Living Economics

Brand-name products usually sell for higher prices than their generic equivalents. Nowhere are these price differences more dramatic than in prescription drugs. For example, 20 mg of Prozac (an anti-depressant) sells for $2.70 while its generic equivalent sells for $0.91. 15 mg of BuSpar (another anti-depressant) sells for $2.20, while its generic equivalent sells for $0.98 (USA Today 6/6/02). In general, it is not unusual for the price of a generic drug to be 40% or more lower than its brand-name equivalent.

The reason for the price drop is that the 20-year monopoly patent granted to the company covering the brand-name drug has expired. On the surface of it, this seems to be a classic example of why monopoly is less efficient than competition by charging higher prices and producing at a lower level of output. But competition would not have been possible had the brand-name drugs never been invented and marketed. Far from converting a generic product into a monopoly, the brand-name drug company is turning over a proven new product to its generic competitors. So in spite of the high profit margin for brand-name drugs, monopoly is a necessary stage leading to competition for many new products requiring expensive R&D. Without the high profit margin promised by an exclusive patent as an inducement, many otherwise very useful products would never have been invented and marketed.

That the generic market has been created by the brand-name drug companies is beyond dispute. Brand-name drug companies spend more money to market their drugs than on their R&D. But makers of generic drugs cannot afford to and do not advertise to build market share because most of the benefits from expensive advertising go to their competitors. Makers of generic drugs also do not have to go through the time-consuming and expensive three-phase clinical testing for safety and efficacy of their generics like the makers of their brand-name equivalents did when the drugs were first approved. Instead, they simply feed their generic pills to healthy adults and take blood tests to determine how the medicine is absorbed into their bloodstream. If the generic is absorbed in the same fashion as the name brand, it is deemed "bioequivalent" (San Francisco Chronicle 6/24/02).

This transfer of products and product recognition from the brand-name drug companies to their generic competitors is massive. Generic drugs shot up from 19% of all prescriptions in 1984 to 49% in 2002 (USA Today 6/6/02). The sale of products facing patent expiration between 2002 and 2006 accounted for 26.7 cents of every prescription dollar spent in 2001 (St. Louis Post-Dispatch 6/4/02).

This free transfer is, of course, not voluntary. The Hatch-Waxman Act of 1984 facilitated this transfer by exempting the generic drug makers from repeating the three phases of clinical trials required to prove the safety and efficacy of new drugs. Understandably, the brand-name drug companies have not been passively cooperating with this compulsory transfer of market power. Drug companies can gain an extra six months of patent protection on a drug by conducting clinical studies on children to determine the best doses for young people. These companies can also try to extend their patent protection for 30 months by suing a potential generic competitor for infringing peripheral patents on packaging, dosing schedules or other secondary issues (NY Times 6/10/02).

It is understandable that the brand-name drug companies are fighting hard to hold on to their patent protection. Most drugs have far fewer than 20 years of patent protection because the protection starts from the date the patent is filed not when the drug first enters the market. Also, the average expenditure for developing a new drug is $500 million to $800 million because half of only 1 in 10 of the drugs that enter human trials makes it through Phase III.