Perverse Reverse Price Competition: Average Wholesale Prices and Medicaid Pharmaceutical Spending

53 Pages Posted: 30 Aug 2013

See all articles by Abby Alpert

Abby Alpert

RAND

Mark Duggan

University of Pennsylvania - Business & Public Policy Department

Judith K. Hellerstein

University of Maryland - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: August 2013

Abstract

Generic drugs comprise an increasing share of total prescriptions dispensed in the U.S., rising from nearly 50 percent in 1999 to 75 percent in 2009. The generic drug market has typically been viewed at the wholesale level as a competitive market with price approaching marginal costs. However, the large presence of third party payers as final purchasers may distort prices at the retail level relative to what a standard model of price competition would predict. In this paper, we investigate how generic drug producers compete in the presence of the procurement rules of the Medicaid program. Medicaid reimbursement to pharmacies, like that of other payers, is based on a benchmark price called the average wholesale price (AWP). The AWP is reported by generic producers themselves, and until recently has been subject to essentially no independent verification. As a result, generic producers have had an incentive to compete for pharmacy market share by reporting AWPs that exceed actual average wholesale prices, as this "spread" leads to larger pharmacy profits. In 2000, after a federal government audit of actual wholesale prices of generic products, states were advised to reduce Medicaid reimbursement by as much as 95% for about 400 generic and off-patent drug products. We use variation induced by the timing of this policy along with its differential impact on drug products' Medicaid reimbursement to estimate the impact of this exogenous price change on the market share of targeted products. Our findings indicate that pharmacies did respond to the perverse incentives of the Medicaid program by dispensing products with the highest AWPs. Overall, the Medicaid market share fell by about 45% for targeted drug products as a result of the policy.

Suggested Citation

Alpert, Abby and Duggan, Mark and Hellerstein, Judith K., Perverse Reverse Price Competition: Average Wholesale Prices and Medicaid Pharmaceutical Spending (August 2013). NBER Working Paper No. w19367. Available at SSRN: https://ssrn.com/abstract=2318270

Abby Alpert (Contact Author)

RAND ( email )

P.O. Box 2138
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Santa Monica, CA 90407-2138
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Mark Duggan

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

Judith K. Hellerstein

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States
301-405-3545 (Phone)
301-405-3542 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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