The economic welfare gains from the introduction of generic weight-loss drugs

The Financial Times reported this week (paywalled):

India’s powerful copycat pharmaceutical industry is set to roll out generic weight-loss drugs in the UK within weeks, with one leading producer forecasting a “huge price war” that could widen access to the popular medicines.

Bengaluru-based Biocon is the first company to win UK authorisation to offer a generic version of Novo Nordisk’s Saxenda weight treatment and is ready to launch sales by November.

Saxenda is an older drug of the same GLP-1 drug class as the Danish company’s popular Ozempic diabetes treatment and Wegovy weight-loss medication.

In an interview with the Financial Times, Biocon chief executive Siddharth Mittal declined to comment on his pricing strategy for generic Saxenda, but predicted his company’s sales of the drug would reach £18mn annually in the UK after the expiry of its patent protection there next month. Mittal said he expected Biocon’s generic version of Saxenda to be approved by the EU this year and in the US by 2025.

“When the generics come in there will be a huge price war,” he said. “There is a huge demand for these drugs at the right price.”

To see how the introduction of generic medicines affects the market, consider the diagram of the market for Saxenda below. When the active ingredient in Saxenda is protected by a patent, the market is effectively a natural monopoly. That means that the average cost curve (AC in the diagram) is downward sloping for all levels of output. This is because, as the quantity sold increases, the large up-front cost of developing Saxenda (see here for example) will be spread over more and more sales, lowering the cost on average. If Novo Nordisk (the producer of Saxenda) is maximising its profits, it will operate at the quantity where marginal revenue meets marginal cost, i.e. at QM, which it can obtain by setting a price of PM (this is because at the price PM, consumers will demand the profit-maximising quantity QM). Novo Nordisk makes a profit from Saxenda that is equal to the area PMBKL. [*]

Now consider what happens in this market when the patent expires and generic versions of Saxenda enter the market. We end up with a market that is more competitive, which would operate at the point where supply (MC) meets demand. This is at a price of PC, and the quantity of QC. Notice that the price of Saxenda falls dramatically - this is how the price war that Mittal mentions will play out.

Now consider what happens to the other areas of economic welfare. Before the patent expires, the consumer surplus is equal to the area GBPM. After the patent expires, the consumer surplus increases to the area GEPC. Consumers are made much better off by the patent expiry, because they can buy Saxenda at a much lower price, and they respond by buying much more of it. The producer surplus, which was PMBHPC, becomes zero. [**] The competition between the producers drives this producer surplus down. Total welfare (the sum of consumer and producer surplus) increases from GBHPC to GEPC. So, society is better off after the patent expiry.

Now, you could argue based on this that expiring the patent earlier would be even better, given the economic welfare gain that would result. And while I have some sympathy for that view, governments should be a little cautious here. The large producer surplus from having the patent in place creates an incentive for the big pharmaceutical firms to develop these pharmaceuticals in the first place. So, an appropriate balance between patent protection and incentives for pharmaceutical development needs to be found. Nevertheless, it is clear that once patents expire, there is a large welfare gain to society at that point.

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[*] This is different from the producer surplus, which is the area PMBHPC. The difference between producer surplus and profits arises because of the fixed cost - in this case, the cost of development of Saxenda.

[**] If we treat this as continuing to be a natural monopoly after the patent expiry, the market makes a negative profit of -JFEPC (because the price PC is less than the average cost of production ACC). However, you could argue that because the firms producing the generic version didn't face the up-front cost of development, this is no longer a natural monopoly once the patent has expired.