OHE Authors Develop a Supply and Demand Model of Pharmaceutical Markets to Set Cost-Effectiveness Thresholds to Maximise and Distribute Social Welfare

Article by: Mikel Berdud and Adrian Towse

OHE authors developa supply and demand model of pharmaceutical markets to analyse the social welfaredistribution between consumers (payers) and developers (industry) to set an optimal cost-

effectiveness threshold

OHE authors develop a supply and demand model of pharmaceutical markets to analyse the relationship between cost-effectiveness threshold (CET) and the distribution of the social welfare between consumers (payers) and developers (industry). Economic analysis that does not capture payers’ bargaining power and sunk R&D expenditure may lead to some new and cost-effective technologies being denied access.

In many healthcare systems around the world, medicines reimbursement decisions are based on health technology assessments (HTA) applying cost-effectiveness criteria. Some HTA bodies use a CET as a rule for such decisions. A recent OHE report opens the debate around current approaches to defining and estimating CETs, highlighting that using the ‘wrong’ threshold value can lead to inefficient resource allocation, ultimately reducing future innovation.

The role of CET is becoming more prominent as it is used not only as a resource allocation guide, but to regulate price. In Canada, for example, the Patented Medicines Prices Review Board (PMPRB) is establishing nationwide guidelines, whereby the maximum (rebated) price of patented medicines, with sales or treatment costs above a certain amount, will be set using factors including incremental QALYs, valued using a CET of CA$60,000 per QALY gained. Draft guidelines are expected to be published for consultation in the week of 15th June 2020. 

The new model, presented in a forthcoming OHE paper (Berdud, Ferraro and Towse, 2020), builds on Pandey, Paulden and McCabe (2018), which has been discussed by the PMPRB Working Group. Pandey and colleagues assume that

  • developers have all the bargaining power, so set prices equating their Incremental Cost Effectiveness Ratios (ICERs) to the CET;
  • developers do not supply at a loss, although R&D costs do not always feature in their model; and
  • suppliers reserve ICERs are uniformly distributed along the value of the threshold, so for given increases in the size of the threshold value an equal number of additional developers will be willing to enter the market.

As a result of these assumptions, the authors argue that an efficient CET for the payer is below the CET based on the opportunity cost in the health system (or supply-side CET). The OHE authors’ general framework brings together a bargaining process with elements of the demand and supply side of the pharmaceutical markets. The key result is that, if plausible conditions hold, the optimal value of CET that maximises the social welfare (measured as the sum of consumer and developer surpluses) can be higher than the supply-side CET. Maximising social welfare – or alternatively, implementing allocations that distribute the social welfare more equally but efficiently – implies a CET set at a value that reconciles incentives for developers to keep investing in future medical innovations with the maximum possible patient access to currently available innovations. Maximising consumer (payer) surplus though, focuses only on maximising access in the present (static efficiency), at the risk of reducing the amount of future medical innovation to a suboptimal level (dynamic inefficiency).

The authors explain that the new structure is relevant because:

  1. as single monopsonist buyers, also empowered to design market policy and regulation, payers/purchasers have a significant degree of bargaining power. Governments can apply budget caps and other forms of cost-containment measures, and competition among medicines might arise. Both drive medicines prices down, ex-post, when prices are set according to the accepted CET. The model considers a bargaining stage to explain market pricing behaviour based on the Nash Bargaining Solution (Binmore, Rubinstein and Wolinsky, 1986; Grennan, 2013; Jelovac, 2015). It shows that an efficient threshold value, which distributes social welfare evenly between consumers and developers, could be higher than the supply-side CET with sufficiently large payer bargaining power.
  2. the incorporation of developers’ R&D cost shows which values of the CET should be considered to be dynamically efficient, i.e. that reward long term investments in innovation. The optimal CET may be higher than the one that maximises short-term health gain and net population benefit. In such cases, some short-term population benefit should be traded off via a higher CET to get more long-term population benefit from an optimal level of long term pharmaceutical R&D investment.
  3. the distribution of market entrants in response to the value of the CET shapes the market supply curve and therefore has an impact on socially optimal and dynamically efficient thresholds. If developers’ reserve ICERs (the minimum ICER at which they are willing to accept a price and sell the medicine) concentrate around a certain level of the CET, the optimal value of the threshold will be close to that value.  Lower CET values would be inefficient as many cost-effective medicines will be denied access. Moreover, knowing the actual distribution of developers’ reserve ICERs from a payer perspective is technically challenging and legally sensitive as it would involve companies disclosing cost information to their competitors.

To conclude, under the three conditions discussed above, applying a supply-side CET to determine maximum reimbursable price may result in suboptimal solutions, where new and cost-effective technologies could be denied access in the long-term. This could reduce society’s benefit in the short-run (patients not having access to valuable interventions and developers’ making a loss) and in the long-run (investment in R&D being reduced). Pharmaceutical price regulation should be informed by a clear understanding of pharmaceutical market structure, and of the procurement and contracting environment. On the demand side, factors including budget caps and other forms of cost-containment measures, and on the supply side, factors including the optimal level of R&D investment required for long-run dynamic efficiency and the distribution of reserve ICERs that shapes the industry’s supply curve, should be considered.

For more information, please contact: Mikel Berdud

Acknowledgement of Funding

This study was commissioned and funded by Hoffmann La Roche. 


Berdud M., Ferraro J., Towse A. A theory on ICER pricing and optimal level of cost-effectiveness threshold: a bargaining approach. OHE Consulting Report, London: Office of Health Economics. 

Pandey, H., Paulden, M., McCabe, C. (2018). Theoretical models of the cost-effectiveness threshold, value assessment, and health care system sustainability. Institute of Health Economics. Available at https://www.ihe.ca/publications/theoretical-models-of-the-cost-effectiveness-threshold-value-assessment-and-health-care-system-sustainability

Binmore, K., Rubinstein, A., & Wolinsky, A. (1986). The Nash bargaining solution in economic modelling. The RAND Journal of Economics, 176-188.

Jelovac, I. (2015). On the relationship between the negotiated price of pharmaceuticals and the patients’ co-payment. Economics Bull 2015, 35, 481-93.

Grennan, M. (2013). Price discrimination and bargaining: Empirical evidence from medical devices. American Economic Review, 103(1), 145-77.

Berdud, M., Wallin-Bernhardsson, N., Zamora, B., Lindgren, P., and Towse, A (2019). The Case of Risperidone: Assessing the Life-cycle Value of Second-Generation Antipsychotics in Sweden and the UK. OHE Research Paper. Available at https://www.ohe.org/publications/case-risperidone-assessing-life-cycle-value-second-generation-antipsychotics-sweden-and


Related Research

Cubi-Molla, P., Errea, M., Zhang, K. and Garau, M., 2020. Are cost-effectiveness thresholds fit for purpose for real-world decision making? OHE Consulting Report. London: Office of Health Economics.

Hernandez-Villafuerte, K., Zamora, B., Parkin, D., Devlin, N. and Towse, A., 2019. Exploring variations in the opportunity cost cost-effectiveness threshold by clinical area: Results from a feasibility study in England. OHE Research Paper 18/07.

Hernandez-Villafuerte, K., Zamora, B. and Towse, A., 2018. Issues Surrounding the Estimation of the Opportunity Cost of Adopting a New Health Care Technology: Areas for Further Research. OHE Research Paper 18/07.

Berdud, M., Wallin-Bernhardsson, N., Zamora, B., Lindgren, P., and Towse, A (2019). The Case of Risperidone: Assessing the Life-cycle Value of Second-Generation Antipsychotics in Sweden and the UK. OHE Research Paper. OHE Research Report. London: Office of Health Economics


Posted in Drug Development/R&D, Innovation, Value-Based Pricing | Tagged Consulting Reports