Chapter 8

Competitive Markets

8.1   INTRODUCTION

Our focus shifts to models in which demanders and suppliers interact.  The setting in which this interaction occurs is called a market.  This term in economics denotes the web of interactions between those who have commercial relationships or the potential to have such relationships with other buyers and sellers of similar commodities.

The market analyses that we will examine consist of 3 categories of concepts.

·         Phenomena to be explained: these are objective events, such as changes in the price or the quantity of health care utilized.

·         Economic forces: degrees of willingness of demanders to purchase at specific prices and propensities of providers to supply at specific prices.  Referred to as demand and supply.

·         Factors influencing forces.  Strength of demand and supply can be increased or decreased by individual factors, such as incomes and tastes on demand side and input prices on supply side.

 

8.2   THE COMPETITIVE MODEL: ASSUMPTIONS

·         Individual Demand.  Consumers are fully informed about the nature of the services they require and the benefits they can obtain.  This implies that physicians cannot directly influence consumer demand for medical care.

·         Market Demand. Many consumers in market and they are competing for physician services.

·         Individual supply. Assuming supplier profit maximization and no supplier influence over price, then MC curve is the supply curve.

·         Market supply.  Many suppliers, do not collude with each other to influence prices, and none is large enough by itself to influence price.

 

8.3   THE COMPETITIVE MODEL: PREDICTIONS

8.3.1          Market price

8.3.2          Price and Quantity Movements caused by Demand Shifts

Demand shift can be caused by higher consumer incomes or a greater degree of illness in the population.  Or by an increase in amount of health insurance purchased.

If quantity utilized is to increase, additional quantity must be available.  Utilization refers to actual quantity traded in the market.

8.3.3          Price and Movements caused by Supply Shifts

Changes in supply can occur because of changes in circumstances that are beyond the control of supplying firms or because of changes that the present or potential suppliers themselves initiate.  (e.g., if price of paramedic services increases, this will shift the supply curve of all producers who use this input to the left.

3 types of situations in which provider initiates change in supply:

1.       Change in input combinations: e.g., physicians hire paramedics or nurse practitioners to perform, at a lower cost, services previously provided by physicians themselves.  →shift MC to right.  If all suppliers made the change, market supply would shift to right and price will fall → profit may not be greater than before.

2.       Increase in capital stock of existing suppliers.  Same result as in 1.

3.       New suppliers enter industry in response to high profits →Increase in supply → P decreases → Profits decrease for all existing suppliers.

 

8.3.4          Simultaneous demand and supply shifts

8.3.5          Shortages

Persistent shortages have been observed in blood market, market for nurses, physician services market, and in some countries, hospital market.  Slight modification of competition model allows us to explain why these shortages occur and how they can be eliminated.  In a competitive market, a shortage can only persist if price is somehow administered to remain below market-clearing price.

8.3.6          Surpluses

Surplus in hospital beds. High hospital reimbursement rates have induced a large quantity supplied; at given out-of-pocket prices, there has not been enough quantity demanded to clear the market.

8.3.7          Multimarket analyses

Model can be used to make predictions about effect of supply and/or demand changes in one market on price and quantity in a related market.  E.g. The demand function for inpatient care is dependent on the out-of-pocket price for outpatient surgery because the two are substitutes.

 

8.4    EVIDENCE FOR AND AGAINST THE COMPETITIVE MODEL

8.4.1 Overview

8.4.2 Excessive profits

Studies made of profits accruing from medical practice have shown these profits to be persistent and considerable.

8.4.3 Fee differences among patients

Before the spread of health insurance, physician pricing was characterized by a sliding scale of fees, with high-income patients paying higher prices than low-income patients.  This has led economists to reject the competitive model as inappropriate for physician services market and to substitute a monopoly model.

8.4.4 Quality of care

Product quality is a major element of a hospital’s output.  When a supplier can vary its quality, it can attract consumers on the basis of its quality.  It follows that some “brand loyalty” may ensue, and buyers will not switch brands easily.  This phenomenon is called product differentiation, and it implies that each supplier then faces a downward-sloping demand curve, not a horizontal one (as is the case in perfect competition), and can choose to compete with other providers on the basis of price or product quality.

8.4.5 Restricting competitive behavior

Advertising bans have been enforced by state medical societies, and although such bans are no longer legally enforceable, their existence in the past was evidence that physicians were able to intervene in the market on behalf of themselves and eliminate some degree of competition in the market.

8.4.6 Consumer Ignorance and Supplier-Induced Demand

 

8.5   COMPETITIVE BIDDING

Occurs when a purchaser (e.g., a government agency) requests bids from alternative competing providers and allocates the right to treat patients based on the bids.  Object is to have patients treated for least cost.  Bidder faces 2 possible outcomes: (1) bid is accepted, or (2) bid is rejected.   Table 8-1, p. 189.

Assume that wealth, for the bidder, has diminishing MU (col. 6 of Table 8-1).  Bidder will choose option that maximizes his or her expected utility measured as the product of probability of success (PS) and utility associated with wealth level of that option.  For the risk averse bidder, pick option E, which yields E (U) = 90 [= .9 × 100]

E(A) = .2 (126) = 25.2

E(B) = .4(122) = 48.8

E (C) = .6(118) = 70.8

E(D) = .8 (110) = 88

E(E) = .9 (100) = 90

 

For risk taker: increasing MU

E(A) = .2(2000) = 400       Pick option A

E(B) = .4(800) = 320

E (C) = .6(400) = 240

E (D) = .8 (200) = 160

E (E) = .9(100) = 90