The Australian Pharmaceutical Subsidy Gambit: Transmuting Deadweight Loss and Oligopoly Rents to Consumer Surplus

Mark Johnston, Richard Zeckhauser

NBER Working Paper No. 3783
Issued in July 1991
NBER Program(s):Health Economics, Industrial Organization

Australia pays less than other developed nations for her pharmaceuticals, about 45% as much as the United States. She achieves this result with an ingenious price-contingent subsidy scheme, which turns deadweight loss (due to pricing above marginal cost) into consumer surplus. Pharmaceutical companies are offered a per unit subsidy from the government for selling their product at marginal cost in the Australian market. The subsidy is calibrated to enable the companies to recover what they would otherwise receive in monopoly profits. When two or more firms possess market power for a particular therapeutic use, the subsidy scheme creates a game -- in effect a race -- to determine who joins first and reaps most of the benefits. Properly constructed, the game transfers significant oligopoly profits to the consumer. Australia's success -- she reaps benefits equal to 15% of its drug expenditures stems in part from her small size and geographic isolation. She can free ride on drug research, and can work her scheme almost without notice.

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Document Object Identifier (DOI): 10.3386/w3783

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