The Food and Drug Administration (FDA)
The Food and Drug Administration (FDA) is responsible for ensuring the safety and efficiency of new drugs before their introduction in the market. The FDA regulatory process takes considerable time and results in a drug lag before new medicines are introduced into the market. The regulation of drugs helps keep unsafe or ineffective medicines from the market, preventing loss of lives or adverse side effects. However, the delay in approval can keep safe and effective drugs from the market for a significant period or completely prevent the introduction. Many people may end up losing their lives because of a lack of access to these drugs occasioned by FDA bureaucracy.
Information asymmetry occurs when one party in a transaction has greater material knowledge than the other party. Widespread information asymmetry in the pharmaceutical industry necessitated the expansion of the regulatory role of the FDA to guarantee the quality of new drugs. Drugs are classified as credence goods because customers require costly information to determine their safety and effectiveness. The quality of some drugs can only be determined after the usage for a significant amount of time. Some drugs have to be used together with others, thus evaluating their effectiveness is quite problematic. The quality of drugs can only be established through the application of statistical analysis on large samples. Extensive analysis to determine quality can only be carried out by drug companies. Therefore, there is acute information asymmetry about the quality of drugs because sellers have more information than buyers.
The issue in the pharmaceutical industry is a case of adverse selection. Adverse selection occurs where one party has more precise and detailed information than the other. The drug companies have more accurate information about the quality of drugs than buyers. The buyers are disadvantaged because they have inadequate information. Information asymmetry regarding the quality of drugs may result in the introduction of low-quality drugs, disguised as quality drugs. Sellers of high-quality drugs may be driven out of the market by the lower quality sellers. Selfish sellers fail to provide accurate information to consumers to benefit from market imperfections. FDA regulation ensures that drugs are of the appropriate quality and that the drug industry functions optimally.
References
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Roman, A. (2013). The FDA and the pharmaceutical industry: Is regulation contributing to drug shortage? Albany Law Review, 77(2), 539.
Nickolas, S. (2020, April 03). Understanding the Difference Between Moral Hazard and Adverse Selection. Retrieved June 16, 2020, from https://www.investopedia.com/ask/answers/042415/what-difference-between-moral-hazard-and-adverse-selection.asp