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Reference Pricing of Pharmaceuticals

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  • Brekke, Kurt R

    ()
    (Department of Economics, Norwegian School of Economics and Business Administration)

  • Königbauer, Ingrid

    ()
    (Department of Economics, University of Munich)

  • Straume, Odd Rune

    ()
    (Department of Economics, University of Bergen)

Abstract

We consider a therapeutic market with potentially three pharmaceutical firms. Two of the firms offer horizontally differentiated brand-name drugs. One of the brand-name drugs is a new treatment under patent protection that will be introduced, if the profits are sufficient to cover the entry costs. The other brand-name drug has already lost its patent and faces competition from a third firm offering a generic version perceived to be of lower quality. This model allows us to compare generic reference pricing (GRP), therapeutic reference pricing (TRP), and no reference pricing (NRP). We show that competition is strongest under TRP, resulting in the lowest drug prices (and medical expenditures). However, TRP also provides the lowest profits to the patent-holding firm, making entry of the new drug treatment least likely. Surprisingly, we find that GRP distorts drug choices most, exposing patients to higher health risks.

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Bibliographic Info

Paper provided by University of Bergen, Department of Economics in its series Working Papers in Economics with number 19/05.

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Length: 35 pages
Date of creation: 29 Nov 2005
Date of revision:
Handle: RePEc:hhs:bergec:2005_019

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Web page: http://www.uib.no/econ/en
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Keywords: Pharmaceuticals; Reference Pricing; Product differentiation;

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References

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  1. Lopez-Casasnovas, Guillem & Puig-Junoy, Jaume, 2000. "Review of the literature on reference pricing," Health Policy, Elsevier, vol. 54(2), pages 87-123, November.
  2. Brekke, Kurt R. & Grasdal, Astrid L. & Holmås, Tor Helge, 2006. "Regulation and Pricing of Pharmaceuticals: Reference Pricing or Price Cap Regulation?," Working Papers in Economics 14/06, University of Bergen, Department of Economics.
  3. Brekke, Kurt R. & Nuscheler, Robert & Straume, Odd Rune, 2002. "Quality and location choices under price regulation," Working Papers in Economics 24/02, University of Bergen, Department of Economics.
  4. Patricia M. Danzon & Jonathan D. Ketcham, 2003. "Reference Pricing of Pharmaceuticals for Medicare: Evidence from Germany, the Netherlands and New Zealand," NBER Working Papers 10007, National Bureau of Economic Research, Inc.
  5. Ching-to Ma & James Burgess, 1993. "Quality competition, welfare, and regulation," Journal of Economics, Springer, vol. 58(2), pages 153-173, June.
  6. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June.
  7. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
  8. Economides, Nicholas, 1989. "Quality variations and maximal variety differentiation," Regional Science and Urban Economics, Elsevier, vol. 19(1), pages 21-29, February.
  9. Grabowski, Henry G & Vernon, John M, 1992. "Brand Loyalty, Entry, and Price Competition in Pharmaceuticals after the 1984 Drug Act," Journal of Law and Economics, University of Chicago Press, vol. 35(2), pages 331-50, October.
  10. Mats A. Bergman & Niklas Rudholm, 2003. "The Relative Importance of Actual and Potential Competition: Empirical Evidence From the Pharmaceuticals Market," Journal of Industrial Economics, Wiley Blackwell, vol. 51(4), pages 455-467, December.
  11. Nina Pavcnik, 2002. "Do Pharmaceutical Prices Respond to Potential Patient Out-of-Pocket Expenses?," RAND Journal of Economics, The RAND Corporation, vol. 33(3), pages 469-487, Autumn.
  12. Anna Merino, 2000. "The impact of the reference price system on the pharmaceutical market: A theoretical approach," Economics Working Papers 524, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 2003.
  13. Jaskold Gabszewicz, J. & Thisse, J. -F., 1980. "Entry (and exit) in a differentiated industry," Journal of Economic Theory, Elsevier, vol. 22(2), pages 327-338, April.
  14. Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, vol. 51(5), pages 1469-83, September.
  15. Antonio Cabrales, 2003. "Pharmaceutical generics, vertical product differentiation and public policy," Economics Working Papers 662, Department of Economics and Business, Universitat Pompeu Fabra.
  16. 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.
  17. Konigbauer, Ingrid, 2007. "Advertising and generic market entry," Journal of Health Economics, Elsevier, vol. 26(2), pages 286-305, March.
  18. Zweifel, Peter & Crivelli, Luca, 1996. "Price Regulation of Drugs: Lessons from Germany," Journal of Regulatory Economics, Springer, vol. 10(3), pages 257-73, November.
  19. F. M. Scherer, 1993. "Pricing, Profits, and Technological Progress in the Pharmaceutical Industry," Journal of Economic Perspectives, American Economic Association, vol. 7(3), pages 97-115, Summer.
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