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Price Controls and the Drug Industry

In an earlier blog post, I pointed out that price controls imposed by the federal government were causing shortages of drugs designed to fight cancer. Cancer Drugs and Price Controls is another article describing the shortages caused by government-imposed price controls. While it is routine for economists to point to shortages as a consequence of price controls, there is another problem caused by price controls that often gets much less attention. Price controls can cause firms to cease production of the product subject to price controls.

Awi Federgruen is a faculty member at Columbia University. In The_Drug_Shortage_Debacle, Professor Federgruen points out that in 1967, there were 26 firms producing drugs in the U.S. whereas, today, there are only six. The managers of publicly-owned firms have a fiduciary responsibility to earn profits for the benefits of stockholders, the owners of the firm. If price controls make it unprofitable to produce a drug subject to price controls, the only rational response by the firm’s managers is to cease production of unprofitable drugs. To do otherwise would result in the firing of the managers responsible for the production of unprofitable drugs and these managers may even be subject to lawsuits by the stockholders who have incurred these losses. As firms leave an industry due to price controls, shortages grow in size as fewer and fewer firms are willing to produce drugs at the controlled prices.

In addition, the production of drugs must now be authorized by the Federal Drug Administration (FDA). If there are production problems that cause production to shut down in one firm, another firm cannot increase production until the FDA authorizes the additional production. Any bureaucratic delays at the FDA may also result in shortages.

These articles underscore the fact that the drug industry in the U.S. is now heavily regulated, much like it would be in a socialist or centrally-planned economy. It is not shocking to an economist that centrally planned industries are subject to shortages, containing firms that cannot respond to market incentives. These are precisely the types of problems caused by central planning.

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  1. November 21, 2012 at 2:18 PM
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