The Cost of US Pharmaceutical Price Reductions: A Financial Simulation Model of R&D Decisions
AbstractPrevious empirical studies that have examined the links between pharmaceutical price controls, profits, cash flows, and investment in research and development (R&D) have been largely based on retrospective statistical analyses of firm- and/or industry-level data. These studies, which have contributed numerous insights and findings to the literature, relied upon ad hoc reduced-form model specifications. In the current paper we take a very different approach: a prospective micro-simulation approach. Using Monte Carlo techniques we model how future price controls in the U.S. will impact early-stage product development decisions in the pharmaceutical industry. This is done within the context of a net present value (NPV) framework that appropriately reflects the uncertainty associated with R&D project technical success, development costs, and future revenues. Using partial-information estimators calibrated with the most contemporary clinical and economic data available, we demonstrate how pharmaceutical price controls will significantly diminish the incentives to undertake early-stage R&D investment. For example, we estimate that cutting prices by 40 to 50 percent in the U.S. will lead to between 30 to 60 percent fewer R&D projects being undertaken (in early-stage development). Given the recent legislative efforts to control prescription drug prices in the U.S., and the likelihood that price controls will prevail as a result, it is important to better understand the firm response to such a regulatory change.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11114.
Date of creation: Feb 2005
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Publication status: published as Thomas A. Abbott & John A. Vernon, 2007. "The cost of US pharmaceutical price regulation: a financial simulation model of R&D decisions," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(4-5), pages 293-306.
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Find related papers by JEL classification:
- I1 - Health, Education, and Welfare - - Health
- L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
- L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
- L5 - Industrial Organization - - Regulation and Industrial Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-02-13 (All new papers)
- NEP-CMP-2005-02-13 (Computational Economics)
- NEP-COM-2005-02-13 (Industrial Competition)
- NEP-HEA-2005-02-13 (Health Economics)
- NEP-INO-2005-02-13 (Innovation)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- DiMasi, Joseph A. & Hansen, Ronald W. & Grabowski, Henry G., 2003. "The price of innovation: new estimates of drug development costs," Journal of Health Economics, Elsevier, vol. 22(2), pages 151-185, March.
- repec:reg:rpubli:202 is not listed on IDEAS
- Henry Grabowski & John Vernon, 2000. "The determinants of pharmaceutical research and development expenditures," Journal of Evolutionary Economics, Springer, vol. 10(1), pages 201-215.
- Frank R. Lichtenberg, 2006.
"Importation and Innovation,"
NBER Working Papers
12539, National Bureau of Economic Research, Inc.
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