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innovation the two indices show opposite trends, with the hedonic price increasing and the quality-adjusted index decreasing. This discrepancy may be due to the fact that the hedonic price index is less sensitive to “filling the spectrum” or “extending the range” types of innovation (Trajtenberg (1990)), which is the one that seems to occur during this period. In contrast, the vertical model shows an increase in the prices due to innovation of about 28% over the 13-year period. This model is an extreme case, where there are no unobserved shocks to preferences, and the patients are heterogeneous due to permanent components. The levels of the quality-adjusted logit, vertical and hedonic price indices demonstrate that the pricing strategies of pharmaceutical firms allow them to appropriate most of the extra welfare they generate from improved product attributes. For all the models the indices remain fairly constant over the period studied. All of the new drugs in our sample period are still under patent protection. Presumably consumers would capture more of the surplus once generic drugs enter the market.

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Overview of Colorectal Cancer

Colorectal cancer is a good health condition for studying the welfare effects of medical innovation because it is a common health condition, the majority of pa- tients today are treated with drugs that did not exist a decade ago, and treatment costs are rising rapidly. According to the National Cancer Institute, approxi- mately 112,000 patients will be diagnosed with colorectal cancer in the United States in 2007, and 52,000 will die from the disease. This places colorectal cancer as the fourth most common cancer based on number of new patients, after breast, prostate, and lung. It is estimated that people born today will have a 5.4 percent chance of being diagnosed with colorectal cancer over their lifetime. The disease is treatable, however; between 1996 and 2003, colorectal cancer patients had a 64 percent chance of surviving for five years. The probability a patient will survive for five years ranges from 93 percent for those diagnosed with Stage I cancer to

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