The Interaction between a Most-Favored-Customer Clause and Price Dispersion: An Empirical Examination of the Medicaid Rebate Rules of 1990

This paper examines the effect of the MFC rules adopted by Medicaid on both price dispersion and price levels in the wholesale pharmaceutical market. Theory suggests that the regulations should reduce price dispersion and increase the average price for those products with a high initial level of price dispersion. Using data which can only measure some dimensions of price discrimination, I find that discrimination falls for products sold to hospitals, but not drugstores. Branded drugs facing generic competition have the most dispersion "ex ante". Prices of these brands rise with dispersion at the implementation of the new rules. The last two results are consistent with Scott Morton (1997), where I look only at price changes due to the law. The results of this paper confirm that part of the mechanism of action for the price increase is the high level of price dispersion for some products combined with the MFC. Copyright (c) 1997 Massachusetts Institute of Technology.