Monopoly pricing under a Medicaid-style most-favored-customer clause and its welfare implication

Peter Klibanoff*, Tapas Kundu

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review


To control Medicaid's expenditure on prescription drugs, 1990 legislation established a rebate program guaranteeing Medicaid a rebate on each unit purchased by Medicaid participants. The rebate is the difference between the minimum price and the average manufacturer price (minimum price rule) or a proportion of the average manufacturer price (average price rule). We characterize the optimal pricing strategy of a third-degree price discriminating monopolist under these rules. Under the minimum price rule, the minimum price gross of rebate always increases whereas prices gross of rebate in at least some of the markets always decrease. In contrast, under the average price rule, these prices may move in the same direction in all markets, with all increasing in some circumstances and all decreasing in others. We also examine the effects of such provisions on social welfare. We analyze a modified version of our minimum price rule model suitable for applications beyond Medicaid.

Original languageEnglish (US)
Article number77
JournalB.E. Journal of Economic Analysis and Policy
Issue number1
StatePublished - 2010


  • MFC
  • Medicaid
  • monopoly pricing
  • welfare

ASJC Scopus subject areas

  • Economics and Econometrics
  • Economics, Econometrics and Finance (miscellaneous)


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