Bias Premiums

When the subject of huge pharma company profits comes up, I usually contend that this is largely due to their powers of marketing: if you have two medications that do more or less the same thing, one brand name and one generic, people will usually demand the more expensive brand name one. It did not occur to me, though it should have, that this could ironically confer an actual benefit: since people stupidly use price and brand as a proxy for quality, this can prime placebo effects over and above what the generic would, making even chemically identical pills more effective. Is it wrong that I find great humor in this?

Share this

The value of brands, the high value of slight differences

"More or less the same thing" doesn't mean that people should be more or less indifferent. If a five-dollar pill has a 98% chance of saving my life and a $500 pill has a 99% chance of saving my life, I rationally prefer the $500 pill, because the 1% increase in probability is worth $495 price difference to me, so a proportionally slight difference in effect may motivate me to pay a proportionally large premium. And even if two pills are, in theory, exactly the same, brand name indirectly conveys information to the customer about quality of manufacture. An anonymous seller may indeed sell a pill exactly as good as the pill sold under a brand name, but I as a customer have no way of knowing this. The brand gives me some added confidence about the quality of the pill. And the point about the $5 and $500 pill applies here as well: a slight increase in confidence can rationally translate to a large increase in price.

The bias is exhibited in non

The bias is exhibited in non life threatening situations, even for minor problems (otherwise mentionning the placebo effect would be pretty pointless) so that doesn't fully explain it.

Point applies there as well

The life-threatening situation was simply an example of the general idea. The point is not limited to life-threatening situations.

I think it applies where the

I think it applies where the value of what is at stake is way too low to warrant your explaination (cold remedies, allergies, etc).

What would I pay

If there were no alternative, I would gladly pay $10 to be free of a bad headache for an afternoon. Fortunately for me, there are medicines that will relieve me of my headache for much less, approximately a penny. For as small as a 1% greater chance of being free of my headache, I would rationally be willing to pay 10 cents. So I am willing to pay ten times as much for a brand name pain reliever as I am for a generic pain reliever even if I am only 1% more confident in the brand name pain reliever.

So the phenomenon that I described still holds for something as minor as a headache.

Price Inelasticity is Key

Inelasticity of prices encompasses both Constant's explanation of high cost, life threatening medical goods, as well as an explanation for low cost, non-life threatening medical goods. Insulin for diabetics is often given as an example of an inelastic good in Intro Micro courses, because no matter how much the price of insulin increases or decreases, diabetics will generally purchase about the same amount of insulin as they did before the price change. Another example of an inelastic good given in Intro Micro courses is something like salt or sugar, a product that the average consumer doesn't need very much of and doesn't constitute a significant portion of their grocery budget. The same should hold true for relatively cheap medical goods like Aspirin or Tylenol - changes in price aren't going to effect consumption very much.

So in the case of inelastic, high cost, life threatening medical goods like insulin, it might be rational to pay that extra premium for the brand name for the reason Constant gave - the potential difference between brand name and generic as measured by life-or-death health outcomes is so large, even at low probabilities, that it outweighs any price concerns. And in the case of inelastic, low cost, non-life threatening medical goods like Aspirin, the price difference between the brand name and the generic is so low, because the product itself is so cheap, that it just isn't that important to most people to do price comparisons - just grab whatever is most convenient, usually the brand name that you saw on TV, and thereby avoid the Barry Schwartz Paradox of Choice effect.

Brandon's point is also related to inelasticity - if I'm not the one paying for it, I'm obviously not going to be very sensitive to price.

Matt's observation about the placebo effect seems similar to the phenomenon of positional goods or Veblen goods, but instead of an increase in price leading to an increase in demand as a result of status effects, an increase in price leads to an increase in demand as a result of consumers using price and brand as proxies for quality, which, as Matt notes, becomes a self-fulfilling prophecy as a result of the placebo effect.

Marketing and the Revolution in IP

I think that your marketing point, if pushed further, may have more exciting revelations in the field of IP protections. Many people believe the US would fall off the face of the earth without them. Not so -- but even more costs may go to marketing while, of course, mergers would occur in big pharma. More marketing is not necessarily a bad thing at all.

Only when subsidized

If you have two medications that do more or less the same thing, one brand name and one generic, people will usually demand the more expensive brand name one.

As I understand it, people are much more likely to choose the generic alternative when paying the full cost out of pocket, or when faced with a significantly higher co-pay for the brand-name drug. So it's not that people irrationally prefer expensive brand-name drugs even at considerable cost to themselves; it's that they rationally prefer expensive brand-name drugs when it doesn't cost them any more.