THE ETHICAL PHARMACEUTICAL industry is an important one, not so much for its economic size as for the benefits that it delivers to users of its products. The industry has been transformed structurally since the 1940s from a producer of selected chemicals to a research-oriented sector that makes a major contribution to the technology of health care. I Its very success in generating a stream of new drugs with important therapeutic benefits has involved the industry in intense public policy debates over the financing of the cost of its research, the veracity of claims for its products, the prices charged for them (not to mention who pays those charges), and the socially optimal degree of patent protection. The policies and policy debates bearing on competition in the pharmaceutical industry revolve around two interrelated issues of welfare economics. The first is the trade-off between promoting innovative effort and securing competitive market outcomes. The research-oriented We would like to thank Joshua Angrist, Zvi Griliches, Andrea Shepard, and members of the National Bureau of Economic Research productivity group for helpful comments and discussion; numerous individuals in the industry who generously gave their time to provide us with background information; Denise Neumann for research assistance; and Ann Flack and Claudia Napolilli for their help in preparing this manuscript. Whinston thanks the National Science Foundation for financial support (SES-8921996). 1. Temin (1980, chaps. 1-4).
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