TY  - JOUR
AU  - Abbott,Thomas A.
AU  - Vernon,John A.
TI  - The Cost of US Pharmaceutical Price Reductions: A Financial Simulation Model of R&D Decisions
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 11114
PY  - 2005
Y2  - February 2005
UR  - http://www.nber.org/papers/w11114
L1  - http://www.nber.org/papers/w11114.pdf
N1  - Author contact info:
Thomas A. Abbott, III
106 Davis Drive
North Wales, PA 19454
Tel: 215/353-7319
Fax: 215/619-0089
E-Mail: thomas_abbott@merck.com

John Vernon
University of North Carolina at Chapel Hill
Department of Health Policy & Management
1101C McGavran-Greenberg Hall
Chapel Hill, NC 27599-7411
Tel: 919/966-8930
E-Mail: vernon@email.unc.edu
AB  - Previous empirical studies that have examined the links between pharmaceutical price controls, profits, cash flows, and investment in research and development (R&D) have been largely based on retrospective statistical analyses of firm- and/or industry-level data. These studies, which have contributed numerous insights and findings to the literature, relied upon ad hoc reduced-form model specifications. In the current paper we take a very different approach: a prospective micro-simulation approach. Using Monte Carlo techniques we model how future price controls in the U.S. will impact early-stage product development decisions in the pharmaceutical industry. This is done within the context of a net present value (NPV) framework that appropriately reflects the uncertainty associated with R&D project technical success, development costs, and future revenues. Using partial-information estimators calibrated with the most contemporary clinical and economic data available, we demonstrate how pharmaceutical price controls will significantly diminish the incentives to undertake early-stage R&D investment. For example, we estimate that cutting prices by 40 to 50 percent in the U.S. will lead to between 30 to 60 percent fewer R&D projects being undertaken (in early-stage development). Given the recent legislative efforts to control prescription drug prices in the U.S., and the likelihood that price controls will prevail as a result, it is important to better understand the firm response to such a regulatory change.
ER  -