Rewarding inventors with inefficient monopoly power has long been regarded as the price of encouraging innovation. Public prescription drug insurance escapes that trade-off and achieves an elusive goal: lowering static deadweight loss, while simultaneously encouraging dynamic investments in innovation. As a result of this feature, the public provision of drug insurance can be welfare-improving, even for risk-neutral and purely self-interested consumers. In spite of its relatively low benefit levels, the Medicare Part D benefit generate $3.5 billion of annual static deadweight loss reduction, and at least $2.8 billion of annual value from extra innovation. These two components alone cover 87% of the social cost of publicly financing the benefit. The analysis of static and dynamic efficiency also has implications for policies complementary to a drug benefit: in the context of public monopsony power, some degree of price-negotiation by the government is always strictly welfare-improving, but this should often be coupled with extensions in patent length.
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Length: Date of creation: Oct 2007 Date of revision: Handle: RePEc:nbr:nberwo:13501
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Find related papers by JEL classification: H2 - Public Economics - - Taxation, Subsidies, and Revenue H51 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Health I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets
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