Parallel Trade and the Pricing of Pharmaceutical Products Frank Müller-Langer Conference on „Health Economics and the Pharmaceutical Industry“

Parallel Trade and the Pricing of Pharmaceutical Products

Frank Müller-Langer

Conference on„Health Economics and the Pharmaceutical

Industry“

Frank Müller-LangerUniversity of HamburgInstitute of Law and Economics

2

Agenda

1 Introduction

2 Prior literature

3 Double marginalization model with complete information

4 Conclusion and ideas for further research


3

Parallel imports (PIs)

• When do parallel imports actually occur?• Why should we care about parallel imports?

- Advocates of strong patent rights for new pharmaceutical products support a global regime of banning parallel imports- Restraints on parallel imports vary widely between developed and developing countries and even amongst developed countries


4

Questions to be analyzed

1. Why may parallel imports actually occur in equilibrium when information is complete?

2. Are parallel imports beneficial or detrimental to the producer of a patented product?


5

Agenda

1 Introduction

2 Prior literature: Determinants of parallel trade




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Determinants of Parallel Trade

First strand of literatureExclusive distribution rights in foreign markets, vertical price control and parallel trade [Maskus and Chen (2002, 2004)]


7

Determinants of Parallel Trade

Second strand of literaturePrice regulations by national governments and parallel trade [Ganslandt and Maskus (2004), Jelovac and Bordoy (2005)]


8

Agenda

1 Introduction

2 Prior literature




9

Double Marginalization Game: Assumptions

• Player 1: Monopolistic manufacturer of pharmaceuticals in country A

• Manufacturer has marginal costs of zero• Player 2: Exclusive distributor in country B• Players’ payoff functions: their profits• Demand in country A:• Demand in country B:• Parallel imports are allowed (perfect substitute)• Distributor: marginal costs of parallel trade,

with 1A A AD ( p ) a bp

B B BD ( p ) a bp

wBp t


10

Structure of the game

• First stage: manufacturer chooses the wholesale price at which he sells the pharmaceutical product to the distributor in country B,

• Second stage: distributor chooses the retail price in country B, pB

• Third stage: manufacturer and distributor simultaneously choose the prices at which they sell the product in country A in a Bertrand price competition, and .

wBp

mAp d

Ap


11

Bertrand price competition

• Rules of the gameThe low-price firm serves the entire market

The high-price firm sells nothing• Manufacturer has marginal costs of zero• Distributor has positive marginal costs of

• Manufacturer sets a price that is smaller than the marginal costs of the distributor,

wBp t

m wA Bp t p


12

Bertrand price competition

Result: PIs will never occur in any sub-game perfect Nash equilibrium in the double marginalization game with complete information


13

Distributor‘s decision

• In the second stage, the distributor anticipates that he will be driven out of the market in country A in the third stage

• In the second stage, the distributor sets a retail price in country B that is 50 per cent higher than the wholesale price set by the manufacturer


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Maximization problem of the manufacturer

subject to 0

and 0

and

m wA B

wm m w BA A B

p ,p

mA

wB

m wA B

a-bpmax p a bp +p

2

p

p

p t p


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Solution 1 for low trade costs and high

• We use the Kuhn-Tucker Theorem and obtain two solutions

• Solution 1:

• Solution 1 only satisfies the non-negativity restrictions if

12 1

6 3m*A

ap t

b

12

at

b

22 1

6 3w*B

ap t

b


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Solution 2 for

• equal to the monopoly price in the double marginalization game when parallel imports are prohibited

• equal to the profit-maximizing wholesale price in the double marginalization game when parallel imports are prohibited

12

a

tb

2m**A

ap

b

2w**B

ap

b


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Equilibrium Quantities and Prices

PI‘s allowed PI‘s prohibited

Price in A

Quantity in A

Wholesale Price in B

Retail Pr. in B

Quantity in B

2m**A

ap

b

2w**B

ap

b

3 6 3m*A

a a tp

b b

2

3 6 3w*B

a a tp

b b

2**A

aq

2

3 6 3*A

a a btq

4**B

aq 5

12 6 3*B

a a btq

3

4**B

ap

b

7

12 6 3*B

a a tp

b b


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Profit of the manufacturer

1. Parallel imports are allowed:

2. Parallel imports are prohibited:

* m* * w* *A A B Bp q p q

2 2 2 2 2

24 3 3 6 3 6* a at bt a at a

b b b

** m** ** w** **A A B Bp q p q

2 2 2

8 4** a a

b b


19

Net effect on profit when PI‘s are allowed

and

and as b >0.

* ** 2 2 2 2 2

12 3 3 6 3 12

a at bt a at a

b b b

20 1

3 3 3 2maxa bt a a

tt b

2

2

20

3

b

t


20

Net effect on profit when PI‘s are allowed

• For we obtain:

• Hence,

• Result: Manufacturer generates a lower profit when parallel imports are allowed

0

0 maxt \ t

maxt


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Results of the welfare analysis

• The net effect of parallel trade on global welfare is positive if the market in country A is large ( )

• The net effect of parallel trade on global welfare can be negative if trade costs are at an intermediate level and countries are virtually homogenous in terms of market size ( )

5 2/

1


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Summary of the main results

• PIs will never occur in a double marginalization game with complete information

• If , potential competition from parallel trade does not arise. The manufacturer charges the monopoly price in country A and the optimal wholesale price in country B

• If , potential competition from parallel trade arises. The manufacturer strategically sets the wholesale price in country B and the price in country A, in order to prevent that parallel trade occurs

12

at

b

12

at

b


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Summary of the main results

• The manufacturer generates a lower profit when parallel imports are allowed as he has to set prices strategically in order to deter parallel imports


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Agenda

1 Introduction

2 Prior literature


4 Ideas for further research


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Ideas for further research

• Does parallel trade occur when country A is less attractive in terms of market size, [ ], and trade costs are very low [ ] ?

• Impact of a price cap in country B?

0 0t


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Ideas for further research

• Parallel trade and medicines for neglected infectious and tropical diseases- 99 per cent of global demand for medicines for such diseases is generated in the developing world- Country A high-income country:

- Country B low-income country:

with 1A A AD ( p ) a bp

with 1B B BD ( p ) a bp


27

Thank you


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Follow-up paper: New timing of the game

• Stage 0: Manufacturer chooses retail price in country A

• Stage 1: Manufactuer chooses wholesale price in country B

• Stage 2: Distributor chooses retail price in country B

• Stage 3: If , a third firm will enter the market, buys the product from the distributor in country B and then re-sells the product in country A

m wA B p t p


29

Game with asymmetric information

• First stage: Manufacturer chooses the price at which he charges the distributor in country B

• Second stage: Nature chooses the demand in country A and country B

• Third stage: Distributor chooses the price he charges his customers in country B

• Fourth stage: Manufacturer and distributor play a Bertrand game


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Hypothesis

Depending on Nature’s choices with regard to local demand functions parallel imports may occur in equilibrium


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Social welfare analysis of parallel imports

• Infectious diseases kill 14 million people around the world every year, with 90 per cent of those deaths occurring in the developing world

• Furthermore, almost 1,400 new medicines have been developed in the last 25 years, but only 1 per cent of these were medicines for parasitic and infectious tropical diseases that are rampant in the developing world


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Hypothesis

• Hypothesis: There is an important rationale for restricting parallel importation of medicines for parasitic and infectious tropical diseases that are rampant in middle income and low income countries

• Parallel imports would further reduce the incentives to invest in R&D for medicines for parasitic and infectious tropical diseases


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Parallel Imports and the WTO

• WTO members are free to choose whether to allow or prohibit parallel imports

• Article 6 of the TRIPS Agreement:“For the purposes of dispute settlement under this Agreement, subject to the provisions of Articles 3 and 4, nothing in this Agreement shall be used to address the issue of the exhaustion of intellectual property rights.”


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• In the second stage, the distributor anticipates that he will be driven out of the market in country A in the third stage

• Parallel trade does not occur

• Total profit is equal to the profit generated in country B through exclusive distribution


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• The distributor has to pay the wholesale price

• Maximizes profit according to:

wBp

B

wB B B

pmax p p a bp


36


• The first-order condition is given by:

2 0wB B

B

a bp bpp

2

ww B

B B

a bpp ( p )

b


37

Parallel trade can have a negative effect on global welfare [ , and ] 100a 1 2b / 13 8/

Documents

Parallel Trade and the Pricing of Pharmaceutical Products Frank Müller-Langer Conference on „Health Economics and the Pharmaceutical Industry“