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The Distortionary Effects of Government Procurement: Evidence from Medicaid Prescription Drug Purchasing

  • Mark Duggan
  • Fiona Scott Morton

The federal-state Medicaid program insures 43 million people for virtually all of the prescription drugs approved by the FDA. To determine the price that it will pay for a drug treatment, the government uses the average price in the private sector for that same drug. Assuming that Medicaid recipients are unresponsive to price because of the program's zero co-pay, this rule will increase prices for non-Medicaid consumers. Using drug utilization and expenditure data for the top 200 drugs in 1997 and in 2002, we investigate the relationship between the Medicaid market share (MMS) and the average price of a prescription. Our findings suggest that the Medicaid rules substantially increase equilibrium prices for non-Medicaid consumers. Specifically, a ten percentage-point increase in the MMS is associated with a ten percent increase in the average price of a prescription. This result is robust to the inclusion of controls for a drug's therapeutic class, the existence of generic competition, the number of brand competitors, and the years since the drug entered the market. We also demonstrate that the Medicaid rules increase a firm's incentive to introduce new versions of a drug at higher prices and find empirical evidence in support of this for drugs that do not face generic competition. Taken together, our findings suggest that government procurement can have an important effect on equilibrium prices in the private sector.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10930.

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Date of creation: Nov 2004
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Publication status: published as Duggan, Mark and Fiona M. Scott Morton. "The Distortionary Effects Of Government Procurement: Evidence From Medicaid Prescription Drug Purchasing," Quarterly Journal of Economics, 2006, v121(1,Feb), 1-30.
Handle: RePEc:nbr:nberwo:10930
Note: HC IO
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  1. Joan-Ramon Borrell, 1999. "Pharmaceutical Price Regulation: A Study on the Impact of the Rate-of-Return Regulation in the UK," PharmacoEconomics, Springer Healthcare | Adis, vol. 15(3), pages 291-303.
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  7. J. Gruber & A. Yelowitz, . "Public Health Insurance and Private Savings," Institute for Research on Poverty Discussion Papers 1135-97, University of Wisconsin Institute for Research on Poverty.
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  9. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
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