A Model of Generic Drug Shortages: Supply Disruptions, Demand Substitution, and Price Control

In recent years, the U.S. health care system has been plagued by shortages of generic sterile injectable drugs. The shortage problem arose suddenly within a short period of time, and remained persistent afterwards. To gain insights into what may have led to this situation, we develop a model that incorporates key characteristics of the generic drug manufacturing industry, including random supply disruptions, demand substitution across di¤erent brands, and regulatory control of prices. In our model, …rms competitively choose their production capacities anticipating future supply disruptions. These capacity choices in turn determine product availability. Our equilibrium analysis reveals a number of counterintuitive results. First, drug availability increases as productions become more prone to disruptions. Second, allowing temporary price increases during shortages may or may not increase drug availability, depending on how severe the shortage is. Based on these insights, we discuss how external factors may have interacted with …rm decisions to result in the current drug shortage situation.