For a long time there has been concerns about the price of medical drugs. Especially cures for rare, severe diseases can be very expensive (say costing in excess of $100,000 per year) and unaffordable for uninsured patients.
There is also a common hypothesis that there exists an inverse relationship between the price of the cure and the incidence of the disease (some proof exists, see e.g. Messori et al., 2010).
Using a model we show that for severe diseases the high prices and inverse relationship can be caused by the availability of insurance. In simple terms we point out that for severe diseases the demand for the drug may be determined more by what patients can afford to pay, rather than by what the drug is worth to the average patient. In that case budget constraints reduce the optimal price of the drug.
Insurances however are a cost sharing mechanism. If one in ten insured patients become ill, on average ten insured individuals bear the cost of one drug together. This gives insured patients access to drugs they could not afford by themselves, given the drug’s price. However, this also allows the pharmaceutical company to increase its price tenfold without loosing any customer.
We show formally that this leads to an inverse relationship between the price of the drug and the incidence of the disease with a maximum price equal to the expected benefit of the drug to a patient. As long as this price is below that maximum, positive effect of insurance on the access to the drug is absent or very limited.
Our explanation is important for at least two policy considerations. First, the amount of stimulation the government needs to provide in order to develop new orphan drugs may be much smaller if people can insure themselves. Second, if insurance is available, it may be necessary to organize some countervailing bargaining power to oppose the common monopoly position of pharmaceutical companies in these particular markets.
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