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Perverse Reverse Price Competition: Average Wholesale Prices and Medicaid Pharmaceutical Spending

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  • Abby Alpert
  • Mark Duggan
  • Judith K. Hellerstein

Abstract

Generic drugs comprise an increasing share of total prescriptions dispensed in the U.S., rising from nearly 50 percent in 1999 to 75 percent in 2009. The generic drug market has typically been viewed at the wholesale level as a competitive market with price approaching marginal costs. However, the large presence of third party payers as final purchasers may distort prices at the retail level relative to what a standard model of price competition would predict. In this paper, we investigate how generic drug producers compete in the presence of the procurement rules of the Medicaid program. Medicaid reimbursement to pharmacies, like that of other payers, is based on a benchmark price called the average wholesale price (AWP). The AWP is reported by generic producers themselves, and until recently has been subject to essentially no independent verification. As a result, generic producers have had an incentive to compete for pharmacy market share by reporting AWPs that exceed actual average wholesale prices, as this "spread" leads to larger pharmacy profits. In 2000, after a federal government audit of actual wholesale prices of generic products, states were advised to reduce Medicaid reimbursement by as much as 95% for about 400 generic and off-patent drug products. We use variation induced by the timing of this policy along with its differential impact on drug products' Medicaid reimbursement to estimate the impact of this exogenous price change on the market share of targeted products. Our findings indicate that pharmacies did respond to the perverse incentives of the Medicaid program by dispensing products with the highest AWPs. Overall, the Medicaid market share fell by about 45% for targeted drug products as a result of the policy.

Suggested Citation

  • Abby Alpert & Mark Duggan & Judith K. Hellerstein, 2013. "Perverse Reverse Price Competition: Average Wholesale Prices and Medicaid Pharmaceutical Spending," NBER Working Papers 19367, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19367
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:jhecon:v:55:y:2017:i:c:p:153-167 is not listed on IDEAS
    2. David Dranove & Christopher Ody & Amanda Starc, 2017. "A Dose of Managed Care: Controlling Drug Spending in Medicaid," NBER Working Papers 23956, National Bureau of Economic Research, Inc.
    3. Liam J. A. Lenten, 2016. "Mitigation of Perverse Incentives in Professional Sports Leagues with Reverse-Order Drafts," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 49(1), pages 25-41, August.
    4. repec:spr:aphecp:v:15:y:2017:i:4:d:10.1007_s40258-017-0314-1 is not listed on IDEAS

    More about this item

    JEL classification:

    • H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
    • I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets
    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private
    • I18 - Health, Education, and Welfare - - Health - - - Government Policy; Regulation; Public Health

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