Prescription drug price dispersion in heterogeneous markets

Abstract

A homogeneous good is one that does not vary in quality, time, or space. In a perfectly competitive market with no information or transportation costs, all sellers would charge the same price. However, dispersion exists even for seemingly homogeneous goods. A prescription drug is one of the best examples of a homogeneous good because an individual can buy the drug from several different pharmacies but still receive the exact same good. However, prices for prescription drugs vary tremendously among pharmacies. The purpose of this research is to examine the conditions under which price dispersion exists. This study finds three major causes of price dispersion: differing amounts of search and information costs, differing degrees of competition in each drug market, and differing levels of variation among production costs. Extending previous research, this study includes variables that account for effects caused by differing market characteristics by using variables that measure the percent of individuals in poverty, the percent of the population over 65, and the distance from a Canadian market. Using variables that measure purchase frequency, number of substitutes, average cost, number of manufacturers, and whether or not the drug is a brand or generic, the effects of search, competition, and production costs are examined across drug markets. In addition, the effects of pharmacy heterogeneity on price dispersion are examined by developing a model for price determination. Several variables are used that control for differences in services and quality of pharmacies, such as delivery, convenience to consumers, whether or not the pharmacy is a chain, and location. Additional hypotheses are developed from the price determination models, and the effects of search and competition on prices are reviewed again using the drug and market characteristic variables.