It is frequently argued that the high costs of clinical trials prior to the admission of new pharmaceuticals are stifling innovation. At the same time, regulation of the access to markets is often justified on the basis of consumers` inability to detect the true quality of a product. We examine these arguments from an information economic perspective by setting a framework where the incentives to invest in R&D are influenced by the information structure prevailing when the product is launched in the market at a later stage. In this setting, by changing the information structure, regulation (or the lack of) can thus indirectly affect R&D efforts. More formally, we construct a moral hazard - cum - adverse selection model in which a pharmaceutical firm exerts an unobservable effort towards developing an innovative (high quality) drug (moral hazard) and then announces the (unobservable) quality outcome to an uninformed regulator and/or consumers (adverse selection). We compare the outcomes in regard to innovation effort and expected welfare under two regimes: (i) regulation, where products undergo a clinical trial designed to ascertain product quality at the point of market access; and (ii) laissez-faire with free entry, where the revelation of quality is left to the market process. Results show that whether or not innovation is greater in the presence of entry regulation crucially depends on the efficacy of the trial in identifying (poor) quality, on the probability that unknown qualities are revealed in the market process, and on the preference and cost structure. The welfare ranking of the two regimes depends on the differential effort incentive and on the net welfare gain from implementing full information instantaneously. For example, in settings of vertical monopoly, vertical differentiation and horizontal differentiation with no variable cost of quality, entry regulation tends to be the preferred regime if the effort incentive under pooling is relatively low and profits do not count too much towards welfare. A complementary numerical Analysis shows how the outcomes vary with the market and cost structure. (authors' abstract) / Series: Department of Economics Working Paper Series

Objectives: The Dental and Pharmaceutical Benefits Agency (TLV) is responsible for deciding which prescription pharmaceuticals should be subsidized in Sweden. Cost-effectiveness analyses are fundamental to its decision-making, but future price reductions following patent expiry are excluded from these analyses. The purpose of this study is to investigate and illustrate the economic and strategic aspects of including these future price changes in reimbursement decisions for prescription pharmaceuticals. Methods: We construct a Markov model in R to serve as a laboratory and evaluate the cost-effectiveness of a completely fictional drug, Liunek, under eight sets of assumptions and study differences in incremental cost-effectiveness ratios. Results: Including future price changes in TLV's reimbursement decisions will lead to increased healthcare expenditures if producers respond by raising prices, but may strengthen incentives to develop new pharmaceuticals. Policy implications: Sweden needs to decide whether it is TLV's responsibility to incentivize the development of new pharmaceuticals, and to what extent this should be done.