Persuasion or Information? The Economics of Prescription Drug Advertising
`Keith B. Lefflei‘
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`(55% 9}?
`8 T O R
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`Journal .9wa and Economics, Vol. 24, No. 1. (Apr, 1981), pp. 45—74.
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`Stable URL:
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`Mon Dec 11 11:48:39 2006
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`Argentum Pharm. LLC V. Alcon Research, Ltd.
`Case IPR2017-01053
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`ALCON 2071
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`PERSUASION OR INFORMATION?
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`THE ECONOMICS OF PRESCRIPTION
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`DRUG ADVERTISING”
`KEITH B. LEFFLER
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`University of Washington
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`THE economic and welfare effects of advertising have been extensively
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`studied over the last half-century. However, these efforts have not led
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`to a consensus either as to the effects or the value of advertising.
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`Economists continue to reach polar conclusions that appear to be derived
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`mainly from preconceptions of the social desirability of advertising. On
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`the one hand is research that emphasizes promotion’s ability to create
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`“artificial” product differentiation and thereby produce informational
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`confusion.l This line of research stresses the empirical association of
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`extensive advertising with high concentration and high accounting
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`profits—evidence judged to support increased market power and entry
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`barrier effects.2 A contrary body of research emphasizes the value of
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`advertising in providing information and, hence,
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`tition.a The empirical findings most consistent with this view are that
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`prices paid by consumers in (selected) markets are lower with advertising
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`* Yoram Barzel provided helpful comments.
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`L This “Harvard View” of advertising was developed by Edward Chamberlin, The
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`Theory of Monopolistic Competition (1933]. Joe Bain, Barriers to New Competition: Their
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`Character and Consequences in Manufacturing Industries (1956); and William S. Comanor &
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`Thomas A. Wilson. Advertising and Market Power (1974), pursue some of the issues raised
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`by Chamberlin. The Comanor and Wilson book provides the most—cited work supporting the
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`product-differentiation, entry—barrier view of advertising.
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`2 James M. Ferguson, Advertising and Competition: Theory, Measurement, and Fact
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`(1974), reviews much of the empirical literature on advertising’s effect. Papers in Part IV of
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`Issues in Advertising: The Economics of Persuasion (David G. Tuerck ed.) (Am. Enterprise
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`Inst. 1978), also discuss the relationship between advertising, concentration, and profits.
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`i' This “Chicago“ view is represented by Lester G. Telser, Advertising and Competition,
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`72 J. Pol. Econ. 53? {1964); Philip Nelson. Advertising as Information, 82 J. Pol. Econ. 729
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`(19%); and Yale Brozen, Entry Barriers: Advertising and Product Differentiation. in Indus—
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`trial Concentration: The New Learning 115 (Harvey J. Goldschmid, I-I. Michael Mann. & 1.
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`Fred Weston eds. 1974).
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`“ See, for example, Lee Benham, The Effect of Advertising on the Price of Eyeglasses, 15
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`J. Law & Econ. 33? (1972); and Robert L. Steiner, Does Advertising Lower Consumer
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`Prices? 37 1. Marketing 19 (1973).
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`45
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`46
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`THE JOURNAL OF LAW AND ECONOMICS
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`Economic analysis generally treats advertising as a homogeneous ac-
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`tivity that is evaluated independently of why it might increase demands“)
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`Yet advertising’s effects need not be the same in different markets or in
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`different settings within a market. For example, price comparison ads of
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`standardized products (for example, ground beef) may lower both entry
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`costs and average price paid, while “image advertising" of heterogeneous
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`products (for example, perfumes) may increase prices and the cost of new
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`entrants gaining consumer trials. Both positive and normative analysis
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`should therefore be prefaced by the particulars of the products advertised,
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`the message delivered, and the buyers addressed.6 If advertising is a
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`multifaceted, heterogeneous activity, general statements as to the effects
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`and efficiency of advertising may not be possible, and empirical studies
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`using individual industries as cross-sectional observations may be eco-
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`nomically uninterpretable."v However, the study of advertising within a
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`single industry can provide a piece in the montage required for economic
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`understanding.
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`This paper analyses one market characterized by very large promo-
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`tional expenditures—the market for prescription drugs. This market is
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`especially appropriate for detailed analysis since the polar positions on
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`the desirability of advertising are well represented in policy discussions of
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`the prescription drug market. The continual introduction of new, poten-
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`tially life-saving products makes the potential gains from the rapid dis-
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`5 Comanor & Wilson. supra note 1, briefly discuss advertising that is designed to produce
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`“bandwagon“ effects and artificial product differentiation. Even though their normative
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`analysis seems predicated on such advertising effects, they fail to operationally define such
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`notions. Indeed, they model only advertising that provides correct information about a
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`product‘s characteristics. K. Boyer, Informative and Goodwill Advertising, 56 Rev. Econ.
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`& Stat. 541 (1974), does explicitly recognize that advertising is not homogeneous either in its
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`purpose or its effects. However, his definition of goodwill (versus informative) advertising as
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`tha “which has the effect of encouraging buyer inertia and loyalty,“ id. at 541, fails to
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`distinguish advertising types.
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`G In a working paper, An Analysis of the Functions of Advertising (March 1980) (unpub-
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`lished paper at Univ. of Washington), I define and distinguish five reasons for advertising
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`affecting product sales. These are: (l) supply of (correct or incorrect) information on a
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`product‘s characteristics (price, availability, use, color, odor, and so on), (2) supply of
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`information to nonusers of a product about the tastes, preferences, and self-image of the
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`product‘s users, (3) reduction in the perception or recall costs required to identify products
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`in product classes, (4] information on price—marginal cost differences and, hence. on the
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`incentive to maintain quality, and (5) persuasion designed to substitute emotional decisions
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`for rational, evaluative decisions. I argue that the competitive effects of advertising depend
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`upon what function advertising plays.
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`7 This problem of heterogeneous relationships within the data is confirmed in studies by
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`Boyer, supra note 5; M. Porter, Consumer Behavior, Retailer Power, and Market Perfor—
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`mance in Consumer Goods Industries, 56 Rev. Econ. & Stat. 419 (1974]; and Frank Bass,
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`Phillippe Cattin, & Dick Wittink, Market Structure and Industry Influence on Profitability,
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`in Strategy + Structure = Performance 181 (Hans B. Thorelli ed. 19??).
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`PRESCRIPTION DRUG ADVERTISING
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`semination of product information via advertising substantial. Nonethe-
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`less, government investigations of the pharmaceutical industry stress that
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`intensive advertising of drugs results in excessive use of high-priced,
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`heavily promoted brand-name products even though equivalent low-
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`priced products are available. Those viewing pharmaceutical advertising
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`with disfavor insist that these ads are frequently uninformative and seem
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`simply to harp the products1 names in order to persuade doctors to select
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`products out of habit rather than by evaluative choice.'3
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`The advertising of medicines is closely monitored by government au-
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`thorities.9 To understand constraints on pharmaceutical advertising, Sec-
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`tion I of this paper briefly considers the history and the regulation of
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`pharmaceutical advertising in the United States. Section II empirically
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`examines drug advertising that focuses on the informative versus the
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`“habit formation“ roles of product promotion. Hypotheses concerning
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`the variance in advertising intensities across drug submarkets and among
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`individual drug products are developed and tested for these two altema-
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`tive advertising theories. Section III explores the welfare effects of phar-
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`maceutical advertising. The empirical analysis concentrates on the re-
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`lationships between product innovation, product entry, product price,
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`and the promotional strategies of both established and new products.
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`The empirical results developed here indicate a dual role of phar—
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`maceutical advertising: advertising appears to inform physicians about
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`the existence and characteristics of new products while also producing
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`“brand-name recall” effects that favor established products facing new
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`competition. Pharmaceutical advertising thus serves to speed the entry of
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`3 In the Kefauver hearings leading to the 1962 amendments to the FDA act a witness from
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`Premo Pharmaceutical testified that' ‘the only real competition we have in our field is the
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`tremendous competition for the eye and ear of the physician—how many pages of advertis-
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`ing we can put out how many samples we can distnbute how many detallmen we can put in
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`the field. These.
`a.lone govern the ultimate acceptance of the product. ” Citedin Richard
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`Harris, The Real Voice 90 (1964). Senator Kefauver concluded that, “the promotional
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`efforts .
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`cians.“ Id. Kefauver repeatedly noted the large price differentials between brand-name and
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`generic drugs even when they were produced in the same plant by the same manufacturer.
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`This was attributed to the continuing barrage of promotional material addressed to physi-
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`cians. Advertising also was considered the prime cause of alleged excess profits.
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`9 This feature of the pharmaceutical market serves to limit the roles of advertising such
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`that the analysis is relatively tractable compared to other markets. The combination of FDA
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`testing and quality-control requirements and FDA and FTC monitoring of advertising con-
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`tent suggests that advertising of prescription drugs will not provide fraudulent or incorrect
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`persuasive messages and also will not be crucial in guaranteeing product quality. In addition,
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`the private nature of drug consumption and the reliance on third—party experts should limit
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`the value of "image“ advertising for prescription drugs. This contrasts, in my view, to much
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`of the advertising of "social" drugs (tobacco and alcohol) through which consumers can
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`indicate their tastes and preferences to their associates via the (public) consumption of
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`advertised products.
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`48
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`THE JOURNAL OF LAW AND ECONOMICS
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`superior new products while likely retarding the entry of later, low-priced
`close substitutes.
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`I. DRUG ADVERTISING AND ITS REGULATION
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`Medicines are claimed to be the first products advertised in printed
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`form.10 Regulation of medical advertising was not long in following. The
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`colony of Virginia was first to pass such regulatory legislation in the
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`United States. Setting a precedent followed until 1962, Virginia‘s 1736
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`legislation required only that the “label“ of medicines specify the ingre-
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`dients.lll Claims about the effects of the drugs were not addressed. The
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`first federal legislation relating to the promotional material accompanying
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`medicinals was passed in 1848.” This legislation applied only to imported
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`drugs and again required only a correct listing of the ingredients of the
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`drugs.
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`Until the late 1800s, medicines were mixed by pharmacists from stan-
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`dardized generic ingredients. Pharmacists served both as advisors and the
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`assurers of quality. However, by about 1880, advances in the technology
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`of large-scale mixing, forming, and bottling of tablets led to more cen—
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`tralized production of medicines.13 Pharmacists were no longer able to
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`directly monitor the ingredient mixes of the centrally produced drugs they
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`dispensed. This provided the manufacturers of pharmaceuticals with the
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`opportunity to compete by providing homogeneous, high—quality prod-
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`ucts. However, such competition requires the identification and knowl-
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`edge of individual manufacturers. Thus, manufacturer trademarks and
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`brand-name promotion became important means of internalizing the gains
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`from producing high-quality, unpatented drugs.”
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`“1 Frank Preshrey, The History and Development of Advertising 289 (1929). reports that
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`“The ‘first puff", which appeared in a German news book in 1591, announced the discovery
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`of a mysterious and wonderful curative herb. In France and England the quacks. who have a
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`much longer history than advertising, were the quickest to appreciate the printed word as an
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`aid to selling."
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`“ Parts of this legislation are reproduced in Edward Kremers. Georg Urdang, & Glenn A.
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`Sonnedecker, Kremers and Urdang‘s History of Pharmacy 158 (4th ed. 1976].
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`‘5 See Stephen Wilson, History of Pure Food and Drug Legislation 10 (Am. Council of
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`Public Affairs [942).
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`la See Frank 0. Taylor, Forty-five Years of Manufacturing Pharmacy, 4 J. Am. Phat.
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`Ass‘n 468 (1915). The centrally manufactured products were nonpatented proprietary prod-
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`ucts sold by generic name with formulae and dosage published in the Association of Pharma—
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`cists Guide, the Pharmacopeia.
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`1“ See R. George Kedersha, Brand Name Prescription Products and Their Impact: A
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`Historical Survey, Medical Marketing and Media, May 1978, at 32-38. By 1877, Parke, Davis
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`and Company was publishing a “house journal“ mailed largely to physicians. The magazine
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`documented the therapeutic uses and quality of Parke, Davis products. Kedersha, supra at
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`33. The centralized drug manufacturers also developed patented “specialties" and prior to
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`PRESCRIPTION DRUG ADVERTISING
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`49
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`With increased drug promotion came increased agitation over exagger-
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`ated product claims. In 1906 the first food and drug act was passed, and
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`the Bureau of Chemistry of the Department of Agriculture was designated
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`as the agency to monitor compliance with federal “labeling require-
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`ments” for drug products.15 Among other endeavors,
`the bureau at—
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`tempted to act against false therapeutic claims. However,
`in 1911 the
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`Supreme Court ruled in United States v. Johnson that the labeling provi-
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`sion can “by no possible construction be extended to an inquiry as to
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`whether or not the prescription be efficacious or worthless to effect the
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`remedy claimed for it.” ‘6
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`Three years later, the federal government attempted to regulate the
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`therapeutic claims of drug producers via the 1914 Federal Trade Commis—
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`sion Act. 1? However, in 1931 the Supreme Court again intervened, ruling
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`that the FTC act was applicable only to those false claims which injure
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`present or potential competitors.18 As a result, the act was powerless to
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`prevent injuries to consumers from falsely advertised products.
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`The loopholes in both the FTC and food and drug regulations were not
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`rectified until 1938.
`In that year, Congress passed the Wheeler—Lea
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`amendment to the FTC act, which made false advertising for the purpose
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`of inducing the sale of an article injurious to health a violation of the FTC
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`act regardless of the competitive effects. Like the original act, advertise-
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`1900 used salesmen to market these products and extoll their quality control to both physi-
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`cians and pharmacists.
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`‘5 On June 29, 1906, the federal government passed a Food, Drug, and Cosmetic Act
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`designed to regulate interstate commerce in food, drink, cosmetics, and drugs. The bill as
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`first introduced into Congress prohibited any false or misleading statements in or on drug
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`packages. Under pressure from patent medicine interests, the bill as finally passed prohib-
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`ited only false claims about the ingredients of a drug.
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`“5 Johnson was shipping medicine interstate with labels claiming the medicine would cure
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`cancer and that the product was "guaranteed under the Pure Food and Drug Act.“ See H.
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`Leo Fusilier & Jerome C. Darnell, Competition and Public Policy 377 (1971].
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`The Sherley Amendment of 1912 to the Food and Drug Law, ch. 352, 37 Stat. 416—17
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`(1912), was passed shortly after this judicial decision. This amendment designated a drug as
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`misbranded "if its package or label shall bear or contain any statement, design or device
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`regarding the curative or therapeutic effects of such article .
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`lent.“ Id. In addition to being restricted to labeling, the requirement for the government to
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`prove fraudulent intent rendered the amendment impotent.
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`L7 Federal Trade Commission Act of 1914, ch. 311, 38 Stat. 717.
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`l” FTC v. Raladam Co. , 283 U.S. 643 (1931]. Raladam Company was the business name of
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`Edward Hayes. Hayes was in frequent trouble with both the Post Office and the FTC for his
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`patent medicine merchandising techniques and had been convicted ofmail fraud prior to the
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`Raladam Case. The present action resulted from his promotion of Maramola, an anti-
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`obesity drug containing thyroid. The FTC issued a complaint against Raladam in 1928 ob—
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`jecting to Hayes‘s claim that Maramola was "safe, effective, dependable and without danger
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`of harmful results.“ Even though the FTC demonstrated that Maramola was highly danger—
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`ous, the Court ruled that since Raladam‘s rivals were engaged in similar hyperbole, the FTC
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`was precluded from taking any action against Hayes.
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`50
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`THE JOURNAL OF LAw AND ECONOMICS
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`ments to physicians were exempted.19 The Wheeler—Lea amendment re—
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`sulted from an extended congressional debate about food and drug regu-
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`lation. At the same time the FTC amendment was passed, a new food,
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`drug, and cosmetic act became law. The 1938 Food, Drug, and Cosmetic
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`Act was explicitly intended not to give the FDA authority over drug
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`promotion because such authority belonged to the FTC.” However, the
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`FDA drug-labeling requirements were extended to include directions for
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`use and “adequate warnings“ on all drug labels.
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`The apparently innocuous labeling requirements were given a broad
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`interpretation by the FDA. Temin reports that
`in the FDA‘s view
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`adequate directions for laymen could not be written for many drugs. It
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`followed that any directions written for laymen were misleading. Ef-
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`fectively,
`this made many over-the-counter products automatically
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`mislabeled. However, since directions and warnings written for physi-
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`cians were not judged so harshly, the FDA’s regulatory interpretation led
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`firms to restrict most drugs to prescriptions use only.21
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`The shift to prescriptive drugs enabled the FDA to usurp FTC power
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`since the FTC authority over drug promotion specifically exempted
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`promotion directed to physicians. While the FDA initially interpreted
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`labeling to include all written, printed, or graphic matter accompanying a
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`medicine at any time, by 1948 they had extended their interpretation to all
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`promotional material whether or not it accompanied the drug.22 The re-
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`striction of the labeling provision to “material” did, however, place the
`19 “No advertising of a drug shall be deemed to be false if it
`is disseminated only to
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`members of the medical profession." Federal Trade Act of 1938, § 15(a](1), ch. 49, 52 Stat.
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`111, 116. See Morton J. Simon, The Law of Advertising and Marketing 52? (1956).
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`2“ Hearings on a revised food and drug law were first held in 1933 before the Senate
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`Commerce Committee. See Food, Drugs and Cosmetics: Hearings before a Subcomm. Of
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`me S. Commerce Comm. on S. 1944, ?3rd Cong, 2d Sess. (I933). The bill introduced
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`included expanded controls over advertising: “An advertisement of a food, drug or cosmetic
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`shall be deemed to be false if in any particular it is untrue, or by ambiguity or inference
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`creates a misleading impression regarding such food, drug or cosmetic.“ S. 1944, 3-‘3rd
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`Cong, 2d Sess. (1933). This vague section of the proposed law was vehemently opposed by
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`both patent medicine producers and newspaper and magazine interests. A revised bill, S. 5,
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`?4th Cong, 1st Sess., including a misleading advertising section but explicitly relieving
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`publishers of responsibility, passed the Senate in 1935, but did not pass the House due to a
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`jurisdictional dispute over FTC versus FDA regulation of advertising. In 1938, the ”elixir
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`sulfanilamide“ tragedy spurred the compromise that the Wheeler-Lea Amendment and the
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`revised Food, Drug, and Cosmetic Act represented. See Peter Temirt, The Origin of Com-
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`pulsory Drug Prescriptions, 22 J. Law & Econ. 91 (1979], for discussion.
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`‘1 Temin, supra note 20, at 97—98. The promotion of both prescription drugs and some
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`designated over-the-counter drugs (together called the ethical drugs) can, by FDA regulatory
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`degree, he directed only toward physicians. The ethical drugs currently comprise over 80 per
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`cent of total drug sales. The major category Of non-prescription ethical drugs is cough and
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`cold preparations which comprise about LS per cent Of total drug sales.
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`2’ This interpretation of the Food, Drug, and Cosmetic Act was upheld by Supreme Court
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`in Kordel v. United States, 335 [1.8. 345 (1948).
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`

`

`PRESCRIPTION DRUG ADVERTISING
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`51
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`verbiage of the detail men (drug salesmen) beyond the direct control of the
`FDA.
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`Beginning in 1958, the Senate Subcommittee on Monopoly, chaired by
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`Senator Kefauver, held hearings on the pharmaceutical industry. Among
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`other allegations, pharmaceutical promotion directed to physicians was
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`claimed to be misleading, uninformative, and responsible for high drug
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`prices.23 The hearings culminated in the 1962 amendments to the Food,
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`Drug, and Cosmetic Act. In addition to codifying extant FDA policy
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`towards pharmaceutical promotion, the 1962 amendments required firms
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`to submit to the FDA all promotional material relating to ethical drugs.“
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`The amendments imposed other specific requirements for pharmaceutical
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`advertising. The chemical name and quantitative composition of a drug
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`were to be included in all advertisements, “printed prominently and in
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`type at least half as large as that used for any trade or brand name.”"5 A
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`statement “in brief summary” of side effects, contraindications, and
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`effectiveness was also required. The effectiveness statement was inter—
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`preted by the FDA to mean that “advertising was to avoid conveying a
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`false, incomplete, or otherwise misleading impression that the drug is a
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`panacea, or more effective or more safe than is medically justified.“ 2“ The
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`FDA does not provide explicit guidelines on what constitutes a misleading
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`impression,
`though “commonly encountered defects" include “non—
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`sequiturs, such as drawing conclusions or projections by inference; the use
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`of anecdotal
`testimony; vague, open-ended claims or suggestions of
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`superiority; lack of appropriate contextual and physical fair balance; and
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`casting the “brief summary in small black print contrasted to vividly
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`colored, bold-lettered promotion.‘ ‘ 27
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`Since the 1962 amendments, the FDA has considered “all oral state-
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`ments, in fact any form of communication, calling attention of medical
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`and other audiences to a drug product“28 to be subject to their regulatory
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`jurisdiction under the labeling provisions of the Food, Drug, and Cos-
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`metic Act. Hence, the activity of detail men is in principle regulated by
`the FDA.
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`23 See Harris, supra note 8, for a very illuminating account of the legislative process,
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`gaming behavior, and compromise that preceded the 1962 amendments to the Food, Drug,
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`and Cosmetic Act.
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`1‘ See Food and Drugs, 21 C.F.R. § 3 [0.300, 67b (I980). Labeling is taken to includejournal
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`ads, brochures, house magazines, price lists, literature reprints, and audio—visual materials.
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`See FD Form 2253 (SW), ”Transmittal of Advertisements and Promotional Labeling.“
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`“5 Drug Amendments of [962, 7'6 Stat. 791.
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`1“ H. W. Chadduck, Division of Drug Advertising, FDA, In Brief Summary: Preseription
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`Drug Advertising, 1962—1971, 6 FDA Papers, February 1972, at 13.
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`1" Chadduck, supra note 26, at 2425.
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`25 Id
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`52
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`THE JOURNAL OF LAW AND ECONOMICS
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`The controls over promotion by the FDA seem sufficiently stringent to
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`make fraudulent advertising by pharmaceutical producers unprofitable.
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`Drugs may only be promoted for approved uses, and the promotional
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`material, including both journal advertisements and detail “handouts,”
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`is scrutinized by the FDA. Companies are frequently required to rewrite
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`their promotional literature and occasionally “asked" to run corrective
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`advertisements.29 Of course, the compliance of detail men to FDA rules is
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`conjectural. Detection of inappropriate verbal claims depends essentially
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`on physician complaints.
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`II. WHY DOES PHARMACEUTICAL ADVERTISING INCREASE DEMAND?
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`Prescription drugs are one of the most heavily promoted products in the
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`American economy .3" Table 1 reports the expenditures on pharmaceutical
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`promotion, the sales of these products through drug stores, and the pro-
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`motion to sales ratios for the years 1961 and 1968 to 197?.31 The promotion
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`averaged about 13 per cent of sales over this period.32 As mentioned in
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