Estimating Competitive Effects in Firm Entry with Applications in the Generic Pharmaceutical Industry

Rising health care costs are of significant public concern. A sizable portion of these costs stems from the prescription drug industry, which accounted for 12% of US health care spending ($234 billion) in 2008. Price competition between generic pharmaceutical companies should, in theory, reduce costs, but insufficient market entry by generic firms may keep drug prices high. Thus, I seek to understand the factors that influence generic entry decisions; specifically, I examine how firms make entry decisions based on expectations of competitor entry. I demonstrate that a simple logistic regression fails to properly identify this competitive effect because entry decisions between players are simultaneously determined. Instead, I model entry as a static game of incomplete information. This results in a negative coefficient on competitor entry that lowers a firm’s equilibrium entry probability by 10% on average for each additional competitor. I apply the resulting structural model to predict the effect of a direct subsidy (or tax) on firm entry and show that firm entry is relatively inelastic to subsidies and taxes, compared to predictions from the logit model.