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Dynamic Equilibrium in the US Prescription Drug Market After Patent Expiration

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  • Andrew Ching

    (University of Minnesota)

Abstract

In this paper I formulate and estimate an empirical dynamic oligopoly model that incorporates consumer learning, consumer heterogeneity and forward-looking firms. I apply this model to explain the evolution of pharmaceutical markets after patent expiration, and to address its related policy issues. I develop a practical method to estimate the parameters of the model that does not require finding instruments or solving the equilibrium model. Using this new method and a data set detailing the evolution of prices and market shares for 31 chemical entities from 1984-1990, I estimate the distribution of consumer preferences that determine how consumers evaluate risks, perceived attribute levels, and prices when choosing among brand-name originals and generics. I also design and program a backward induction algorithm to numerically solve the equilibrium model with different market structures. This computer program, together with the estimated preference parameter values and calibrated cost parameter values, are used to select a market structure that best fits the data, and the selected market structure is applied to analyze the firms' strategic behavior. According to the preliminary estimate results based on data from two markets, flurazepam and temazepam, I find that learning plays an important role in explaining the slow increase in market share for generic drugs. I also demonstrate that consumer heterogeneity has the potential to explain the pricing pattern that brand-name prices increase in response to generic entry. Finally, the model will be used to quantify the benefits of introducing generic drugs and to simulate the impact of various new public policies, including restricting the price for brand-name originals below some arbitrary level, reducing the average approval time for marketing generic drugs, and changing the cost of obtaining such approval.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1242.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1242

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  1. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers 709, Cowles Foundation for Research in Economics, Yale University.
  2. Ernst R. Berndt & Linda T. Bui & David H. Lucking-Reiley & Glen L. Urban, 1996. "The Roles of Marketing, Product Quality, and Price Competition in the Growth and Composition of the U.S. Antiulcer Drug Industry," NBER Chapters, in: The Economics of New Goods, pages 277-328 National Bureau of Economic Research, Inc.
  3. G. Steven Olley & Ariel Pakes, 1992. "The Dynamics of Productivity in the Telecommunications Equipment Industry," NBER Working Papers 3977, National Bureau of Economic Research, Inc.
  4. Becker, Gary S & Murphy, Kevin M, 1993. "A Simple Theory of Advertising as a Good or Bad," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 941-64, November.
  5. Berndt, Ernst R & Griliches, Zvi & Rosett, Joshua G, 1993. "Auditing the Producer Price Index: Micro Evidence from Prescription Pharamceutical Preparations," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(3), pages 251-64, July.
  6. Matthew Shum, 1998. "Characterizing Informational Barriers To Entry In The Anti-Ulcer Drug Market," Working Papers mshum-98-03, University of Toronto, Department of Economics.
  7. McFadden, Daniel, 1989. "A Method of Simulated Moments for Estimation of Discrete Response Models without Numerical Integration," Econometrica, Econometric Society, vol. 57(5), pages 995-1026, September.
  8. Pakes, Ariel & Pollard, David, 1989. "Simulation and the Asymptotics of Optimization Estimators," Econometrica, Econometric Society, vol. 57(5), pages 1027-57, September.
  9. Heckman, James & Singer, Burton, 1984. "A Method for Minimizing the Impact of Distributional Assumptions in Econometric Models for Duration Data," Econometrica, Econometric Society, vol. 52(2), pages 271-320, March.
  10. Fiona M. Scott Morton, 1997. "Entry Decisions in the Generic Pharmaceutical Industry," NBER Working Papers 6190, National Bureau of Economic Research, Inc.
  11. Ellison, S & Cockburn, I & Griliches, A & Hausman, J, 1996. "Characteristics of Demand for Pharmaceutical Products : an Examination of four Cephalosporins," Working papers 96-24, Massachusetts Institute of Technology (MIT), Department of Economics.
  12. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-90, July.
  13. Pakes, Ariel S, 1986. "Patents as Options: Some Estimates of the Value of Holding European Patent Stocks," Econometrica, Econometric Society, vol. 54(4), pages 755-84, July.
  14. Keane, Michael P, 1994. "A Computationally Practical Simulation Estimator for Panel Data," Econometrica, Econometric Society, vol. 62(1), pages 95-116, January.
  15. James J. Heckman, 1981. "Heterogeneity and State Dependence," NBER Chapters, in: Studies in Labor Markets, pages 91-140 National Bureau of Economic Research, Inc.
  16. Tülin Erdem & Michael P. Keane, 1996. "Decision-Making Under Uncertainty: Capturing Dynamic Brand Choice Processes in Turbulent Consumer Goods Markets," Marketing Science, INFORMS, vol. 15(1), pages 1-20.
  17. Stigler, George J & Becker, Gary S, 1977. "De Gustibus Non Est Disputandum," American Economic Review, American Economic Association, vol. 67(2), pages 76-90, March.
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Citations

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Cited by:
  1. Xinlei Chen & Yuxin Chen & Charles Weinberg, 2013. "Learning about movies: the impact of movie release types on the nationwide box office," Journal of Cultural Economics, Springer, vol. 37(3), pages 359-386, August.
  2. Bergemann, Dirk & Valimaki, Juuso, 2002. "Entry and Vertical Differentiation," Journal of Economic Theory, Elsevier, vol. 106(1), pages 91-125, September.
  3. Andrew T. Ching & Tülin Erdem & Michael P. Keane, 2013. "Learning Models: An Assessment of Progress, Challenges and New Developments," Economics Papers 2013-W07, Economics Group, Nuffield College, University of Oxford.
  4. Laura Magazzini & Fabio Pammolli & Gianluca Papa & Nicola Carmine Salerno, 2005. "Generici vs. Branded: confronto internazionale su prodotti off-patent rimborsati dal SSN," Working Papers 01-2005, Competitività Regole Mecati (CERM).
  5. Andrew Ching & Masakazu Ishihara, 2010. "The effects of detailing on prescribing decisions under quality uncertainty," Quantitative Marketing and Economics, Springer, vol. 8(2), pages 123-165, June.
  6. Anna Merino, 2000. "The impact of the reference price system on the pharmaceutical market: A theoretical approach," Working Papers, Research Center on Health and Economics 524, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 2003.
  7. Laura Magazzini & Fabio Pammolli & Massimo Riccaboni, 2004. "Dynamic competition in pharmaceuticals," The European Journal of Health Economics, Springer, vol. 5(2), pages 175-182, May.
  8. Ching, Andrew & Ishihara, Masakazu, 2007. "The Effects of Detailing on Prescribing Decisions under Two-Sided Learning," MPRA Paper 4935, University Library of Munich, Germany.

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