Going through the roof: On prices for drugs sold through insurance

Abstract

This paper studies public concern grounds for high prices of drugs treating rare and debilitating diseases. We offer a theory that explains how drug indivisibility, individual budget constraints, and insurance interact to drive up drug prices, especially for drugs treating rare and severe diseases. For a broad range of drug production costs and income distributions, our model predicts that drug prices are either set at their highest levels covered by insurance or inversely related to the prevalence of the disease. In the latter case, producer profits decrease with prevalence. The effect of production costs on prices and profits is non-monotonic.