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					                        The Effect of Canadian Imports
                   on Prescription Drug Prices in the U.S.*

                                   March 29, 2011




                                 Jonathan Hamilton
                             Department of Economics
                    Warrington College of Business Administration
                                University of Florida
                                Gainesville FL 32611
                                 hamilton@ufl.edu




* This is a revised version of a paper presented at the 2006 Southern Economic
Association Meetings in Charleston SC. Simon Anderson provided many valuable
comments and insights during the preparation of earlier drafts.
        I thank Mark Fister for compiling the drug price table and Adam Narkiewicz and
Ed See for research assistance. I also thank the Warrington College of Business
Administration for financial support of this research.
        Please do not quote or cite without permission.
                          The Effect of Canadian Imports
                    on Prescription Drug Prices in the U.S.*




                                         Abstract

       Reimportation of prescription drugs by American consumers from Canada has

been a high-visibility policy issue. The large price discrepancies for some patented drugs

arise from market pricing in the U.S. and a system of administered pricing in Canada.

The model assumes that there are two classes of U.S. consumers: one group who cannot

reimport drugs at any cost, and a second group with a distribution of reimportation costs.

Under the assumption that the group who can reimport drugs has lower willingness to

pay, reimportation serves as a mechanism for price discrimination in the U.S. market.

       The results include the following: 1) a decline in the Canadian price may raise

the U.S. price; 2) a shift down in the distribution of reimportation costs may similarly

raise the U.S. price; 3) a shift down in the distribution of reimportation costs may raise

drug manufacturer profits.
1. Introduction

       American consumers, health insurers, and health policymakers have become more

vocal about their dissatisfaction with high pharmaceutical prices paid by Americans.

Many studies have established that there are large discrepancies in wholesale and retail

prices between American pharmacies and those in other wealthy countries. Table 1

illustrates differences in mail-order prices between U.S. chains and Canadian firms

marketing to U.S. consumers. These price differences are much larger for patented drugs

than for generic ones.1

       Because pharmaceuticals have high sunk costs for development, prices must

exceed marginal costs of production by substantial amounts if drug firms are to continue

to develop new drugs. One would certainly expect that drug firms price discriminate

across markets whenever they can, and indeed many policymakers have striven to enable

drug manufacturers to sell at low prices in poor countries without facing risks of

reimportation back to markets in wealthier countries.

       The price discrepancies between the U.S. and other wealthy countries such as

Canada, France, Germany, Japan, and the U.K. are quite large and cannot simply be the

result of drug firms pricing in response to cross-country differences in willingness to pay.

Outside the U.S., national health authorities bear a large fraction of pharmaceutical

expenditures on behalf of their citizens, and they have implemented a variety of

administered pricing systems. While they work in different ways, these pricing systems



1
 Generic drugs may be less expensive in the U.S. than in other developed countries. It
should not come as a surprise that generic drugs have a larger share of the market in the
U.S. than in countries with administered pricing systems. See McClellan [2003] for
evidence on generic pricing and market penetration.
severely limit the ability of drug firms to earn large monopoly rents on new products in

these countries. In contrast in the U.S., managed care systems and pharmacy benefit

managers (PBMs) may negotiate prices for their patients, but only some of these

organizations have much market power on the buying side. (Ellison and Snyder [2010]

explain that prescription volume matters less than the ability of organizations to direct

physicians to prescribe particular drugs in a therapeutic class.) During debate on the

2003 Medicare prescription drug plan, proposals to have Medicare negotiate drug prices

on behalf of elderly consumers were defeated.

       One argument in support of market pricing of drugs has been that drug firms must

cover their considerable development costs to bring new drugs to market. Mark

McClellan, when he was head of the Food and Drug Administration, observed that high

drug prices in the U.S. result in American consumers bearing most of the development

costs, even though new products benefit consumers around the world (McClellan,

[2003]). Many researchers have worried about drug firms concentrating their

development efforts on drugs that have high profit potential. Indeed, this is one

motivation for proposals to encourage development of drugs needed in the developing

world. However, the differences in disease incidence between the U.S. and much of the

rich world (especially Canada and Western Europe) are not great enough that research

could be directed specifically at the U.S. market alone.2 To some extent, the countries

with administered price systems free ride on drug research funded by American

consumers.



2
 What is more distinctive about the U.S. is the market environment for prescription
drugs.



                                             2
        One reaction to the price discrepancies has been an increase in attempts to import

drugs from Canada into the U.S. Since most such drugs are manufactured in the U.S.,

this is, in fact, reimportation. Imports outside of standard manufacturer channels, in

particular to frustrate international price discrimination, are often referred to as parallel

imports.3 American pharmaceutical manufacturers have fought attempts to import from

Canada and have been supported by the U.S. FDA, which is concerned about the

feasibility of monitoring safety of parallel imports. Despite this, several state and local

governments have announced plans to import drugs from Canada for their employee

health plans. Currently, wholesale importation is effectively banned. In contrast,

individuals can import products purchased at retail in Canadian pharmacies, although

U.S. Customs has begun seizing mail-order shipments. In the summer of 2006, Congress

considered legislation to legalize imports by individuals [Wall Street Journal, 24 July

2006, p. B1].

        The debate over allowing imports from Canada has focused on several issues: the

effect of reduced profitability on future drug development by private firms; safety issues,

and projected reactions by drug firms to exports by Canadian wholesalers. Almost taken

for granted in the discussion is that prices will fall, at least on average, in the U.S. I

explore the reactions by American manufacturers to increases in imports from Canada in

a model with distinct groups of U.S. consumers.




3
  Malueg and Schwartz [1994] analyze a model with arbitrage costs and international
price discrimination, but no parallel imports occur in equilibrium. Chen and Maskus
[2002] and Maskus and Chen [2004] study parallel importing when foreign retailers ship
the good to the domestic market. In my model, consumers bear the reimportation costs
directly, which allows them to differ across consumers.



                                               3
       Pecorino [2002] has studied the effect of parallel imports from Canada in a model

with monopoly prices in the U.S. and prices in Canada which are determined through

Nash bargaining between the Canadian government and the manufacturers. He shows

that Canadian prices will rise if parallel importing becomes widespread. Anis and Wen

[1998] discuss the Canadian pricing regime and suggest that a bargaining approach

between manufacturers and the Canadian government does not capture the nature of

price-setting very well. It is, however, true that manufacturers have threatened to

establish quantity limits on Canadian wholesalers if exporting from Canada to the U.S.

becomes prevalent. Kyle [2011] discusses a variety of policies that pharmaceutical

manufacturers have employed in the EU to frustrate parallel imports. Similar policies

could be used to frustrate parallel imports from Canada to the U.S. My model does not

consider the implementation of such policies and focuses only on the induced price

changes in the U.S.

       What Pecorino and other analysts have ignored is the possibility that parallel

imports from another country may facilitate price discrimination within a single country.

Anderson and Ginsburgh [1999] develop a model of parallel trade where within-country

discrimination is impossible, but there are only limited arbitrage possibilities between

countries. I use a variant of that model to explore the effects of increases in parallel

imports of drugs. There are two groups of American consumers. One group has no

ability to engage in parallel importation; consumers with generous health insurance

coverage for prescription drugs often have little ability to go outside their health network.

Even if they find lower prices (before reimbursement) elsewhere, insurance

reimbursement is only available for purchases through specified retailers. The second




                                              4
group of consumers has a distribution of willingness to pay for a prescription drug and a

distribution of costs of importation from Canada. These importation costs can be psychic

or real (or a combination). If consumers must travel to Canada to get prescriptions filled

there, distance to Canada will be an important determinant of reimportation cost. The

cost can also reflect some measure of the riskiness of buying drugs outside FDA-

approved (and FDA-monitored) channels. Because the first group of consumers has

more comprehensive health insurance, the distribution of willingness to pay has a higher

mean value for the first group.

       I approach these questions through two types of comparative statics exercises.

First, since the Canadian price regulation regime appears to have become more stringent

over time, I consider the effects of an exogenous change in the Canadian price.4 It is

certainly the case that greater spreads between Canadian and U.S. prices have been

observed over time and that this has led to increased interest in parallel importing. I also

examine the effect of shifts in the distribution in the cost of arbitrage (every consumer’s

parallel importing cost changes by the same multiplicative factor). The two effects turn

out to be quite similar in many, but not all, respects

       The main finding is that the price charged in the U.S. market (paid by all

purchasers in the first group and by those in the second group who purchase in the U.S.)

may well increase in response to a decrease in the Canadian price or a decrease in the

distribution of arbitrage costs. Depending on the level of the Canadian price, the U.S.

price may be higher or lower than the U.S. monopoly price in the absence of arbitrage.

Profitability may rise or fall as a result of an increase in arbitrage from either source,

4
 My analysis differs from that of Anderson and Ginsburgh [1999] in that the Canadian
price is not chosen by the monopolist, but rather determined administratively.


                                               5
depending on the level of the Canadian price. An increase in arbitrage may, but need not,

cause the monopolist to want to charge a higher price in Canada.


2. The simplest model

       There are two types of drug consumers in the U.S. Group 1 only purchase drugs

in the U.S.—because their cost of importing drugs from Canada is prohibitively high.

One possibility is that this group consists of consumers with private health insurance that

covers prescription drugs. Their insurance plans only reimburse drug purchases through

the plan, so they have no incentive to purchase off-plan. Their demand curve is Q1 = a –

P1, where one should interpret P1 as the full price paid by the insurer and the insured for

the drug.5

       The second group of consumers may purchase drugs in the U.S. or in Canada (or

through any other outlet, but think of Canada as the sole alternative). Let  = fraction of

group 2 consumers who buy in the US (1-  of the group 2 consumers purchase from

Canada). The U.S. demand from these consumers is Q2 = (b – P2), so inverse demand is

           Q2
P2 = b         . For this simple model, assume that the two groups of consumers are equal
           

in size—the more detailed model of the next section relaxes this assumption.

       In principle, the division of group 2 consumers into Canada and U.S. purchasers

depends on the U.S. price, the Canadian price, and the distribution of parallel import

costs of consumers. Holding the fraction buying in Canada fixed to determine individual




5
 This insured group would also never purchase drugs in Canada unless the retail price in
Canada were lower than the net price after reimbursement in the U.S.



                                               6
drug prices is appropriate if the decision to shop in Canada depends on prices in the

aggregate (as in an insurer’s decision to import Canadian drugs for its policyholders).

       First, one can find the optimal single monopoly price as a function of  and show

that it has some desirable properties for the model.

       Add the U.S. demand curves together to obtain:

        Q  a   b  (1   ) P .

Invert this demand curve to obtain:

             a  b Q
        P             .
                1 

                                        a   b  2Q
Then marginal revenue (MR) equals                    . Let marginal cost be constant and
                                           1 

equal to c. Setting MR = MC, the non-discriminating monopoly price is the solution to:

                a   b  2Q                            a   b  1    c
                             = c or            Q* =
                   1                                           2

                       a   b a   b  1    c    a  b c
and             P* =                               =            .
                       1         2 1            2 1    2

For reference, the discriminating prices in the U.S. would be:

               ac                                      bc
        P* 
         1                       and            P2*        .
                2                                        2

The quantities sold at the single price to the two groups are:

                   a  b c                    a  b c       2b   b  a c 
       Q1 = a               and Q2 =   b 
                                                          
                                                               2 1     2 
                                                                                
                                                                                  .
                  2 1    2                2 1    2                   

We can easily obtain the effect on the U.S. price of a change in the fraction of group 2

                                        P *       b        a  b          ba
consumers purchasing in Canada:              =                                      .
                                             2 1    2 1    2
                                                                         2 1   
                                                                                    2




                                               7
Result 1: A decrease in  (a rise in Canadian imports) increases the monopoly price in

the U.S. if b < a (if the market segment which is sensitive to the Canadian price has the

lower willingness to pay—and thus has more elastic demand at a uniform price).



       The parallel import cost could be linear with a uniform distribution of these costs.

That is, consumers would import the drug if P* > PC + t, where t is uniformly distributed

among group 2 consumers and PC is the Canadian price. If drug producers were to take 

as given (even though they are monopolists in their product, the import decision depends

on the aggregate prices of a large bundle of drugs in the US and Canada), one can derive

(P*, PC, F(t)) and solve for similar comparative statics with respect to PC and F(t). In

the next section, I examine a model where each producer takes account of the effect of its

own price on the level of reimportation.


3. A more sophisticated model

       Initially, take the Canadian price (denoted by PC) as given. Holding the Canadian

price fixed is intended to reflect the fact that drug prices in Canada are set by an

administrative procedure (Anis and Wen, 1998). As before, there are two groups of U.S.

consumers. Group 1 has no ability to buy drugs in Canada; the consumers have a

uniform distribution of reservation prices (denoted by r) from 0 to a, and there are N1 of

                                                                    aP
this type. Thus, let demand from group 1 consumers be D1 = N1           , where P is the
                                                                     a

US price.

       There are N2 consumers in group 2, and they are defined by two characteristics:

                                                                        t
their reservation price and their cost of importing from Canada. Let      denote a
                                                                        α


                                              8
consumer’s cost of importing, where t is uniformly distributed from 0 to . The

parameter  allows us to examine shifts in the distribution of transport costs. The

reservation prices are distributed uniformly from 0 to b, and reservation prices are

independent of import costs. If distance from the Canadian border is the primary

influence on importation costs (as when consumers must travel to Canada for purchase),

independence of willingness to pay and importation cost seems reasonable.

        Let PC denote the Canadian price. Group 2 consumers purchase in the U.S. if r 

P and t  α(P  PC ) , that is, if their reservation price is high enough and their transport

cost is high enough that the U.S. price is lower than the Canadian price plus transport

                                                          t
costs. Group 2 consumers buy in Canada if r  PC +          and t < α(P  PC ) ; the delivered
                                                          α

price from Canada is lower than both their reservation price and the U.S. price. See

Figure 1 for a graph of these regions in (r, ) space. Write these two demand functions as

 U       b  P   θ  α  P  PC  
D2 =N 2                            for purchases in the U.S. and
         b              θ         

          b  PC  b  P  α  P  PC 
D C =N 2 
  2                                     for purchases in Canada. In the absence of parallel
                2b             θ

imports, the discriminating prices in the US would be:

               ac                                       bc
        P* 
         1                      and              P2*        ,
                2                                         2

and the nondiscriminating monopoly price is a weighted sum of these two:

                                              N1                 N2
               ac            bc
        P*        1        where     a    and 1      b    .
                2              2            N1 N 2
                                              
                                                               N1 N 2
                                                                 
                                            a    b             a    b




                                                9
           Let c denote marginal cost. Then profits as the sum of profits from each type of

demand equals:

                        ˆ          U
                        Π = Π1 + Π 2 + Π C
                                         2



                               N1
where                   1        a  P  P  c  ,
                               a


                                    b  P      P  PC    P  c  ,
                                N2
                        U 
                                b
                         2



                               N2
and                     C          P  PC  b  PC  b  P  PC  c  .
                               2b
                         2



           To find the profit-maximizing price (assuming no ability to discriminate within

the US), taking as given the Canadian price (set using a reference price system),

              ˆ
differentiate Π with respect to P:

       ˆ
      Π N1
           a  c  2P 
      P a

            
                N2
                b
                    
                     P  c      P  PC     b  P      P  PC      b  P  P  c   
                N 2
            
                2b
                      2b  P  PC  PC  c    P  PC  PC  c 

          N1
      =       a  c  2P 
          a

      
          N2
          2b
                
              2  b  c  2 P      P  PC    2  b  P  P  c   2  b  P  PC  c    

      =
          N1
          a
                             N
              a  c  2P   2
                             b
                                         b  c  2P      P  P      b  P  P  P  .
                                                                        C                      C



           Assume throughout that parameter values are such that there is not a corner

solution where only group 1 consumers buy in the U.S. To proceed, consider the




                                                            10
comparative statics questions of what happens as the Canadian price or the distribution of

transport costs shifts. Totally differentiate the FOC to obtain:

                   ˆ
                 2
         dP    PP
              2 C .
         dPC     ˆ
                P 2

           ˆ
         2                        dP                           ˆ
                                                               2
Since         0 from maximization,     has the same sign as       . Furthermore,
        P 2                        dPC                      PPC

             ˆ
           2                                          N2
                2   b  c  2 P     b  P  =
                N
                                                             2b  c  3P  .
         PPC b                                       b

                              ˆ
                   2b  c  2 
Result 2: If P          ,        0 . A decline in the Canadian price (perhaps as the
                     3     PPC

result of tougher negotiation by the Canadian single payer) will cause an increase in the

American price.



                       bc                                2b  c b  c
        Clearly, P        in the absence of imports, but             , so this condition
                        2                                   3      2

                                                                        2b  c
may or may not hold. One can also compare the threshold value                  to the no-
                                                                          3

arbitrage monopoly price (which is the U.S> price if a = 0). The threshold value is less

                                 2b  c    ac            bc
than the no-arbitrage price if                1        or
                                   3        2              2 

       3         1
b          a        c (which is a convex combination of a and c). For higher values of
     1  3    1  3

 , b a , and b c , the threshold value lies below the no-arbitrage price, thus making it




                                                11
easier to satisfy the condition that P exceeds the threshold value. When this holds true,

dP                         dP
    0 at   0 , and thus      0 for higher values of .
d                         dPC

                         ˆ
                       2
         Consider          , where an increase in  corresponds to a decline in transport cost
                     P

for all group 2 consumers. I find that:

             ˆ
           2
                2   b  c  2 P  ( P  PC )  (b  P)( P  PC )
                N
         P b

              N 2 ( P  PC )                                                               ˆ
                                                                                          2
         =                     2b  c  3P  , which always takes the opposite sign of       .
                    b                                                                  PPC

Result 3. More consumers buying in Canada (either because the Canadian price or the

distribution of import costs falls) moves the domestic price in the same direction. That is,

dP       dP
     0    0.
dPC      d



         There are a few interesting bounds on the US price to look at for particular values

of the Canadian price, PC. These boundary results indicate some of the incentives for the

producer and help with some intuition. First, if the Canadian price equals marginal cost

(an extreme assumption), then:

          ˆ
         Π N1
              a  c  2P 
         P a

                                 P  c    b  c  2 P     b  P  P  c   .
                          N2
                      
                          b                                                           

                  a  c               b  c 
At P  P*                   1                 (the nondiscriminatory monopoly price in the
                     2                      2
U.S.),



                                                         12
        ˆ
                                1 
                                             P  c    b  a     b  P  P  c   
    1
            1    a  b                                                                 
N1 N 2 P 
                                                                                            
a   b

           1                                        
                      P  c    b  a    b  P  
                                                        
                                                         

           1   
                                b  c 3  a  b   
                                                       
                      P  c                      0 .
         
                                 2        2       

                  ac            bc
Thus, at P           1        (the monopoly price when no US consumers buy in
                   2              2

            ˆ
           Π
Canada),       0 , and the arbitrage possibilities reduce the price in the U.S. For a
           P

Canadian price this low, the monopolist wants type 2 consumers to purchase in the U.S.

                  bc
        If PC        (the type 2 monopoly price),
                   2

 ˆ
Π N1                 N              b  c                                    b  c 
     a  c  2 P   2      P          b  c  2P     b  P   P         .
P a                  b               2                                        2 

At P = P*, then

         ˆ
        Π N1                   N  b  a 
            1    a  b   2            4    b  c  3  a  b    , and
        P a                     b   4                                       


            1   ˆ
                                                                b  c  3  a  b   
                    1    a  b   1      b  a  1                          .
        N1 N 2 P
                                                              
                                                                           4              
                                                                                            
        a   b

                                             ˆ
                                            Π
        Thus, if b  c  3  a  b  ,         0 at P*, and Canadian import pressures result in
                                            P

the U.S. price exceeding the monopoly price in the absence of arbitrage. Since

b  c  a  b must hold for both types to buy at the monopoly price, the full requirement is

that a  b  b  c  3  a  b  . In this case, the Canadian price is high enough that losing



                                                        13
sales to Canada helps the monopolist to price discriminate between type 1 and type 2

consumers.


4. Endogenizing the Canadian price

       I have focused on the feedback effects of changes in the Canadian price on the US

market, while viewing the Canadian price as being determined in an administrative

process. Pecorino [2002] has studied a Nash bargaining process for the Canadian price

and how that changes with the development of a parallel import market. It is worth

examining how the monopolist would want to change the Canadian price with the

development of parallel imports, assuming that the monopolist has this discretion. (This

analysis may be more relevant for imports from developing countries—such as Mexico—

where the monopoly price may be significantly lower than in the US. It seems hard to

explain the US-Canadian price differential by differences between US and Canadian

consumer incomes and preferences—the administered price system is what drives the

price difference.)

       Let    1  U   C   C ( PC )    P, PC    C ( PC ) denote total profits in the
                       2     2
                                              ˆ

                                                      d C
two markets. In the absence of parallel imports,            0 determines the Canadian
                                                      dPC

                                                   U  C d  C
price. With parallel imports, the FOC changes to:        2
                                                                2
                                                                         0 (since
                                                  PC   PC   PC    dPC

1                                  U  N 2
     0 ). First, simplify to obtain   2
                                               b  P  P  c   0 and
PC                                  PC   b

         C  N 2
        PC
           2
             
               2b
                    2b  PC  P  P  c  2 PC    P  PC  PC  c 



                                                14
                        N2
                   
                       2b
                            3PC2  4bPC  P 2  2bP  2cPC  2bc .

        U  C  N 2
Thus,     2
        PC
            
              PC
                 2
                   
                     2b
                         3PC2  4bPC  3P 2  2cP  2cPc  4bP .

The term in braces can be written as:  P  PC   3P  3PC  4b  2c  .

        Since b  P  c , this expression is positive for PC near c, so that parallel imports

                                                                     bc
may put upward pressure on the Canadian price. If PC =                   (the group 2 monopoly
                                                                      2

                                                  5b  c
price), this expression is positive for P               (and this may or may not hold).
                                                    6

Depending on the precise method for determining the Canadian price, Canadian

consumers (and health insurance programs) may be worse off with an increase in parallel

imports. This also indicates that manufacturers may become willing to restrict sales in

Canada to avert parallel imports by the methods discussed in Kyle, Allsbrook, and

Schulman [2008].


5. Effects on profits

        It is also of interest to examine the effect of a change in the cost of arbitrage on

profits in the US. From   P, PC   1  U   C , use the envelope theorem to obtain:
                        ˆ
                                            2     2



           ˆ   ˆ
         d   dP  ˆ    N2
                             b  P  P  c 
         dPC P dPC PC    b

              N2
         
             2b
                    b  PC  b  P  PC  c    P  PC  PC  c    P  PC  b  PC  b  P 

              N2
        =
             2b
                  3PC2  4bPC  3P 2  2cP  2cPc  4bP .
The ambiguities in this expression were discussed above.


                                                     15
        The effect of a change in the cost of arbitrage is:

          ˆ   ˆ    ˆ
        d   dP     N
                     2  b  P  P  PC  P  c 
        d P d      b

                     N2
                         P  PC  b  PC  b  P  PC  c  .
                     2b

An increase in  corresponds to easier arbitrage—for the same cost difference, there will

be more parallel imports.

         N 2  P  PC 
         ˆ
        
           
                2b
                          2  b  P  P  c    b  PC  b  P  PC  c  .

If c = 0, the expression in braces equals 2  b  P  P   2b  PC  P  PC . This takes on its

                                                   2b  P
maximum value with respect to PC at PC                   , and
                                                     2

                                                1
        2  b  P  P   2b  PC  P  PC 
                                                4
                                                  8bP  8P 2  4b2  4bP  P 2 
            1
        
            4
              9 P 2  12bP  4b2   1  3P  2b 2  0 at that value for PC.
                                      4

                                                                     ˆ
                                                                    
Result 4: There is a range of values for PC and c such that             0 , and thus it is
                                                                    

possible that making arbitrage easier would increase profits from US consumers.



        American manufacturers have opposed allowing consumers to import patented

drugs from Canada and have threatened to impose restrictions on Canadian wholesalers

who export.6 If American manufacturers oppose allowing imports, presumably they do

not think that reimportation would increase their profits. In order for easier arbitrage to


6
  See, for example, Baker’s [2004] discussion of ways in which manufacturers might
attempt to minimize the quantities of reimported drugs.


                                                    16
raise manufacturer profits, the Canadian price needs to be sufficiently high. For low

Canadian prices, manufacturers lose from easier arbitrage. The opposition to imports

from manufacturers is consistent with current Canadian prices being so low that imports

reduce profits. However, the U.S. price could still increase if arbitrage becomes easier—

the conditions for that result are less restrictive.


6. Conclusions and further work

        The difference between groups in demands and their abilities to reimport drugs

from Canada lead to different predictions about the effects on drug prices in the U.S. if

reimportation becomes easier. This contrasts with much of the policy discussion which

assumes that reimportation would lower prices (at least weakly) for all U.S. consumers.

Drug manufacturers’ objections to reimportation support a prediction that profits would

fall, but profits could fall whether the U.S. prices rise or fall. The evidence from the EU

on easing parallel imports has not been strong (Kyle, Allsbrook, and Schulman [2008]).

This may reflect manufacturers’ success in frustrating attempts to parallel import. It is

important to recognize that there are many institutional differences in drug retailing

between the U.S. and many EU countries.

        There are a number of qualifications to these results, even in this stripped-down

model. First, unlike some other instances of parallel importing, the domestic

manufacturers of prescription drugs may have considerable opportunity to price

discriminate within the domestic market. Whether they can discriminate between the two

groups in this model (which are distinguished by low or high reimportation costs) is less

clear. The high importation cost group includes many consumers with insurance

coverage for prescription drugs. The low-demand group may correspond to consumers


                                               17
with no prescription drug coverage—they may have the least bargaining power and not

be in a position to benefit from discriminatory prices.

       Currently, consumers covered by the Medicare prescription drug plan cannot gain

from bargaining for favorable prices. Some insured consumers obtain prescriptions

through pharmacy benefit managers (McGahan [1994]) who do negotiate prices with

manufacturers. Many other insured consumers do not benefit from reduced wholesale

prices because of a lack of bargaining (Ellison and Snyder [2010]). If groups of insured

consumers benefit from price discrimination, one can view my model as describing the

residual market of consumers who do not buy at negotiated prices. If threats of Canadian

imports permit groups of insured consumers to negotiate lower prices, this model could

accommodate that by letting the sizes of the two groups buying at the standard US price

adjust as reimportation became easier.

       One must consider that this does not appear to be a typical environment with price

discrimination in which a group with lower willingness to pay and more elastic demand

obtains a lower price than another group. The consumers who obtain reduced prices for

prescription drugs are those who enroll in insurance programs that can do a better job of

keeping physicians adhering to formularies. If consumers in this group could import

drugs from Canada as only individual purchasers (in contrast to through their health

plans), reimportation possibilities and the US-Canadian price differential seem unrelated

to the prices these groups can negotiate.




                                             18
                                      References
Anderson, S., and V. Ginsburgh, Price discrimination with costly consumer arbitrage,
      Review of International Economics 7: 126-139 (1999).

Anis, A., and Q. Wen, Price regulation of pharmaceuticals in Canada, Journal of Health
       Economics 17: 21-28 (1998)

Baker, C. , Would prescription drug importation reduce U.S. drug spending,
       Congressional Budget Office Economic and Budget Issue Brief,
       http://www.cbo.gov/ftpdocs/54xx/doc5406/04-29-PrescriptionDrugs.pdf (2004)

Chen, Y., and K. Maskus, Parallel imports in a model of vertical distribution: Theory,
       evidence, and policy, Pacific Economic Review 7: 319-334 (2002)

Danzon, P., and L.-W. Chao, Cross-national price differences for pharmaceuticals: How
      large, and why?, Journal of Health Economics 19: 159-195 (2000)

Ellison, S., and C. Snyder, Countervailing Power in Wholesale Pharmaceuticals, Journal
        of Industrial Economics 58: 32-53 (2010)

Kyle, M., Strategic Responses to Parallel Trade, The B.E. Journal of Economic
       Analysis & Policy: Vol. 11: Iss. 2 (Advances), Article 2. Available at:
       http://www.bepress.com/bejeap/vol11/iss2/art2 (2011)

Kyle, M., J. Allsbrook, and K. Schulman, Does Reimportation Reduce Price
       Differences for Prescription Drugs? Lessons from the European Union, Health
       Services Research 43: 1308-1324 (2008)

Malueg, D. and M. Schwartz, Parallel imports, demand dispersion, and international
      price discrimination, Journal of International Economics 37: 167-195 (1994)

Maskus, K., and Y. Chen, Vertical price control and parallel imports: Theory and
      Evidence, Review of International Economics 12: 551-570 (2004)

McClellan, M. Speech before 1st International Colloquium on Generic Medicine, U.S.
      FDA, http://www.fda.gov/NewsEvents/Speeches/ucm053614.htm (2003)

McGahan, A. Focus on Pharmaceuticals: Industry Structure and Competitive
     Advantage, Harvard Business Review, pp. 115-124, Nov-Dec (1994)

Pecorino, P., Should the U.S. allow prescription drug reimports from Canada?, Journal of
       Health Economics 21: 699-708 (2002)
                               Mail-Order Prices for Selected Prescription Drugs
                                        (See endnotes for data description and sources.)

Product         # of pills   Min CDN price   Max CDN price    Min USA price      Min USA/Max CDN      Min USA/Min CDN
 Dose                                                                                  (in percent)         (in percent)

Lipitor
10mg                  90            134.16          157.90             219.97                139.3                164.0
20mg                  90            163.34          208.90             306.00                146.5                187.3
40mg                  90            184.26          225.90             307.49                136.1                166.9
80mg                  90            235.02          252.90             310.97                123.0                132.3

Lexapro
10mg                  90            139.18          168.27             207.99                123.6                149.4
20mg                  90            169.74          192.78             213.69                110.8                125.9

Nexium
20mg                  90            203.57          269.26             403.37                149.8                198.1
40mg                  90            226.17          269.26             394.97                146.7                174.6

Singulair
4mg                   90              153           217.93             274.68                126.0                179.5
5mg                   90            164.98          217.93             270.00                123.9                163.7
10mg                  90            202.41          239.90             274.97                114.6                135.8

Plavix 75mg           90            237.86          299.89             363.49                121.2                152.8

Advair Diskus
100/50mcg             60                82          115.90             146.47                126.4                178.6
250/50mcg             60                97          134.90             166.99                123.8                172.2
500/50mcg             60            136.85          189.90             229.87                121.0                168.0

Effexor XR
37.5mg                90             91.12          104.31             257.97                247.3                283.1
75mg                  90             169.2          190.71             279.88                146.8                165.4
150mg                 90            176.59          206.91             310.20                149.9                175.7
Protonix
20mg            90     149.7   182.62   319.09   174.7   213.2
40mg            90     159.7   206.91   309.87   149.8   194.0

Lotrel
5mg/20mg        90    207.07   207.07   207.97   100.4   100.4
10mg/20mg       90    142.15   142.15   252.97   178.0   178.0

Allegra 60mg    180    91.58   152.70   254.09   166.4   277.5

Diovan
40mg            90    116.04   118.80   138.73   116.8   119.6
80mg            90    115.71   128.46   164.96   128.4   142.6
160mg           90    125.36   149.89   162.97   108.7   130.0
320mg           90    209.98   222.56   209.98    94.3   100.0

Wellbutrin XL
150mg           90     65.98   155.98   289.97   185.9   439.5
300mg           90    121.32   222.35   437.71   196.9   360.8

Celebrex
100mg           60      47.4    57.54   113.31   196.9   239.1
200mg           60     90.88    97.74   189.99   194.4   209.1

Zetia 10mg      90     174.6   206.91   249.69   120.7   143.0

Avandia
2mg             60     94.68   119.90   133.31   111.2   140.8
4mg             60      105    179.34   196.06   109.3   186.7
8mg             60     153.6   259.90   343.32   132.1   223.5

Viagra
25mg            10     96.25   168.68    99.99    59.3   103.9
50mg            10     117.5   168.68    99.99    59.3    85.1
100mg           10     122.5   169.10    99.99    59.1    81.6
                                        Figure 1



                θ




                                                                US
(transport
   cost)
                          no purchase
    t

        α(P − PC )




                                                       Canada



                0
                     PC                            P                 b

                                          r

                                 (reservation price)

				
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