Equilibrium Price Dispersion in Retail Markets for Prescription Drugs

This study seeks to establish the empirical importance of price dispersion due to costly consumer search by examining retail prices for prescription drugs. Posted prices in two geographically distinct markets are shown to vary considerably across pharmacies within the same market, even after one controls for variation due to pharmacy differences. Pharmacy heterogeneity accounts for at most one‐third of the observed price dispersion. The empirical analysis hinges on the observation that consumers’ incentives to price‐shop depend on characteristics of the drug therapy. Cross‐sectional patterns in price distributions across drugs are consistent with the predictions of a search model: prices for repeatedly purchased prescriptions (for which the expected benefits of search are highest) exhibit significant reductions in both dispersion and price‐cost margins.