Consumer Learning and Heterogeneity: Dynamics of Demand for Prescription Drugs after Patent Expiration

Abstract

This paper investigates whether aggregate consumer learning together with consumer heterogeneity in price sensitivity could explain why (i) there is a slow diffusion of generic drugs into the market, and (ii) brand-name originators keep increasing their prices over time even after the number of generic entrants has become fixed. To examine these hypotheses, I estimate a structural demand model that incorporates consumer learning and heterogeneity in price sensitivity. By conducting a counterfactual experiment, which eliminates the uncertainty of generics, I find that learning plays a role in explaining the slow diffusion. By simulating the model, I find that the branded pricing pattern could be explained by: (a) the diffusion rate of generics for price-sensitive patients is faster than that for price-insensitive patients, causing the proportion of price-insensitive patients faced by brand-name firms to slowly increase over time; (b) the brand-name price elasticities of demand (evaluated at the observed prices) are often less than one and increase over time, suggesting that brand-name firms may set their prices lower than what they would do if they were myopic, in order to slow down the learning process for generic qualities. But such an incentive may diminish over time as the uncertainty slowly resolves.

Keywords: Consumer Learning, Consumer Heterogeneity, Brand-name Drugs, Generic Drugs, Demand Analysis

JEL Classification: C15, D12, D83, I11, L15, L65