Price Competition in Pharmaceuticals: The Case of Anti-Infectives

By Wiggins, Steven N.; Maness, Robert | Economic Inquiry, April 2004 | Go to article overview

Price Competition in Pharmaceuticals: The Case of Anti-Infectives


Wiggins, Steven N., Maness, Robert, Economic Inquiry


I. INTRODUCTION

A fundamental question in industrial organization regards the relationship between price and the number of sellers (N). The interest in this issue has been rekindled by substantial recent work. (1) This article uses an extensive data set to provide an empirical analysis of the price N relationship for antiinfective pharmaceutical products. (2) The analysis shows that (1) prices fall rapidly moving from one seller to a few and (2) subsequent increases in the number of sellers continue to reduce prices, even when there are numerous sellers. (3) Prices fall about 83% as the number of sellers increases from 1 to between 6 and 15, and fall by another 52% as sellers increase from the 6 to 15 range to more than 40. These results contrast with previous work on pharmaceuticals using more limited data and showing little impact of entry on branded prices. (4) The results here indicate instead that the effect of an increase in number of sellers on prices in pharmaceuticals is similar to that found in other settings.

Pharmaceutical pricing behavior has attracted scrutiny from both policy makers and academic economists. As such, there have been a number of studies of pharmaceutical pricing behavior in general and the impact of generic entry on branded and generic drug prices in particular. Most of the previous studies have concentrated on small sets of drugs that have faced patent expiration across a number of therapeutic classes. Early studies focused on reduced form or semireduced form regression models that showed that branded prices and generic prices responded differently to generic entry. In particular, these studies showed that branded prices responded little to generic entry, and in some studies even increased (see Caves et al., 1991; Grabowski and Vernon 1992; 1996). Frank and Salkever (1992) developed a theoretical model to explain the anomaly of rising branded prices in the face of generic competition. Their model posited a segmented market where there existed two groups of consumers--a quality-conscious segment that continues to buy the established branded product after generic entry and a price-conscious segment. Frank and Salkever show that because of the segmented nature of the market, entry likely makes the demand facing the branded manufacturer less elastic and thus leads to price increases. Frank and Salkever (1997) provide empirical tests and confirm that, consistent with the segmented markets theory, branded prices rise and generic prices fall in response to generic entry.

Finally, a number of studies have attempted to characterize the behavior of generic firms. Scott Morton (1999; 2000) finds that revenue in the years before patent expiration is the most important determinant of how many generic firms enter a given market. She also finds that generic firms tend to specialize in certain categories of products. Reiffen and Ward (2002) develop a structural model of the response of generic prices to generic entry.

This article investigates how prices decline as the number of sellers rises, evaluating the ability of formal theoretical models to organize the data. The results show that although existing models organize some of the data regarding price declines, there are important discrepancies between the data and existing models. We then characterize the differences between the data and the models, providing a basis for continued theoretical and empirical work.

There are a number of important differences between the data we use and those of previous researchers. First, unlike previous research on pharmaceutical pricing, our data are focused on a single therapeutic category--anti-infectives. This focus on a single therapeutic category provides a number of benefits, particularly with regard to controlling for cost differences and demand differences. Anti-infectives in particular is a useful category because they are primarily used for acute conditions, thus making demand conditions more uniform. …

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