess capacity. That is, the MC firm's profit maximizing output is less than the output associated with minimum average cost. Both a PC and MC firm will operate at a point where demand or price equals average cost. For a PC firm this equilibrium condition occurs where the perfectly elastic demand curve equals minimum average cost. A MC firms demand curve is not flat but is downward sloping. Thus in the long run the demand curve will be tangent to the long run average cost curve at a point to the left of its minimum. The result is excess capacity.

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 Short-Run equilibrium of the firm under monopolistic competition.

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Long-Run equilibrium of the firm under monopolistic competition

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 Imperfect competition in the short run.

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Monopolistic competition in Pharmaceutical market

Here are the features of monopolistic competition

Product differentiation Many firms Free entry and exit in the long run Independent decision making Market Power (Buyers and Sellers have perfect information)

Here is how these features are present in pharmaceutical industry

Product differentiation
In pharmaceutical there are many variations of the same product are available. These drugs have little difference and are sold as different from each other

Many firms
In the pharmaceutical industry we find that there are many firms which are producing the same type of drug for eg: analgesics are produced by many firms in the industry.

Free entry and exit of the firms

In the pharmaceutical industry in long run we find that there is free entry and exit for firms. Though there are restrictions to their entry for manufacturing some drugs which need licensing by the government they may freely enter and exit in the production of other drugs.
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Independent decision making

The power of decision of pricing in these types of firms is fairly independent for the pharmaceutical companies they may change the price of their products without triggering a major change in revenues and demand structure. The firms are thus in control of the price

Market power
The buyers who are usually doctors who prescribe medicines have complete knowledge about the product and so do the sellers who sell the goods.

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Bibliography
Wikipedia.org Scribd.com

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