Summary: Monopolies whose buyers pay fraction c of the product cost respond by raising their price for the initial quantity q0 from p0 to p0 and adjust to a different price and quantity only if profits are thereby raised further. A prescription plan that includes a 20 percent co-payment provision thus magnifies the drug patent holder's profits more than a fivefold increase in price at the original output would.

Pharmaceutical patents are anachronistic holdovers from an era in which modern economic understanding and tax tools were unavailable. Superior mechanisms lie somewhere between a first-best pricing solution for the entire economy at one extreme and the current arrangements at the other. We discuss the economics of suggested alternatives and suggest that the intertemporal bounty is the best way to meet the multiple objectives of immediate distribution at marginal cost pricing of recently-innovated patented drugs and easily administered efficient inducement to continued innovation. The intertemporal bounty prevents the expansion of monopoly power resulting from co-pay or co-insurance provisions common to modern prescription drug plans.

Introduction

The pharmaceutical industry is characterized by large sunk costs, high fixed costs, low variable costs, segmentable markets (where sellers can distinguish consumer types and charge different prices), and strong patent protection for drug discoveries.