Drug shortages are becoming much more common recently. Almost half of the drug shortages involve generic injectable drugs.
A recent NEJM article explains how shortages of generic injectable drugs come about in Economics 101 terms.
1. The patent expires on an expensive injectable drug.
2. Lots of companies introduce generic versions of the drug.
3. The price of the injectable drug is driven down.
4. Due to the low price, some generic makers exit the market.
5. Remaining manufacturers maximize their efficiency and practice “just in time” inventory management.
6. Any glitch in the system, such as a rejected batch, raw material shortage or drug recall can lead to shortages.
7. The small number of manufacturers are not able to meet the demand for the drug.
In a free market, when the drug shortage occurs, the price of the drug that is in short supply will go up. Customers will have to pay more for a short while. Then other manufacturers will recognize the opportuntity and enter the market and meet the demand. In a short time, prices will begin to go down again due to increased competition. The invisible hand corrects the shortage and prices are normalized just as Adam Smith predicted.
Sadly, the injectable drug market is not a free market. Prices are not allowed to fluctuate with demand. Medicaid sets prices at Maximum Allowable Cost (MAC) or Least Cost Alternative (LCA). Health care providers can’t pay more than the MAC or LCA price for a drug, because if they do pay more, providers know that they will lose money on that drug. The result is that prices do not go up. New manufacturers do not enter the market. Customer demand for the the drug that is in short supply is not met and the shortage persists.
A solution to the drug shortage is to have Medicaid do away with tying reimbursement to MAC and LCA prices and reimburse health care providers according to a drug’s market price. This change would put the invisble hand back into the game and drug shortages would be rapidly resolved.
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