Lecture Health economics - Chapter 7: Market structure in the healthcare industry

Lecture Health economics - Chapter 7: Market structure in the healthcare industry. This chapter presents the following content: Defining perfect competition; the market structure continuum; monopoly, monopolistic competition, oligopoly, the market for organs.

Market Structure In the Healthcare

Industry

Professor Vivian HoHealth Economics

Fall 2009

These notes draw from material in Santerre & Neun, Health Economics, Theories, Insights and Industry Studies Southwestern Cengate 2010

Defining perfect competition

The market structure continuum

Characteristics of Perfect Competition

Consumers pay the full price of the

product

 Consumers will respond to differences in prices among sellers

All firms maximize profits

 Firms have incentives to satisfy consumer wants and produce efficiently

Characteristics of Perfect Competition (cont.)

There is a large number of buyers and

sellers, each of which is small relative to

the total market

 No one buyer or seller is powerful enough

to influence or manipulate the market price

Characteristics of Perfect Competition (cont.)

No barriers to entry or exit exist

 New firms can enter the industry

All economic agents possess perfect information

 Consumers and firms can make informed choices

All firms face nondecreasing average costs of production

 Rules out a “natural monopoly”

Monopoly Model

In contrast to perfect competition, a

monopoly market has the following

features:

 One seller

 Homogeneous or differentiated product

 Complete barriers to entry

Because there is only one firm, that firm faces the market demand curve, which

is downward sloping

Monopoly Model (cont.)

What is the profit-maximizing price and quantity for a monopolist?

 Recall that all firms will maximize profits where MR=MC

 We have already seen that the marginal cost curve for a firm depends on its

production function and input prices

 What does the firm’s MR curve look like?

Monopoly Model (cont.)

MR = P + Q • ( P/ Q)

Because the second term in this

formula represents a revenue loss, it is always negative

 Thus, at each level of output, marginal revenue is always lower than price

 The marginal revenue curve lies under the demand curve

Monopoly Model (cont.)

Monopoly Model (cont.)

We are now ready to find the

profit-maximizing output for a monopolist

The monopolist sets output at a level where MR=MC

 On a graph, find the level of Q where the

MR and MC curves intersect

To determine the price the monopolist will charge, locate the price on the

demand curve at this same output level

Monopoly Model (cont.)

Monopoly Model (cont.)

The monopolist’s level of profits can

then be determined by adding its

average total cost curve to the graph

Profits will be the difference between P* and ATC, multiplied by Q*

Monopoly Model (cont.)

Contrast to Perfect Competition

The higher price and lower output in a monopolized market is why

economists claim that competition is better for social welfare

Monopoly Model (cont.)

A monopoly only maintains its status if there are no substitutes for the product

it sells

 There must be barriers to entry, so that

other firms cannot enter the market to

compete

 The two most common barriers to entry:

Economies of scale

Legal restrictions

Monopoly Model (cont.)

can meet demand with only 40-50 beds

Unless a new hospital could take away a

substantial share of the existing hospital’s

patients, it could not match the existing hospital

in costs (and therefore profits as well)

Monopoly Model (cont.)

The Market Structure Continuum

We have talked about 2 extremes of the market structure continuum

The Market Structure Continuum

Perfect

Competition

Monopolistic Competition

Oligopoly

Monopoly

Monopolistic Competition (cont.)

Because products are differentiated across firms, each seller has some ability to control price

 Each seller faces a slightly downward sloping

demand curve

Sellers have an incentive to “differentiate”

their product from competitors

 Doing so is likely to raise demand for their product

Monopolistic Competition (cont.)

Output

Dollars

per Unit

Demand under perfect competition

Demand under monopolistic competition

2 potential demand curves for an

individual firm

Monopolistic Competition (cont.)

How do sellers differentiate their

product?

 Advertising

Is advertising bad for consumers?

 Creates imaginary or artificial wants

 Persuasive, not informative

 Business stealing, w/ no benefits to

consumer

 Habit buying is a barrier to entry

Monopolistic Competition (cont.)

Benefits of advertising

 May convey important info on value of a

good or service

People benefit from real diversity & choice

Cheap info to customers to distinguish b/w

products

 May promote quality competition

Firms willing to invest in creating a brand name reputation will work to keep it

 May inform the consumer of good or

service they weren’t aware of

Shift the D curve out

 What were the consequences?

(Iizuka & Jin, 2003)

DTC Drug Advertising

Iizuka & Jin track monthly expenditures

on DTC advertising for 1994-2000

They also track monthly visits to the

doctor in a recurring national survey for 1994-2000

 Survey indicates whether a drug was

prescribed during the visit, and for what

class

DTC Drug Advertising

Classes of drugs w/ heavy advertising had large ↑ in prescribing

DTC Drug Advertising

Classes of drugs w/ less advertising had no ↑in prescriptions

DTC Drug Advertising

IV column: After deregulation, each $1 ↑ in DTC Ads raises # of visits w/ a prescription

by 0464

DTC Drug Advertising

IV column: After deregulation, each $1 ↑ in DTC Ads raises # of visits w/ a prescription

by 0464

How much ad spending is needed to get

one extra prescription?

 1/.0464=$21.55

Does DTC advertising look profitable to

drug companies?

Few, dominant sellers

Homogeneous or differentiated productSubstantial barriers to entry

Examples

 Tertiary services at teaching hospitals

 Many prescription drugs

Because there are only a few dominant sellers, actions of any one firm can

change the overall market price

Like monopoly, oligopoly will lead to

lower output and higher prices than

would be observed under perfect

competition

 Regulators are concerned about consumer welfare in oligopolistic markets

Markets for Organs

Should we allow markets for organs for transplant surgery?

Payment to donors of organs is

currently forbidden in developed

countries

Yet there is persistent excess demand for organ transplants (Becker and Elias,

JEP 2007)

Markets for Organs

Markets for Organs

Markets for Organs

Estimate excess demand from the

growth in the waiting list in any year, plus # deaths for those on waiting list

 Excess demand in kidney market grew from 2,500 persons in 1991 to 7,000 in 2000.

The Price of an Organ

How much pay is required to induce an individual to sell an organ?

Compensate individual for:

- Risk of death

- Time lost during recovery

- Risk of reduced quality of life

Pricing Risk of Death

risk of death x Value of a statistical lifeEstimated range $1.5 - $10 m for

someone with a $35,000 average

annual income in 2005

Risk of death ~ 1%

e.g $5 m x 1% = $5,000

Time Lost During Recovery

Assume donor earns $35,000 / yearLoses 4 weeks of work while in

recovery

$35,000 x 4 weeks => $2,700

Risk of Quality of Life

No comprehensive data on how kidney donation affects QOL

Some studies suggest kidney donors can live normal lives, unless high

physical contact (e.g athletes)

But other studies find kidney donors at high risk of high blood pressure

Could arbitrarily assume $7,500

Market for Organs

Cost of Performing Kidney transplant surgery = $160K

– Risk of Death $5,000 – Time Lost in Recovery 2,700 – Risk of QOL 7,500

$15,200 Live donors raise total price 15,200 / 160,000 = 9.5%, but supply is perfectly elastic

Markets for Organs

Excess Demand if Sales are Banned

Market for Organs

Markets for Organs

Under a range of assumptions, allowing the sale of live donor organs

substantially raises the # of transplants.See Table 3, Becker