A Primer on the Economics of Prescription Pharmaceutical Pricing in Health Insurance Markets

41 Pages Posted: 21 Mar 2011 Last revised: 14 Feb 2021

See all articles by Ernst R. Berndt

Ernst R. Berndt

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Thomas G. McGuire

Harvard University - Department of Health Care Policy

Joseph P. Newhouse

Harvard Medical School; Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Date Written: March 2011

Abstract

The pricing of medical products and services in the U.S. is notoriously complex. In health care, supply prices (those received by the manufacturer) are distinct from demand prices (those paid by the patient) due to health insurance. The insurer, in designing the benefit, decides what prices patients pay out-of-pocket for drugs and other products. In this primer we characterize cost and supply conditions in markets for generic and branded drugs, and apply basic tools of microeconomics to describe how an insurer, acting on behalf of its enrollees, would set demand prices for drugs. Importantly, we show how the market structure on the supply side, characterized alternatively by monopoly (unique brands), Bertrand differentiated product markets (therapeutic competition), and competition (generics), influences the insurer's choices about demand prices. This perspective sheds light on the choice of coinsurance versus copayments, the structure of tiered formularies, and developments in the retail market.

Suggested Citation

Berndt, Ernst R. and McGuire, Thomas G. and Newhouse, Joseph P., A Primer on the Economics of Prescription Pharmaceutical Pricing in Health Insurance Markets (March 2011). NBER Working Paper No. w16879, Available at SSRN: https://ssrn.com/abstract=1789462

Ernst R. Berndt (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Thomas G. McGuire

Harvard University - Department of Health Care Policy ( email )

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Joseph P. Newhouse

Harvard Medical School; Harvard Kennedy School (HKS) ( email )

Department of Health Care Policy
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United States

National Bureau of Economic Research (NBER)

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United States

Harvard University - Harvard Kennedy School (HKS) ( email )

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