The Impact of the Reference Price System on the Pharmaceutical Market: A Theoretical Approach

UPF Economics and Business Working Paper No. 524

33 Pages Posted: 30 Aug 2001

See all articles by Anna Merino Castello

Anna Merino Castello

Marsh & McLennan Companies - Madrid Office; Universitat Pompeu Fabra

Abstract

This article analyses the impact of the reference price system on the price-setting strategies of the pharmaceutical firms and on the level of generic usage. This model is the first to take explicitly into account the impact of the reference price mechanism on the level of competition between brand-name and generic drugs and national pharmaceutical spending. We consider a duopolistic model with one firm producing the brand-name drug, whose patent has already expired, and the other producing the corresponding generic version. We work in a partial equilibrium framework where firms set prices sequentially and consumers face heterogeneous switching costs.We show that brand producers compensate the decline of profits by selling greater quantities instead of charging higher prices, thus fostering price competition in the pharmaceutical market. This result is a consequence of both the assumption of a vertically differentiated model and the introduction of the reference price system.

Keywords: Brand-name and generic drugs, pricing mechanism and switching costs

JEL Classification: I18, L11, L15, L51

Suggested Citation

Castello, Anna Merino, The Impact of the Reference Price System on the Pharmaceutical Market: A Theoretical Approach. UPF Economics and Business Working Paper No. 524, Available at SSRN: https://ssrn.com/abstract=273408 or http://dx.doi.org/10.2139/ssrn.273408

Anna Merino Castello (Contact Author)

Marsh & McLennan Companies - Madrid Office ( email )

Paseo de la Castellana 13
28046 Madrid
Spain
+34 912126407 (Phone)

Universitat Pompeu Fabra

Ramon Trias Fargas 25-27
08005 Barcelona
Spain

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