Market size in innovation: Theory and evidence from the pharmaceutical industry

This white paper by MIT develops a simple model linking innovation to potential market size, and shows that under a variety of circumstances, a greater market size for a particular product, which implies greater profitability from sales, spurs faster innovation for the product. The paper provides evidence from the pharmaceutical industry by looking at changes in the potential market size for various drug categories driven by U.S. demographic changes. The theoretical analysis suggests that delays in the development and approval processes are unlikely to create delays in the entry of new drugs in response to changes in market size, but there is room for new drugs to enter before the actual increase in market size because of anticipation effects.

Finally, this white paper suggests that future research, in the response of innovation in a specific industry and by comparing variations in market size across different industries, is necessary to substantiate the importance of market size and profit incentives on innovation.

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