Dynamic Competition and Price Regulation when Consumers Have Inertia: Evidence from Medicare Part D

Sebastian Fleitas (KU Leuven)


When consumer choices have inertia, firms have incentives to use dynamic pricing by first
reducing the price to build a large market share, and then by increasing prices. This strategy may
reduce consumer welfare through increases in the prices for incumbents, while also changing the
patterns of entry and exit in the market. Although the presence of inertia in health care markets
has been well established, little is known about the welfare implications of dynamic pricing in
these markets. In order to assess these implications, in this paper I develop and estimate a
dynamic model of supply and demand for Medicare Part D prescription drug insurance plans,
where multi-product firms consider consumer inertia in their decisions about premiums, offerings
of new plans, and exit of plans. Using the model and the estimated parameters, I conduct
counterfactual exercises where I explore the welfare effects of a policy that limits dynamic pricing
by imposing fixed markups. I find that this policy, given the actual consumer inertia present in
this market, would improve consumer welfare by 3.1%, through a reduction in premiums that is
partially off-set by a reduction of entry into the market. When the same policy is implemented
in a counterfactual scenario without inertia, it has a larger positive effect, increasing consumer
welfare by 9.4% relative to the benchmark. This dierence indicates that policies that limit
dynamic pricing can be more effective in improving consumer welfare in markets with lower
levels of consumer inertia, where they are less likely to harm market entry.