Study on the vertical price formation and the monopoly mechanism of intermediate product market: concurrent discussion on the monopoly cause and antitrust regulation of API market

LI Shijie1 LI Wei2

(1.School of Economics, Hainan University)
(2.Institute of Industrial Economics of Chinese Academy of Social Sciences)

【Abstract】In recent years, the monopoly of active pharmaceutical ingredient (API) market has attracted wide attention, and become the key object of antitrust regulation. From a theoretical perspective, the monopoly of API market reflects the monopoly of intermediate product market under the vertical industrial chain; however, the traditional economics research mainly focuses on the final product market and pays little attention to the monopoly of intermediate product market and its mechanism. This paper built a vertical industrial chain model composed of the intermediate product market and the final product market. By analyzing the vertical price formation mechanism of the industrial chain, it explored the welfare loss caused by monopoly price markup in the intermediate product market and its internal mechanism. It is found that monopoly price markup in the intermediate product market affects industrial chain efficiency and social welfare through three channels: transmission effect, synergy effect and suppression effect. Based on the modeling of the three effects, this paper built a theoretical equation to measure the losses caused by monopoly price markup in the intermediate product market, and made simulation analysis; then, based on the monopoly cases of China’s API market, it discussed the influence and mechanism of the monopoly of API market, and proposed suggestions on antitrust regulation.

【Keywords】 intermediate product market; monopoly price markup; industrial chain efficiency; API market; anti-monopoly;

【DOI】

【Funds】 National Natural Science Foundation of China (71473066) National Natural Science Foundation of China (71903196) National Natural Science Foundation of China (71963012)

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    Footnote

    [1]. Due to space limitations, the proof of some model equations and the specific information on cases of monopoly of the API market are not reported, but are available upon request. [^Back]

    [2]. (1) On February 2, 2015, the CCTV Live News Room reported the monopoly of API of phenobarbital (for treating epilepsy). In June 2017, several CCTV columns conducted intensive investigations and reports on the phenomenon that the monopoly of API led to the cessation of production of low-priced drugs. [^Back]

    [3]. (2) During the National People’s Congress and Chinese People’s Political Consultative Conference in 2017, Geng Funeng, Vice President of China Medical Pharmaceutical Material Association and Chairman of Gooddoctor Pharmaceutical Group, made a proposal on relevant departments to break the monopoly of API and stabilize drug prices; and Li Zhenjiang, Executive Vice President of China Medical Pharmaceutical Material Association and Chairman of China Shineway Pharmaceutical Group, made a proposal on setting the maximum price for API to promote healthy competition. In March 2018, Xiong Weizheng, Chairman of Henan Lingrui Pharmaceutical Co., Ltd., and other NPC deputies jointly submitted the proposal on further strengthening supervision and reducing access conditions of API during the National People’s Congress and Chinese People’s Political Consultative Conference. [^Back]

    [4]. (3) The fifth part summarizes the cases of API monopoly investigated and punished by anti-monopoly departments in detail. [^Back]

    [5]. (4) See http://sn.people.com.cn/n/2015/0305/c190216-24077162.html [^Back]

    [6]. (5) For the convenience of expression, the intermediate product market (or input product market) is used to refer to the upstream industrial chain, and the final product market is used to refer to the downstream industrial chain. It should be pointed out that this study is also applicable to more general vertical relationships, such as upstream final product market and downstream retail market. [^Back]

    [7]. (6) The analysis of monopoly in traditional economics is not discussed in detail in this paper, for there is related content in mainstream economics textbooks. [^Back]

    [8]. (7) For a systematic summary of the research on price discrimination in intermediate product market, please refer to Wang and Zhang (2005) and Yu and Ren (2013). [^Back]

    [9]. (8) Traditional economics studies highly abstract the organization and production activities of firms, and regard them as a black box of pursuing profit maximization through the input-output relationship. The input contains the vertical transaction relationship with other firms, but traditional economics simplify it through the cost function of firms. In this way, the original rich vertical relationship is contained in the firm cost function and becomes an exogenous variable in economic research. [^Back]

    [10]. (9) Vertical integration and vertical control have been the most active fields in the research of industrial organization theory in the past half century. Due to space limitations, this paper does not discuss them in detail. See literature reviews such as Perry (1989), Joskow (2012), Katz (1989), and Secrieru (2006). [^Back]

    [11]. (10) Economics mainly explores the relationships between firms. One is the relationship among firms that produce and sell the same or substitute products, that is, the horizontal market relationship; the other is the relationship among firms in different links of the industrial chain to complete the production of the same product, that is, the vertical market relationship. The horizontal market relationship among firms is essentially a competitive relationship, while the vertical market relationship is essentially a transaction relationship. [^Back]

    [12]. (11) In 2010, the NDRC investigated the monopoly cases of rice noodle producers in Nanning and Liuzhou, Guangxi. These rice noodle producers colluded with each other to monopolize the supply of rice flour and raise the price. In essence, this case also reflects the monopoly pricing behavior of rice noodle producers on downstream rice noodle stalls. From the perspective of upstream and downstream transaction relationship, the vertical relationship between upstream rice noodle producers and downstream rice noodle retailers (rice noodle stalls) is also the original vertical relationship described in this paper. [^Back]

    [13]. (12) Monopoly and perfect competition in this paper are not based on market structure, but on market efficiency. For example, there are more than one firm in the market, but the monopoly can also be achieved through collusion. [^Back]

    [14]. (13) The number of final product manufacturers is not set here. In fact, ρF is largely determined by the degree of competition in the final product market; and the number of firms and the degree of competition in the final market are reflected in the change of ρF. [^Back]

    [15]. (14) When the manufacturer’s input-output ratio is not 1:1, it can be transformed into 1:1 through the construct of composite products. For example, if two units of intermediate input X are needed to produce one unit of final product Y, then two units of intermediate input X can be regarded as one unit of composite input. In addition, it should be pointed out that it is not assumed that the production of final product Y only needs the intermediate input X. In fact, as long as there is a fixed proportion of the various inputs, the conclusions of this paper are established. The variable factor input ratio will be discussed in the following part. [^Back]

    [16]. (15) The empirical analysis assumes that the upstream and downstream transaction is in a linear pricing mode. The reason is that this paper mainly focuses on the natural vertical relationship, and linear pricing is the main feature of natural vertical relationship. [^Back]

    [17]. (16) The assumption of linear demand function in this paper does not affect the following conclusions. The analysis in the case of general demand function is available upon request. [^Back]

    [18]. (17) Another reason for distinguishing perfect competition and imperfect competition in the final product market is that it follows the methodology of from the particular to the general. Perfect competition of final products excludes the impact of other market factors on monopoly price markup of intermediate products, so that we can obtain the essential mechanism of monopoly of intermediate product market, and then we add the effect of other market environment factors to obtain more general conclusions. [^Back]

    [19]. (18) The loss of vertical market efficiency refers to the loss of social welfare, which is not distinguished in this paper. [^Back]

    [20]. (19) It should be pointed out that triangle MBF is the loss caused by the final product manufacturer’s price markup ρF, rather than the loss caused by the price markup of intermediate product manufacturer, so it should not be included in the impact of the monopoly of intermediate product market. [^Back]

    [21]. (20) It assumes that the buyer bargaining power of the final product manufacturer comes from its market size, for the firms with large final product market size have a large demand for inputs, which results in the vertical buyer bargaining power. In fact, firms with large final product market size also have strong horizontal market power; therefore, the horizontal market power of firms strengthens their vertical bargaining power. The most significant manifestation is the retailer market. For example, the horizontal market power of large retailers such as Wal-Mart and Carrefour in the retail market enable them to have strong buyer bargaining power compared with upstream suppliers. [^Back]

    [22]. (21) API manufacturers have to invest a lot of money and R&D resource to obtain relevant production qualifications, among which the most important and crucial ones are the following. The first is environmental assessment; the second is safety production certification; the third is acceptance inspection of fire protection; and the fourth is certification related to drug production, such as drug registration, drug production license and drug GMP certification. For a detailed analysis of the barriers to the API market access, see the written decision on administrative punishment by Chongqing Administration for Industry and Commerce (Chongqing Administration for Industry and Commerce [2015] No. 15). [^Back]

    [23]. (22) According to the punishment of Chongqing Administration for Industry and Commerce on Chongqing Qingyang Pharmaceutical Co., Ltd., it can be seen that there are six firms with production certification for API of allopurinol in China, and the production certification of four firms had expired before January 2012, and three of these four firms had never produced API of allopurinol. [^Back]

    [24]. (23) See http://www.sohu.com/a/139008158_632014,2017-5-8 [^Back]

    [25]. (24) See http://med.sina.com/article_detail_103_2_21920.html,2017-3-9 [^Back]

    [26]. (25) See http://news.sohu.com/2011115/n325640845.shtml,2011-11-15 [^Back]

    [27]. (26) It needs to be noted that this only shows that pharmaceutical firms have the possibility to increase the price of finished drugs excessively by virtue of rising API prices, but does not make confirm that this situation exists in the cases. [^Back]

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This Article

ISSN:1002-8404

CN: 11-1306/C

Vol , No. 02, Pages 144-155+160

June 2017

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Article Outline

Abstract

  • 1 Introduction
  • 2 Literature review and theoretical basis
  • 3 Mechanism and measurement of the welfare losses caused by the monopoly price markup of the intermediate product market
  • 4 Simulation analysis of welfare losses under the monopoly of intermediate product market
  • 5 Extended discussion: influencing factors and other losses of monopoly of intermediate product market
  • 6 Practical application: cases of domestic API market monopoly and suggestions on anti-monopoly regulation
  • 7 Conclusion and research prospect
  • Footnote

    References