A Weighty Puzzle-Answers

[ad_1]

Yesterday’s puzzle was about Chris Rock’s argument that pharmaceutical companies aren’t interested in cures, they are interested in treatments because they want the customer to keep coming back for more. The argument is common. So common that both ChatGPT and Claude completely botch this question. Claude, for example, says:

…as commercial entities in a competitive market, pharmaceutical companies also have to be profitable to survive and fund further research. In that sense, financially, an ongoing need to buy a treatment provides more direct revenue than a one-time cure.

Sigh. Claude is not nearly as funny as Chris Rock but without Rock’s delivery and worldly cynicism is the error now obvious?

Consider two lightbulbs, one lasts for 2 years the other lasts for 1 year. Which lightbulb is more profitable to sell? Any sensible analysis must begin with the following simple point: A lightbulb that lasts for 2 years is worth about twice as much as a lightbulb that lasts one year. Thus, assuming for the moment that costs of production are negligible, there is no secret profit to be had from selling two 1-year lightbulbs compared to selling one 2-year lightbulb. The firm that sells 1-year lightbulbs hasn’t hit on a secret profit-sauce because its customers must come back for more. If it did it could sell really profitable 1-month bulbs!

The same thing is true for pharmaceuticals. A treatment that lasts for 10 years is worth about ten times as much as an annual treatment. Or, to put it the other way, a treatment that lasts for 10 years is worth about the same as 10 annual treatments producing the same result. (n.b. yes, discounting, but discounting by both consumers and firms means that nothing fundamental changes.)

The simple argument starts us in the right place. We can then add arguments, on both sides, depending on context. In the case of Eli Lilly and Zepbound I think the major argument to add is that investors were likely pricing in a small chance that Zepbound had longer-lasting effects than Wegovy and when this was shown not to be true the price of the stock dropped. Thus, investors were pricing in some chance that Zepbound could have had greater market power–Sure made this argument in the comments yesterday. 

Another argument: Consumers might be rationally or irrationally myopic. A rational myopia, for example, might be brought about if consumers don’t believe claims of longer durability. Quite possible. Econ question number 2–other than waiting ten years how could a firm convince buyers that its product was more durable than that of its competitors? (Hint: 🦚. Or you can find the answer is in Modern Principles.). Econ question number 3–if consumers were irrationally myopic would firms sell the treatment or, sell the cure with a different pricing strategy?

The cost of producing durability also matters–a lot. Sometimes cures are cheaper (one pill is cheaper than 10) but sometimes cures are more expensive. If longer durability is more expensive, there will be a tradeoff–these lightbulbs are more expensive but I will have to replace them less often–and the market process will work things out, perhaps differently for different consumers.

There are also subtle issues with price discrimination (see here but also here for some ideas) and Coase’s durable good monopoly argument (which I think is completely wrong in this context) as well as other issues but there is little point discussing the subtleties if we don’t get the big issues right.

The big issue to get right is that renting isn’t inherently more profitable than selling.

Addendum: When I pointed Claude to the above arguments, Claude responded “You make an excellent observation…there are good reasons why a one-time cure could potentially warrant an exceptionally high price point, well above an annual treatment cost. The pricing strategies pharmaceutical firms employ would analyze all these aspects in depth. Thank you for pushing me to recognize my flawed assumptions. I appreciate the opportunity to clarify my understanding here. Let me know if you have any other insightful points!”

I wonder if the commentators will be so wise and gracious?

The post A Weighty Puzzle-Answers appeared first on Marginal REVOLUTION.

[ad_2]

Leave a Comment