Pharmaceutical Industry, Drug Quality and Regulation - Evidence from US and Italy

Abstract

This paper examines the relationship between drug price and drug quality and how it varies across two of the most common regulatory regimes in the pharmaceutical market: Minimum Efficacy Standards (MES) and a mix of Minimum Efficacy Standards and Price Controls mechanisms (MES PC). Through a simple model of adverse selection we model the interaction between firms, heterogeneous buyers and the regulator. Buyers' heterogeneity stems from differences in the willingness-to pay for drug quality, measured through ex-post efficacy. The theoretical analysis provides two main results. First, MES regime provides higher incentive to produce high quality drugs. Second, the regulatory MES PC mix reduces the difference in terms of high-low quality drug prices. The empirical analysis based on US and Italian data corroborates these results.

Keywords: innovation, pharmaceutical market, regulation