A Little Microeconomics

I heard an interesting story on Marketplace tonight, which suggested a neat application of the price elasticity of demand. The story involves Genentech’s recent decision to double the price of Avastin, a highly effective anti-cancer drug. Treatment for one year used to cost $50,000. Now it will be $100,000. The story discusses the equity of charging so much for a potentially life-saving treatment.

As an economist, I wonder about the profitability of such a policy. I can’t claim to know much about the pharmaceutal industry, so I may be completely wrong about this. I’m guessing though, that the majority of the costs associated with a given drug are fixed in the form of research, development and testing. Once the drug is on the market, the cost of producing a dose is probably very small.

Now let’s think about the revenue side. I suspect that the price elasticity of demand for Avastin over the price range here ($50-100K) is quite high. How many health insurance plans will pay $100,000 for drug treatment for a year? I don’t know, but I can’t help thinking that Genentech would sell more Avastin and bring in more revenues at the lower price. And if the cost of the dose is small, the lower price should correspond to higher profits.

You can listen to the audio here.

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