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Expected Profits and the Scientific Novelty of Innovation (WP-20-16)

David Dranove, Craig Garthwaite, and Manuel Hermosilla

Innovation policy involves trading off monopoly output and pricing in the short run in exchange for incentives for firms to develop new products in the future. While existing research demonstrates that expected profits fuel R&D investments, little is known about the novelty of the projects funded by these investments. Relying on data that describe the scientific approaches used by a large sample of experimental drug projects, the researchers expand on this literature by examining the scientific novelty of pharmaceutical R&D investments following the creation of the Medicare Part D program. They find little evidence that the positive demand shock implied by this program prompted firms to undertake scientifically novel R&D activity, as measured by whether the specific scientific approach had been used before. However, they find some evidence that firms invested in products involving novel combinations of scientific approaches. These estimates can inform economists and policymakers assessing the tradeoffs associated with marginal changes in commercial returns from newly developed pharmaceutical products.

David Dranove, Walter J. McNerney Professor of Health Industry Management, Northwestern University

Craig Garthwaite, Associate Professor of Strategy and IPR Associate, Northwestern University

Manuel Hermosilla, Assistant Professor of Marketing, Johns Hopkins University

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