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AEM 4160: Strategic Pricing Prof.: Jura Liaukonyte Lecture 10 Pricing Gardasil

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AEM 4160: Strategic PricingProf.: Jura LiaukonyteLecture 10 Pricing Gardasil

- The quality-adjusted life year (QALY) is a measure of disease burden, including both the quality and the quantity of life lived.
- It is used in assessing the value for money of a medical treatment.
- The QALY is based on the number of years of life that would be added by the treatment.
- Each year in perfect health is assigned the value of 1.0 down to a value of 0.0 for death.

- Used in cost-utility analysis to calculate the ratio of cost to QALYs saved for a particular health care treatment.
- Helpful in allocating healthcare resources,
- Treatment with a lower cost to QALY saved ratio being preferred over an intervention with a higher ratio.
- Controversial: some people will not receive treatment because it is too costly
- Cost per QALY under $50,000 is acceptable

- An economic value assigned to life in general,
- Marginal cost of death prevention in a certain class of circumstances.
- As such, it is a statistical term, the cost of reducing the (average) number of deaths by one.

- Qa , Qb =probability of fatal injury on job a, b respectively in a given year.
- Wa, Wb = earnings on job a, b in a given year.
- Assume Qa<Qb so that Wa<Wb.
- Compensating difference=Wb-Wa
- Value of a “statistical” life = (Wb-Wa)/(Qb-Qa)
- Example: If a person is faced with .001 higher risk of death per year and is paid $5000 per year extra for that risk, the value of a statistical life is 5000/.001 - $5,000,000.

Viscusi. “The Value of a Statistical Life: A Critical Review of Market Estimates Throughout the World.” Journal of Risk and Uncertainty, v. 27 issue 1, 2003, p. 5.

- Biases in estimates of statistical value of life
- Valuation is correct only for “marginal” worker. Estimate is too high for infra-marginal worker, and too low for workers that didn’t accept job with risk.
- ex post versus ex ante rewards for risk (compensating difference vs. law suits, insurance, etc.)
- Failure to control for other risks correlated with fatality risk
- Fatality risk measured with error

- Is Gardasil a Good Product?

- What factors should Merck consider when setting the price?

- Important or not important?
- Product cost
- R&D Investment?
- Other Vaccines?
- Public Relations?
- Value to the Customer/Benefit?
- Economic Modeling?
- Competition?

- Cost Per QALY = Cost of a quality life year
- STEP 1: Consider the costs per person:
- Cost per dose: ___________________
- Cost per administration:_____________
- Number of doses: _____________________
- Total cost per patient: __________________

- Additional QALYs per person
At age 50, further life expectancy without cervical cancer: ____________

QALY per year: __________________________________________

Total QALYs: ____________________________________________

At age 50, further life expectancy with cervical cancer: ______________

QALY per year: ___________________________________________

Total QALYs: _____________________________________

- Reduction in QALYs with cervical cancer:_________________
- Gardasil prevents:______________________________
- Gardasil incremental QALYs: ________________
- Chance of Getting cervical cancer without Gardasil: _______________
- Incremental QALYs per person: ________________________________
- Cost per QALY:
- Vaccination: _____________________________________
- QALY: ____________________________________
- Cost per QALY:___________________________

- This was a rough calculation because it left out an important piece of a puzzle:
- COST SAVINGS
- Fewer Pap tests
- Fewer LLETZ procedures
- Fewer cervical cancers to treat

- COST SAVINGS

- Calculate COST savings
- Chance that a woman will have CIN 1: ______________
- Chance that a woman will have CIN 2/3:______________
- Chance that a woman will have cervical cancer: ___________
- Cost to treat CIN 1: ________$55______________
- Cost to treat CIN2/3: _____________________
- Cost to treat cervical cancer: ________________

- CIN 1: __________________________________
- CIN 2/3: ________________________________
- Cervical cancer: ___________________________
- Gardasil will prevent (estimates):
- CIN 1: 50%
- CIN 2: 70%
- Cervical Cancer: 70%

- CIN 1: ____________________
- CIN 2/3: ____________________
- Cervical cancer: _________________
- TOTAL SAVINGS: ______________________

- Vaccine given (average or target): __________
- Cancer prevents: _______________
- Difference: ___________________
- Discount the cost savings at say, 8% = $16.50
- In excel the command would be: =PV(0.08, 43, ,-450.2)

- So the total is”
- Cost per person: _______________
- Savings per person: ___________
- QALY per person: 0.038
- COST per QALY:__________________
- Do the risks of a PR backlash and the need to grow quickly outweigh the benefits of a higher price
- Potential entrant is coming
- Patent is not forever

- Suppose prices are set so that cost of QALY is $30,000
- What is the maximum price that could be set?
- x = cost per person
- (x-16.50)/0.038 = 30,000
- x =$1156.5
- Or $1156.5/3 = $385 per dose

- ANSWERS TO BLANK SLIDES

- Cost Per QALY = Cost of a quality life year
- STEP 1: Consider the costs per person:
- Cost per dose: ____________$120_______
- Cost per administration:______$20________
- Number of doses: _________3____________
- Total cost per patient: ________$420_______

- Additional QALYs per person
At age 50, further life expectancy without cervical cancer: ____31.6 years___

QALY per year: ______________________________0.8______________

Total QALYs: _________________0.8*31.6=25.2____________________

At age 50, further life expectancy with cervical cancer: ______20 years_____

QALY per year: ______________________________0.8______________

Total QALYs: _________________0.8*20=16____________________

- Reduction in QALYs with cervical cancer:___25.2-16=9.2___
- Gardasil prevents:__________________70%____________
- Gardasil incremental QALYs: _______.7*9.2=6.4_________
- Chance of Getting cervical cancer without Gardasil: ___0.6%_
- Incremental QALYs per person: ___________0.006*6.4=0.038_______
- Cost per QALY:
- Vaccination: ___________________$420__________
- QALY: ________________________0.038____________
- Cost per QALY:_________________420/0.038=$11,053__________

- This was a rough calculation because it left out an important piece of a puzzle:
- COST SAVINGS
- Fewer Pap tests
- Fewer LLETZ procedures
- Fewer cervical cancers to treat

- COST SAVINGS

- Calculate COST savings
- Chance that a woman will have CIN 1: _______10%__
- Chance that a woman will have CIN 2/3:___2.8%___
- Chance that a woman will have cervical cancer: __0.6%_____
- Cost to treat CIN 1: ________$55______________
- Cost to treat CIN2/3: _________$1400____________
- Cost to treat cervical cancer: _______$100,000_________

- CIN 1: ________10%*$55=$5.50____________
- CIN 2/3: ______2.8% * $1400=$39.20_______
- Cervical cancer: __0.6%*$100,000=$600_____
- Gardasil will prevent (estimates):
- CIN 1: 50%
- CIN 2: 70%
- Cervical Cancer: 70%

- CIN 1: ________5.50*50%=$2.75____________
- CIN 2/3: ______39.20*70%=$27.44__________
- Cervical cancer: __600*70%=$420___________
- TOTAL SAVINGS: _____$450.20______

- Vaccine given (average or target): ___Age 11____
- Cancer prevents: _____Age 54_____
- Difference: _____________43 years______
- Discount the cost savings at say, 8% = $16.50
- In excel the command would be: =PV(0.08, 43, ,-450.2)

- So the total is”
- Cost per person: ________$420_______
- Savings per person: ______$16.50_____
- QALY per person: 0.038
- COST per QALY: $10,618.00
- Do the risks of a PR backlash and the need to grow quickly outweigh the benefits of a higher price
- Potential entrant is coming
- Patent is not forever

- Suppose prices are set so that cost of QALY is $30,000
- What is the maximum price that could be set?
- x = cost per person
- (x-16.50)/0.038 = 30,000
- x =$1156.5
- Or $1156.5/3 = $385 per dose

Advertising And PRICING

- Volume of advertising expenditures is large. For the US, advertising consumes over 2% of GDP
- Underneath this national total is a wide variety in firm advertising behavior
- Car makers (e.g., GM) and household product firms (e.g., Proctor & Gamble) spend the most on advertising
- Basic patterns that emerge are:
- Correlation between advertising & market power
- Consistency of advertising behavior within industries—big advertisers remain big over time and across countries

- Assume a firm faces a downward-sloping demandinverse curve but one that shifts depending on the amount of advertising A that the firm does
P=P(Q, A)

- Recall, the Lerner Index, LI

L = (p - MC)/p = 1/|EP|

Where |EP| is the price elasticity of demand

- The elasticity of output demand with respect to advertising A is defined as

- We can derive the following relationship:

= Advertising/sales ratio

Dorfman-Steiner Condition:For a profit-maximizing monopolist, the advertising-to-sales ratio is equal to the ratio of the elasticity of demand with respect to advertising relative to the elasticity of demand with respect to price.