Essays on the Economics of Healthcare Innovation

This dissertation examines several economic elements associated with healthcare innovation and consists of three chapters. The first two chapters focus on the value of healthcare innovation while the third chapter discusses the pharmaceutical innovation process and the impacts of incentive mechanisms on innovation. In Chapter 1, I present a model for estimating the value of medical innovation. Contrary to traditional models that only estimate the value of a new treatment to individuals who fall sick ex-post, this model estimates the value of medical innovation from an ex-ante perspective, before susceptible individuals know whether or not they will fall sick. Any risk-averse individual who is susceptible to a disease in the future derives value from the existence of a treatment, because risk-averse individuals prefer to insure against uncertainty in future survival outcomes. The difference between ex-ante and ex-post value is the insurance value of medical innovation due to risk aversion. I show that the percentage of insurance value relative to total value is highest for rare diseases, where afflicted patient populations are small but vulnerable patient populations are large. I find that for very rare diseases, up to 64 percent of the value of a cure is ex-ante insurance value. In Chapter 2, I apply the model developed in Chapter 1 to cancer risk and survival data to calculate the full value of cures for cancer. Using a parameterized model and population-level estimates of disease risk for cancer from the National Cancer Institute SEER Database, I find that between 24 and 63 percent of the value of cancer-specific cures is ex-ante insurance value. Estimates vary by the prevalence and mortality risk of each cancer type. Since only sick individuals participate in pharmaceutical market transactions, but a treatment is valued by all susceptible individuals, there will tend to be under-provision of valuable innovation by the private market. The findings in Chapters 1 and 2 suggest that without external intervention, there will tend to be innovation shortages. Chapter 3 examines various elements of the innovation decision process for pharmaceuticals and discusses methods which can be used to correct these shortages. I discuss various factors that firms consider when deciding what types of drugs to develop, and the impacts of incentive and subsidies on healthcare innovation. I then discuss several key points about the economics of rare disease drug development, and examine the consequences of the Orphan Drug Act of 1983 on the development of drugs for rare and non-rare diseases