You know the one about theory and practice? That in theory there is no difference between the two, but in practice there is. Yesterday’s post from the economist Alex Tabarrok about better drugs costing more is a great example. Per Tabarrok:
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.)
Too bad that drugs aren’t lightbulbs, hospitals aren’t hardware stores, and that treating people isn’t the same as selling tchotchkes. Well, maybe they are the same in theory, but we looked at actual cancer drugs, and their actual cost, and how much the cost per year correlates with actual improvements in survival, and the answer was: not at all. Novelty of the mechanism of action doesn’t have much to do with the cost either. We didn’t go into what affected the cost, but as I’ve written before, President Biden made a good guess.
So yes, lightbulbs. Cute story, professor Tabarrok, but true only in theory.