NCPA - National Center for Policy Analysis

Unfortunate Effects of Medicaid in Pharmaceutical Spending

September 18, 2013

The generic drug market has typically been viewed at the wholesale level as a competitive market with price approaching marginal costs. However, the large presence of third party payers as final purchasers (e.g., Medicaid) may distort prices at the retail level relative to what a standard model of price competition would predict, say Abby Alpert, Mark Duggan and Judith K. Hellerstein, researchers with the National Bureau of Economic Research.

Alpert, Duggan and Hellerstein investigate how generic drug producers compete in the presence of the procurement rules of the Medicaid program.

  • Medicaid reimbursement to pharmacies is based on a benchmark price called the average wholesale price (AWP).
  • The AWP is reported by generic producers themselves, and until recently has been subject to essentially no independent verification.
  • As a result, generic producers have had an incentive to compete for pharmacy market share by reporting AWPs that exceed actual average wholesale prices, as this "spread" leads to larger pharmacy profits.

In 2000, after a federal government audit of actual wholesale prices of generic products, states were advised to reduce Medicaid reimbursement by as much as 95 percent for about 400 generic and off-patent drug products.

The findings of the paper indicate that pharmacies did respond to the perverse incentives of the Medicaid program by dispensing products with the highest AWPs. Overall, the Medicaid market share fell by about 45 percent for targeted drug products as a result of the policy.

Source: Abby Alpert, Mark Duggan and Judith K. Hellerstein, "Perverse Reverse Price Competition: Average Wholesale Prices and Medicaid Pharmaceutical Spending," National Bureau of Economic Research, August 2013.


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