Equilibrium Price Dispersion in Retail Markets for Prescription Drugs

Abstract

This study seeks to establish the empirical importance of price dis- persion due to costly consumer search by examining retail prices for prescription drugs. Posted prices in two geographically distinct mar- kets are shown to vary considerably across pharmacies within the same market, even after one controls for variation due to pharmacy differ- ences. Pharmacy heterogeneity accounts for at most one-third of the observed price dispersion. The empirical analysis hinges on the ob- servation that consumers' incentives to price-shop depend on char- acteristics of the drug therapy. Cross-sectional patterns in price dis- tributions across drugs are consistent with the predictions of a search model: prices for repeatedly purchased prescriptions (for which the expected benefits of search are highest) exhibit significant reductions in both dispersion and price-cost margins.