|We consider a therapeutic market with potentially three pharmaceutical firms. Two
of the firms offer horizontally differentiated brand-name drugs. One of the brand-name
drugs is a new treatment under patent protection that will be introduced, if the profits are
sufficient to cover the entry costs. The other brand-name drug has already lost its patent
and faces competition from a third firm offering a generic version perceived to be of lower
quality. This model allows us to compare generic reference pricing (GRP), therapeutic
reference pricing (TRP), and no reference pricing (NRP). We show that competition is
strongest under TRP, resulting in the lowest drug prices (and medical expenditures).
However, TRP also provides the lowest profits to the patent-holding firm, making entry
of the new drug treatment least likely. Surprisingly, we find that GRP distorts drug
choices most, exposing patients to higher health risks.