Answers

Example answer

(i) Define the term market power. [2 marks]

Example answer

Market power refers to the ability of a firm to set price or output in the
market. Market power is largely determined by market share. The more a
firm dominates the market, the more market power they can exert.

(ii) Explain two possible economic reasons why Mylan was able to raise the
price of EpiPens to over 400% from 2009 to 2016. [4 marks]

Example answer

First, Mylan may be able to raise the price of EpiPens significantly because
EpiPens are essential goods for those individuals with allergies, and are hence
price inelastic. Even a significant increase in price of over 400% will bring
about a smaller than proportionate fall in quantity demanded. Mylan can
successfully increase price, without a corresponding fall in total revenue.

Second, Mylan may be able to raise prices if it is the only or the dominant
firm in the market. If Mylan raises its prices, and there are no close
substitutes for EpiPens, then consumers will have no choice but to continue
to buy the good, regardless of the increase in price.

Exam tip

Read the question stem carefully. The information in the question states that Mylan does not hold a patent, a
not be accepted.
(iii) Calculate the profit per EpiPen for Mylan for each year in the US. [2
marks]

Example answer

Price for a pack of Average Profit per EpiPen

two cost

Profit = AR – AC
2009 $124 $10
Profit = (($124/2) – ($10))
Profit = $62 - $10
 Profit = $52

2011 $181 $10 Profit = AR - AC

Profit = (($181/2) – ($10))
Profit = $90.5 – $10
Profit = $80.50

Source: Seven Pillars

Be aware

Always show your working. If there is not enough space in the answer box, always ask for extra paper.
(iv) Explain two economic reasons that may account for different prices for
EpiPens in different markets. [4 marks]

Example answer

First, EpiPens may be cheaper in other countries such as the UK because of

subsidised (universal) health care. In such a case, the government intervenes
in the market to set prices of medicines at an affordable level.

Second, the market for epinephrine delivery devices in the EU might be more
competitive. If there are multiple pharmaceutical companies selling EpiPen
products in the EU, the increased competition in the market will bid down
prices.

(v) Complete the table below. Calculate the price for each year. [2 marks]

Example answer

Year Price (per prescription) Quantity (of prescriptions) Total revenue

2010 P = TR/Q 12 700 $667 000

P = $667 000/12 700
$52.52

2011 P = TR/Q 12 700 $6.3 million

P = $6 300 000/12 700
$496.06
Be aware

Always add the correct unit ($).

(vi) Using the prices from part (v) above, calculate the elasticity for Daraprim
for the price changes from 2010 to 2014. [3 marks]

Example answer

e= % change in Qd
% change in price

% change in Qd
= 12700−88211270012700−882112700 = 387912700387912700
divided by
% change in price
= 52.52−1122.3252.5252.52−1122.3252.52= −1069.852.52−1069.852.52
e =.30543307 ÷ - 20.3693831
e = 0.01499471
e = 0.01

Be aware

A common mistake is to reverse the numerator and denominator for the equation to calculate elasticity.

Exam tip

Be careful not to round down your answer until the very end.
(vii) Assuming patients receive 60 tablets per prescription, calculate how .
much would a prescription for Daraprim increase in price from 2014 to 2015.
[1 mark]

Example answer

The cost of a prescription in 2014 was $1122.32

However, by 2015, the cost of a prescription was (60 tablets) x $750 =

$45 000

Hence the increase in price for a prescription from 2014 to 2015

= ($45 000) - ($1122.32)
= $43 877.68

(viii) Let us assume the government wishes to combat higher drug prices for
drug X through regulation. The government aims to regulate drug prices at
the social optimum. Calculate the change in price and output decisions as a
consequence of regulation of drug prices. [2 marks]

Example answer

Before regulation, the pharmaceutical company will set price and output
decisions at the profit maximising condition where MR = MC.

Hence the drug company will set output at 30, and price at $700.

However, after regulation, the government will require the pharmaceutical

company to set price and output decisions at the social optimum where P
(AR) = MC.

Hence the regulated drug company will set output at 45 and price at $550.

As a result of regulation, output will rise by 15 units and price will fall by
$150.

Figure 5. The cost and revenue curves faced by a pharmaceutical company.

b. Using the data provided and your knowledge of economics, recommend a
policy that could be introduced to reduce the abusive monopoly power of
some pharmaceutical companies.
[10 marks]

Example answer

The government can consider different alternative policies to reduce the

abusive monopoly power of some pharmaceutical companies.

According to the data, in 2009 Mylan held an 85% market share for medical
devices that dispensed epinephrine. Clearly, Mylan dominated the market,
and can therefore be considered a monopoly. Further, there are few
alternatives for individuals when suffering from anaphylactic shock, so the
EpiPen faces few substitutes – and is hence inelastic.

Figure 6. EpiPens are an

inelastic good.
Due to the inelastic nature of their goods, monopolies have an economic
incentive to reduce output from Q1 to Q2 in order to increase price from P1 to
P2 to maximise their profits. According to the data, Mylan increased the price
of EpiPens over 400% from 2009 to 2016. It is clear that Mylan was abusing
its monopoly power.

However, it would be beneficial for the government to intervene as goods

such as EpiPens and Daraprim have positive externalities in production. For
example, Daraprim treats people with stomach parasites. Effective treatment
for the parasites not only benefits the individual, but also the rest of society.
This is because the rest of society is unable to catch the parasites from the
individual that has been treated.

If the government wishes to create an effective policy to overcome the

problems with the pharmaceutical market, then the government must focus on
a solution that increases the consumption of the drug (from Q to Q1) and
makes it available at a lower price.
To increase the benefits of a positive externality such as pharmaceutical
drugs, the government may wish to pay a subsidy to those firms that produce
the goods.

Figure 7a. Inelastic market

demand.

Figure 7b. Elastic

market demand.
For example, a government may wish to pay a subsidy (a payment per unit to
produce) to pharmaceutical companies to encourage them to produce more
drugs such as Daraprim and EpiPens, and sell them at a lower price. A
subsidy will shift out the supply curve from S1 to S2, this will decrease the
price from P1 to P2 and increase output from Q1 to Q2. Since pharmaceutical
drugs are extremely inelastic, we can see from Figure 7a, that a subsidy will
bring about a smaller than proportionate rise in quantity. The subsidy will be
very effective at decreasing the price of drugs, but not so effective at
increasing the stock of drugs available to patients.

But to what extent are subsidies effective or even desirable?

A subsidy entails the government channelling government expenditure out of

welfare and unemployment programmes and into the coffers of profit-making
firms. Pharmaceutical firms are among those that make the greatest profits.
A subsidy is only effective if the social benefits are so large that it outweighs
the opportunity cost of the alternative uses of government funds. From the
data, Mylan is already making a supernormal profit – to pay Mylan to
produce more EpiPens seems to be an economically inefficient solution.

It can be argued that pharmaceutical companies need access to their

supernormal profits, as they use them to fund research and development.
Pharmaceuticals argue they need supernormal profits to fund R&D for new
drugs to save lives. However, in every case (EpiPen, Daraprim, Nitropress,
Ofirmev, Isuprel, Vimovo) the pharmaceutical company acquired the drug
after the research and development had been completed, and incurred no
R&D costs. In every case presented in part (a), after acquiring the drug,
pharma companies increased the price. It seems the argument for higher
prices needing to recoup R&D costs in this case is weak.

Lastly, the data regarding the price of EpiPens in different markets was very
telling. The price for EpiPens in the US was three times higher (over $600)
than the next most expensive country – Germany (less than $200). The same
product, the same producer, and yet a significantly lower price. This may be
because of two reasons. First, pharmaceutical companies are highly regulated
in Europe. It is recognised that there are positive externalities that arise from
medicine and as such everyone should have access to it at lower costs. The
government may intervene in the market to set the price of prescriptions. In
this way, price gouging is avoided. Second, there may be more competition
in Europe for EpiPen type products. The EU encourages competition, and
there are eight companies in Europe selling/competing in the EpiPen market.
This competition drives down prices.

Although it can be argued that government regulation stops firms using the
price mechanism and the profit motive to guide price and output decisions –
in the case of pharmaceutical firms – this may be a good thing! Left to the
market, Mylan has abused their monopoly power by driving up prices so the
product is simply unaffordable for many families. The argument that
supernormal profits are needed to recoup research and development seems to
be very hollow. On balance, in the case of life saving medicine, it seems
government regulation is the best option.