The Price Effect of Drug Price Ceilings: Intended and Unintended Consequences

Abstract

Governments in many developing countries use maximum price or maximum markup policies to control pharmaceutical costs, which represent 20-60% of their overall healthcare expenditure. We study the price effect of price ceiling policies by exploiting a major policy shift in China---the elimination of longstanding ceilings on retail drug prices---to examine the impact of price ceiling regulation on drug prices. We collect weekly price and characteristics data on nearly 4,000 drug SKUs from a leading pharmacy chain. We first apply statistical jump detection methods to the price series of each SKU and extract sharp, discontinuous price changes. We then compare the rate of these changes across drugs under and not under price ceilings during the years before and after the policy change. We find while effective in containing drug prices in some markets, price ceilings---particularly uniform ceilings set irrespective of local economic conditions---can lead to higher prices for some drugs, especially in lower-income regions. We attribute this perverse price effect to focal point pricing and asymmetric information about production costs. Further supporting this view, we find drugs with highly concentrated production and less elastic demand face heightened risks of inflated prices under price ceilings. Moreover, drugs with manufacturer-specific ceilings are more likely to be priced at or near their ceilings and more likely to experience price drops once the ceilings are removed. Overall, this paper documents the unintended perverse effect of price ceilings in pharmaceutical markets and sheds lights on the ongoing debate of drug price regulation.

Keywords: Drug Price Regulation, Price Ceiling, Pharmaceutical Markets, Healthcare Cost