Reference pricing with elastic demand for pharmaceuticals

In this paper, we re-examine the properties of two commonly adopted government reimbursement schemes for pharmaceuticals: reference pricing and fixed percentage reimbursement. We depart from the previous literature by assuming that the individual demand is price-sensitive and depends on the copayment rate (i.e., the part paid by each consumer). We obtain two novel results under reference pricing: first, as the copayment rate increases, so do pharmaceutical prices; second, this increase in pharmaceutical prices reduces social welfare. Whilst reference pricing does emerge as a preferable reimbursement scheme, demand elasticities and the copayment rate interact in complex ways. This leads (unexpectedly) to the possibility that a higher copayment rate (lower reimbursement rate) results in higher government expenditure.