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A Primer on the Economics of Prescription Pharmaceutical Pricing in Health Insurance Markets

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  • Ernst R. Berndt
  • Thomas G. McGuire
  • Joseph P. Newhouse

Abstract

The pricing of medical products and services in the U.S. is notoriously complex. In health care, supply prices (those received by the manufacturer) are distinct from demand prices (those paid by the patient) due to health insurance. The insurer, in designing the benefit, decides what prices patients pay out-of-pocket for drugs and other products. In this primer we characterize cost and supply conditions in markets for generic and branded drugs, and apply basic tools of microeconomics to describe how an insurer, acting on behalf of its enrollees, would set demand prices for drugs. Importantly, we show how the market structure on the supply side, characterized alternatively by monopoly (unique brands), Bertrand differentiated product markets (therapeutic competition), and competition (generics), influences the insurer’s choices about demand prices. This perspective sheds light on the choice of coinsurance versus copayments, the structure of tiered formularies, and developments in the retail market.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16879.

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Date of creation: Mar 2011
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Publication status: published as Ernst R. Berndt & Thomas McGuire & Joseph P. Newhouse, 2011. "A Primer on the Economics of Prescription Pharmaceutical Pricing in Health Insurance Markets," Forum for Health Economics & Policy, Berkeley Electronic Press, vol. 14(2), pages 10.
Handle: RePEc:nbr:nberwo:16879

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  1. Ellis, Randall P. & Manning, Willard G., 2007. "Optimal health insurance for prevention and treatment," Journal of Health Economics, Elsevier, Elsevier, vol. 26(6), pages 1128-1150, December.
  2. Mark Duggan & Fiona Scott Morton, 2010. "The Effect of Medicare Part D on Pharmaceutical Prices and Utilization," American Economic Review, American Economic Association, American Economic Association, vol. 100(1), pages 590-607, March.
  3. Martin Gaynor & Deborah Haas-Wilson & William B. Vogt, 1998. "Are Invisible Hands Good Hands? Moral Hazard, Competition, and the Second Best in Health Care Markets," NBER Working Papers 6865, National Bureau of Economic Research, Inc.
  4. Mark Duggan & Patrick Healy & Fiona Scott Morton, 2008. "Providing Prescription Drug Coverage to the Elderly: America's Experiment with Medicare Part D," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 22(4), pages 69-92, Fall.
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