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Friday, November 03, 2006

Microeconomics quiz of the week II

From the WSJ's ProfessorJournal.com:
"Wielding both carrots and sticks, a growing number of companies are trying harder to push generic drugs on their employees. At prices often 80% cheaper than those of brand-name medicines, generics have become a key tool for health insurers and employers trying to hold back soaring medical costs. There's hardly a health plan today that doesn't use higher copayments on branded drugs as a way to nudge employees toward less-expensive copycat versions. But as employees re-enroll in benefit plans this fall, many will encounter more-aggressive efforts to make generics the clear-cut choice."

The article points to the benefits of employers and insurers of directing employees to the choice of generic drugs. While generic drugs are required to be the exact chemical equivalent of their brand-name counterparts, consumers are choosing brand-name drugs over generics. Considering statins, health plans argue that more than 70% of patients' prescriptions could be filled with generics, only 31% actually were filled in the third quarter of this year. In response, some employers are requiring workers to pay the difference between the prices of the generic and brand-name drugs. Blue Cross and Blue Shield of Minnesota dropped copayments and has been offering free coverage of generics. The health insurer's claimed motivation: for each percentage point increase in the generic share of prescription drugs, drug costs have fallen by one percentage point.

QUESTIONS:
1.) When generics are available, should employers (which offer drug insurance) pay for only the generics, and then workers choose whether to purchase generics or brand-name drugs?

2.) If generics are chemically equivalent to brand-name drugs, why are consumers willing to pay greater prices to purchase brand-name drugs?

3.) Show mathematically the conditions under which increasing the coverage of generics results in lower costs to plan providers and employers. The price to the consumer of a generic drug is p_g and the price of brand-name drug is p_b. The price to an employer of a generic drug is t_g and the price of brand-name drug is t_b. Let q_g(p_g, p_b) denote the consumer's demand for the generic drug and q_b(p_g, p_b) denote the demand for a brand-name drug. The plan provider's objective is to choose p_g and p_b to minimize t_g* q_g(p_g, p_b) + t_b* q_b(p_g, p_b).
Article here (sub req'd)

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