Yesterday I discussed some of the reasons for the current shortage. Today, I will discuss an important paper by Michael Kremer and Christopher Snyder. Kremer and Snyder argue that for the same cost and effectiveness drugs are more profitable to produce than vaccines. As a result, private incentives bias the market against vaccines.
A well known reason is that some people free rider on vaccine provision. When you are vaccinated, I benefit from one less possible transmitter. As a result, some who benefit do not pay. Drugs, in contrast, offer more excludable benefits thereby increasing demand and profits.
Drugs also provide a very natural method for firms to, in effect, price discriminate.
A simple example suffices to illustrate this point. Suppose there are 100 total consumers, ninety of whom have a ten percent chance of contracting the disease and ten of whom have a 100 percent chance. Suppose consumers are risk neutral and are willing to pay 100,000 to be cured of the disease if they contract it. A monopolist selling a vaccine could either charge 100,000 and sell to the ten high-risk consumers or charge 10,000 and sell to all 100 of them. Either way, the monopolist’s revenue is 1,000,000. A monopolist selling a treatment would, in expectation, sell to the nineteen consumers contracting the disease (all ten of the high risk consumers as well as an average of nine consumers from the low-risk group) at a price of 100,000 for a total revenue of 1,900,000, almost twice the revenue from a vaccine.
Damn, that’s clever. I wish I had thought of that.
Having praised Kremer and Snyder I now must say that I am not convinced that the forces they discuss matter very much. First, if the pharmaceutical market is competitive and vaccines pay then they will be produced even when drugs would be more profitable to a monopolist. K&S underestimate the competitiveness of the pharmaceutical market.
Second, my suspicion is that nature and science combine to make it the case that some diseases at some times are better treated by vaccines and other diseases by drugs. K and S’s model works best if there are many cases where drugs and vaccines are close cost-substitutes. Firms then choose drugs even when vaccines would have been more desirable. I think, in contrast, that cost differences will usually exceed the profit differences. On the margin, K and S are correct but suppose vaccines had been subsidized would we today have an AIDS vaccine? I doubt it.
I’m not necessarily against their conclusion, however, that vaccines should be subsidized relative to drugs. It’s sad to say, therefore, that as discussed yesterday we currently do precisely the opposite.