Private versus social incentives for pharmaceutical innovation

Recognition Program

Authors: Paula González, Inés Macho-Stadler and David Pérez-Castrillo

Journal of Health Economics, Vol. 50, No 1, 286-297, December, 2016

We provide a theoretical framework to contribute to the current debate regarding the tendency of pharmaceutical companies to direct their R&D toward marketing products that are "follow-on" drugs of already existing drugs, rather than toward the development of breakthrough drugs. We construct a model with a population of patients who can be treated with drugs that are horizontally and vertically differentiated. In addition to a pioneering drug, a new drug can be marketed as the result of an innovative process. We analyze physician prescription choices and the optimal pricing decision of an innovative firm. We also characterize the incentives of the innovative firm to conduct R&D activities, disentangling the quest for breakthrough drugs from the firm effort to develop follow-on drugs. Our results offer theoretical support for the conventional wisdom that pharmaceutical firms devote too many resources to conducting R&D activities that lead to incremental innovations.

This paper originally appeared as Barcelona School of Economics Working Paper 860
This paper is acknowledged by the Barcelona School of Economics Recognition Program