A Dynamic Oligopoly Structural Model for the Prescription Drug Market after Patent Expiration

International Economic Review, Vol. 51, No. 4, pp. 1175-1207, November 2010

57 Pages Posted: 16 Jun 2008 Last revised: 31 Jul 2012

Andrew Ching

University of Toronto - Rotman School of Management; University of Toronto - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: February 2, 2009

Abstract

Motivated by the slow diffusion of generic drugs and the increase in prices of brand-name drugs after generic entry, I incorporate consumer learning and consumer heterogeneity into an empirical dynamic oligopoly model. In the model, firms choose prices to maximize their expected total discounted profits. Moreover, generic firms make their entry decisions before patent expiration. The entry time of generics depends on the FDA random approval process. I apply this model to the market of clonidine. The parameters of the model are estimated and calibrated. The model replicates the stylized facts fairly well. I confirm that consumer heterogeneity in price sensitivity plays an important role in explaining the brand-name pricing pattern. I also apply the model to examine the impact of a policy experiment, which shortens the expected approval time for generics. Although this experiment brings generics to the market sooner, it also reduces the number of generic entrants as the likelihood of entering a crowded market in the early periods increases. Given the change in magnitude of the policy parameter, the experiment improves the rate of learning, and lowers the equilibrium generic prices throughout the period. However, it hardly raises the overall welfare.

Keywords: Dynamic Oligopoly, Prescription Drugs, Brand-name Drugs, Generic Drugs, Patent Expiration, Consumer Learning, Consumer Heterogeneity

JEL Classification: C73, D43, D83, L13, L65

Suggested Citation

Ching, Andrew, A Dynamic Oligopoly Structural Model for the Prescription Drug Market after Patent Expiration (February 2, 2009). International Economic Review, Vol. 51, No. 4, pp. 1175-1207, November 2010. Available at SSRN: https://ssrn.com/abstract=1146222

Andrew Ching (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6
Canada

HOME PAGE: http://www.rotman.utoronto.ca/andrew.ching

University of Toronto - Department of Economics ( email )

150 St. George Street
Toronto, Ontario M5S3G7
Canada

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