Income Elasticity Decomposition Models and Determinants of U.S. Pharmaceutical Expenditures

Abstract

Prescription drugs are the third largest component of U.S. healthcare spending, and quickly growing. This novel study provides greater information on consumer behavior in the market for prescription drugs, and how that behavior may vary due to fluctuating economic conditions, using an annual panel dataset. Specifically, the research presented applied the income elasticity decomposition methodology to prescription drug expenditures, deriving both its quality and quantity components. Per capita gross domestic product and median home values were used interchangeably to test whether alternative income concepts affect income elasticity estimates. The system generalized method of moments three-stage least squares estimation results revealed that the: (a) 0.647 short-run income elasticity comprises 0.453 and 0.194 in quantity and quality components; (b) long-run income elasticity estimate of 0.167 has 0.027 and 0.140 quantity and quality components. Pharmaceuticals were found to behave as a necessity and normal good with significant tendencies for long-run consumption shifts towards quality. Further illustrated are supply and demand-side impacts, with policy implications for Medicare and Medicaid programs, among others.