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The Australian Pharmaceutical Subsidy Gambit: Transmuting Deadweight Loss and Oligopoly Rents to Consumer Surplus

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  • Mark Johnston
  • Richard Zeckhauser

Abstract

Australia pays less than other developed nations for her pharmaceuticals, about 45% as much as the United States. She achieves this result with an ingenious price-contingent subsidy scheme, which turns deadweight loss (due to pricing above marginal cost) into consumer surplus. Pharmaceutical companies are offered a per unit subsidy from the government for selling their product at marginal cost in the Australian market. The subsidy is calibrated to enable the companies to recover what they would otherwise receive in monopoly profits. When two or more firms possess market power for a particular therapeutic use, the subsidy scheme creates a game -- in effect a race -- to determine who joins first and reaps most of the benefits. Properly constructed, the game transfers significant oligopoly profits to the consumer. Australia's success -- she reaps benefits equal to 15% of its drug expenditures stems in part from her small size and geographic isolation. She can free ride on drug research, and can work her scheme almost without notice.

Suggested Citation

  • Mark Johnston & Richard Zeckhauser, 1991. "The Australian Pharmaceutical Subsidy Gambit: Transmuting Deadweight Loss and Oligopoly Rents to Consumer Surplus," NBER Working Papers 3783, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:3783
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    1. Richard E. Romano, 1988. "A Monopolist Should Always Be Subsidized No Matter How High the Excess Burden," Canadian Journal of Economics, Canadian Economics Association, vol. 21(4), pages 871-873, November.
    2. Reekie, W Duncan, 1978. "Price and Quality Competition in the United States Drug Industry," Journal of Industrial Economics, Wiley Blackwell, vol. 26(3), pages 223-237, March.
    3. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-574, September.
    4. Glenn C. Loury, 1979. "Market Structure and Innovation," The Quarterly Journal of Economics, Oxford University Press, vol. 93(3), pages 395-410.
    5. Mortensen, Dale T, 1982. "Property Rights and Efficiency in Mating, Racing, and Related Games," American Economic Review, American Economic Association, vol. 72(5), pages 968-979, December.
    6. Putnam, Robert D., 1988. "Diplomacy and domestic politics: the logic of two-level games," International Organization, Cambridge University Press, vol. 42(03), pages 427-460, June.
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    Cited by:

    1. Lopez-Casasnovas, Guillem & Puig-Junoy, Jaume, 2000. "Review of the literature on reference pricing," Health Policy, Elsevier, vol. 54(2), pages 87-123, November.
    2. Michael Kremer, 2001. "Creating Markets for New Vaccines - Part I: Rationale," NBER Chapters,in: Innovation Policy and the Economy, Volume 1, pages 35-72 National Bureau of Economic Research, Inc.
    3. Elamin H. Elbasha, 2003. "Deadweight loss of bacterial resistance due to overtreatment," Health Economics, John Wiley & Sons, Ltd., vol. 12(2), pages 125-138.
    4. Kremer, Michael R., 1998. "Patent Buyouts: A Mechanism for Encouraging Innovation," Scholarly Articles 3693705, Harvard University Department of Economics.
    5. Michael Kremer, 2001. "Creating Markets for New Vaccines - Part II: Design Issues," NBER Chapters,in: Innovation Policy and the Economy, Volume 1, pages 73-118 National Bureau of Economic Research, Inc.
    6. Michael Kremer, 1997. "Patent Buy-Outs: A Mechanism for Encouraging Innovation," NBER Working Papers 6304, National Bureau of Economic Research, Inc.

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