Antibiotic resistance, drug prices, and entry

Antibiotics lose power to kill microbes through excessive use, commonly known as antibiotic resistance, which is modeled by future cost increase from current use. The first best incorporates future cost externality due to current consumption. Resistance and consumer welfare deviate from first best in various market structures. Low prices under competition lead to high consumption and resistance. Competitive managed-care plans use rationing contracts, which partially internalize resistance cost externality by restricting use. A drug monopolist fully internalizes the externality, but sets a high price. We derive necessary and sufficient conditions for higher consumer surplus under monopoly than competition. Facing a potential entrant, an incumbent may consider entry deterrence and accommodation. To deter entry, the incumbent reduces current sales to lower future cost; this alleviates antibiotic resistance. Entry accommodation gives rise to two countervailing effects. First, incumbent and entrant will share the market. The incumbent has less incentive to internalize the cost effect, so raises production and exacerbates resistance. Second, the incumbent makes more profit when its future cost is low, so reduces production and mitigates resistance.