Price Discrimination for Pharmaceuticals: Welfare Effects in the US and the EU

Abstract

Standard analysis of the welfare effects of price discrimination for pharma-ceuticals (Scherer, F.M., "How US Antitrust Can Go Astray: The Brand Name Prescription Drug Litigation", International Journal of Business and Economics, 1997, 4, 3, 000-000) is incomplete because it presumes the optimality of marginal cost pricing, ignoring the sunk costs of R&D. Pharmaceutical R&D is a global joint cost of serving all consumers worldwide; it accounts for roughly 30% of total costs. Ramsey pricing principles imply that differential pricing related to inverse demand elasticities is the second best optimal strategy to cover the joint costs. Actual price differentials to managed care customers in the US should roughly approximate Ramsey optimal differentials, in the absence of legal constraints. In the European Union (EU), traditional price differentials between countries are being undermined by parallel trade and regulation based on foreign prices. This break down of market segmentation leads manufacturers to adopt uniform prices EU-wide. Efficiency and distributive effects of such policies are probably negative. Monopsony is a more serious problem in the EU, hence actual price differentials may exceed Ramsey optimal differences. Confidential contracts between manufacturers and governments, including rebates off a common list price, would preserve ex post price differentials and should be consistent with EU law