Transcript Parallel imports

Parallel Trade and the Pricing of
Pharmaceutical Products
Conference on
„Health Economics and the Pharmaceutical
Industry“
Frank Müller-Langer
Agenda
1 Introduction
2 Prior literature
3 Double marginalization model with
complete information
4 Conclusion and ideas for further research
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
2
Parallel imports (PIs)
• When do parallel imports actually occur?
• Why should we care about parallel imports?
- Advocates of strong patent rights for new
pharmaceutical products support a global
regime of banning parallel imports
- Restraints on parallel imports vary widely
between developed and developing
countries and even amongst developed
countries
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
3
Questions to be analyzed
1. Why may parallel imports actually
occur in equilibrium when
information is complete?
2. Are parallel imports beneficial or
detrimental to the producer of a
patented product?
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
4
Agenda
1 Introduction
2 Prior literature: Determinants of parallel
trade
3 Double marginalization model with
complete information
4 Conclusion and ideas for further research
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
5
Determinants of Parallel Trade
First strand of literature
Exclusive distribution rights in foreign
markets, vertical price control and parallel
trade [Maskus and Chen (2002, 2004)]
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
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Determinants of Parallel Trade
Second strand of literature
Price regulations by national governments
and parallel trade [Ganslandt and Maskus
(2004), Jelovac and Bordoy (2005)]
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
7
Agenda
1 Introduction
2 Prior literature
3 Double marginalization model with
complete information
4 Conclusion and ideas for further research
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
8
Double Marginalization Game: Assumptions
•
•
•
•
•
•
•
•
Player 1: Monopolistic manufacturer of
pharmaceuticals in country A
Manufacturer has marginal costs of zero
Player 2: Exclusive distributor in country B
Players’ payoff functions: their profits
Demand in country A: DA ( pA )   a  bpA with   1
Demand in country B: DB ( pB )  a  bpB
Parallel imports are allowed (perfect substitute)
w
Distributor: marginal costs of parallel trade, pB  t
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
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Structure of the game
• First stage: manufacturer chooses the
wholesale price at which he sells the
pharmaceutical product to the distributor in
w
country B, p B
• Second stage: distributor chooses the retail
price in country B, pB
• Third stage: manufacturer and distributor
simultaneously choose the prices at which they
sell the product in country A in a Bertrand price
m
d
p
competition, A and p A .
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
10
Bertrand price competition
• Rules of the game
The low-price firm serves the entire market
The high-price firm sells nothing
• Manufacturer has marginal costs of zero
• Distributor has positive marginal costs of
p t
w
B
• Manufacturer sets a price that is smaller
than the marginal costs of the distributor,
p t p
m
A
w
B
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
11
Bertrand price competition
Result: PIs will never occur in any subgame perfect Nash equilibrium in the double
marginalization game with complete
information
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
12
Distributor‘s decision
• In the second stage, the distributor
anticipates that he will be driven out of the
market in country A in the third stage
• In the second stage, the distributor sets a
retail price in country B that is 50 per cent
higher than the wholesale price set by the
manufacturer
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
13
Maximization problem of the manufacturer
max


p
m
w
p A ,pB
m
A
 a  bp 
m
A
subject to
p 0
and
p 0
and
p t p
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
w

w a-bpB 
+pB 

 2 
m
A
w
B
m
A
w
B
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Solution 1 for low trade costs and high

• We use the Kuhn-Tucker Theorem and obtain two
solutions
• Solution 1:
a
1
2


1


 t
6b
3
a
2
w*
pB   2  1  t
6b
3
• Solution 1 only satisfies the non-negativity
restrictions
a
if t 
  1
p Am* 
2b
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
15
Solution 2 for
p
m**
A

a
t
  1
2b
a
2b
• equal to the monopoly price in the double
marginalization game when parallel imports
are prohibited
p
w**
B
a

2b
• equal to the profit-maximizing wholesale
price in the double marginalization game
when parallel imports are prohibited
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
16
Equilibrium Quantities and Prices
PI‘s allowed
a a t

 
3b 6b 3
2a a bt
Price in A
p
Quantity in A
q 
Wholesale
Price in B
Retail Pr. in B
m*
A
*
A

3
6

a a 2t
p   
3b 6b 3
7a a t
*
Quantity in B
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
PI‘s prohibited
w*
B
pB 


12b 6b 3
5a a bt
*
qB 


12 6 3
p
m**
A
a

2b
a
q**
A 
3
p
w**
B
2
a

2b
3a
p 
4b
a
**
qB 
4
**
B
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Profit of the manufacturer
1. Parallel imports are allowed:
*  p Am* q*A  pBw* q*B
2
2
2
2 2
a
at bt
a  at a 
*
 
 



24b 3
3
6b
3
6b
2. Parallel imports are prohibited:
w** **
**  p Am** q**

p
A
B qB
2
2 2
a
a

**
  
8b
4b
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
18
Net effect on profit when PI‘s are allowed
    
*
**
a
at bt
a  at a 
   
 



12b 3
3
6b
3
12b
2
2
2
2
2

a 2bt a
a
max
 

 0  t     1
and
t
3 3
3
2b
2


2b
and
   0 as b >0.
2
 t
3
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
19
Net effect on profit when PI‘s are allowed
• For
t
max
we obtain:   0
• Hence,
  0 t\t
max
• Result: Manufacturer generates a lower
profit when parallel imports are allowed
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
20
Results of the welfare analysis
• The net effect of parallel trade on global
welfare is positive if the market in country
A is large
(   5 / 2)
• The net effect of parallel trade on global
welfare can be negative if trade costs are at
an intermediate level and countries are
virtually homogenous in terms of market
size (   1 )
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
21
Summary of the main results
• PIs will never occur in a double marginalization
game with complete information
a
  1 , potential competition from
• If t 
2
b
parallel trade does not arise. The manufacturer
charges the monopoly price in country A and the
optimal wholesale price in country B
a
• If t 
  1 , potential competition from parallel
b
trade 2
arises.
The manufacturer strategically sets
the wholesale price in country B and the price in
country A, in order to prevent that parallel trade
occurs
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
22
Summary of the main results
• The manufacturer generates a lower profit
when parallel imports are allowed as he has
to set prices strategically in order to deter
parallel imports
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
23
Agenda
1 Introduction
2 Prior literature
3 Double marginalization model with
complete information
4 Ideas for further research
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
24
Ideas for further research
• Does parallel trade occur when country A
is less attractive in terms of market size,
[   0 ], and trade costs are very low
[ t 0 ] ?
• Impact of a price cap in country B?
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
25
Ideas for further research
• Parallel trade and medicines for neglected
infectious and tropical diseases
- 99 per cent of global demand for
medicines for such diseases is
generated in the developing world
- Country A high-income country:
DA ( pA )   a  bpA with   1
- Country B low-income country:
DB ( pB )  a   bpB with   1
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
26
Thank you
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
27
Follow-up paper: New timing of the game
• Stage 0: Manufacturer chooses retail price
in country A
• Stage 1: Manufactuer chooses wholesale
price in country B
• Stage 2: Distributor chooses retail price in
country B
m
w
• Stage 3: If p A  t  pB , a third firm will
enter the market, buys the product from
the distributor in country B and then resells the product in country A
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
28
Game with asymmetric information
• First stage: Manufacturer chooses the
price at which he charges the distributor
in country B
• Second stage: Nature chooses the
demand in country A and country B
• Third stage: Distributor chooses the
price he charges his customers in country
B
• Fourth stage: Manufacturer and
distributor play a Bertrand game
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
29
Hypothesis
Depending on Nature’s choices with regard
to local demand functions parallel imports
may occur in equilibrium
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
30
Social welfare analysis of parallel imports
• Infectious diseases kill 14 million people
around the world every year, with 90 per
cent of those deaths occurring in the
developing world
• Furthermore, almost 1,400 new medicines
have been developed in the last 25 years,
but only 1 per cent of these were
medicines for parasitic and infectious
tropical diseases that are rampant in the
developing world
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
31
Hypothesis
• Hypothesis: There is an important rationale
for restricting parallel importation of
medicines for parasitic and infectious
tropical diseases that are rampant in
middle income and low income countries
• Parallel imports would further reduce the
incentives to invest in R&D for medicines
for parasitic and infectious tropical diseases
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
32
Parallel Imports and the WTO
• WTO members are free to choose whether
to allow or prohibit parallel imports
• Article 6 of the TRIPS Agreement:
“For the purposes of dispute settlement
under this Agreement, subject to the
provisions of Articles 3 and 4, nothing in
this Agreement shall be used to address
the issue of the exhaustion of intellectual
property rights.”
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
33
Distributor‘s decision
• In the second stage, the distributor
anticipates that he will be driven out of the
market in country A in the third stage
• Parallel trade does not occur
• Total profit is equal to the profit generated
in country B through exclusive distribution
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
34
Distributor‘s decision
• The distributor has to pay the wholesale
w
price p B
• Maximizes profit according to:
max    pB  p
pB
w
B
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
  a  bp 
B
35
Distributor‘s decision
• The first-order condition is given by:

w
 a  2bpB  bpB  0
 pB
a  bp
 pB ( p ) 
2b
w
B
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
w
B
36
Parallel trade can have a negative effect on
global welfare [ a  100 , b  1 / 2 and   13 / 8 ]
Frank Müller-Langer
University of Hamburg
Institute of Law and Economics
37