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to innovate. Conversely, if public and private payers believe technology is help- ing drive down quality-adjusted prices, they are likely to maintain or enhance incentives to innovate.

Berndt et al. (2000) highlight several empirical challenges of measuring a medi- cal price index. Due to health insurance, most consumers do not face the full price of medical care and will seek to consume beyond the point where the marginal value is equal to the full price. Patients also rely on physicians to provide in- formation regarding the value of medical goods and services. The implication is that consumer purchases in the medical market will not necessarily reveal their marginal valuation of a good or service. Perhaps the greatest empirical challenge for constructing meaningful price indexes in health care is how to account for the changing quality of medical products and services.

Due to these considerable empirical challenges, there have been few studies of whether medical prices are rising or falling once one takes into consideration the attributes of the new products and consumers’ valuations of those attributes. Cutler et al. (1998) show that the life expectancy of heart attack patients increased by eight months between 1984 and 1991. The value of per-patient expected longevity ($11,100) increased three times more than treatment costs ($3,600) during this time period in real terms, which implies that the quality-adjusted price index fell by about one percent annually. Berndt et al. (2002) conclude that the real cost of treating major depression decreased by about two percent per year between 1991 and 1996 once one takes into account the probability that a patient’s depression goes into remission.

The pharmaceutical industry is the source of considerable innovation in medi- cal care. The pharmaceutical industry invests over $30 billion per year in research and development, which represents about 16 percent of the industry’s revenue. Most new pharmaceuticals are priced higher than the treatment methods they replace, and this has certainly been the case with colorectal cancer drugs. The average price of providing a colorectal cancer patient with a 24-week chemother-


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