Market Structure In the Healthcare Industry

1
Market Structure In the Healthcare Industry

• Professor Vivian Ho
• Health Economics
• Fall 2009

These notes draw from material in Santerre
Neun, Health Economics, Theories, Insights and
Industry Studies. Southwestern Cengate 2010
2
Outline

• Defining perfect competition
• The market structure continuum
• Monopoly
• Monopolistic competition
• Oligopoly
• The market for organs

3
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

4
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 of a
  product
• All firms in the same industry produce a
  homogeneous product
• A consumer can easily find substitutes for the
  product of any given firm

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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

6
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

7
Monopoly Model (cont.)

• What is the profit-maximizing price and quantity
  for a monopolist?
• Recall that all firms will maximize profits where
  MRMC
• We have already seen that the marginal cost curve
  for a firm depends on its production function and
  input prices
• What does the firms MR curve look like?

8
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

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Monopoly Model (cont.)
Dollars per unit
Demand
MR
Quantity
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Monopoly Model (cont.)

• We are now ready to find the profit-maximizing
  output for a monopolist
• The monopolist sets output at a level where MRMC
• 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

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Monopoly Model (cont.)
Dollars per unit
MC
P
Demand
MR
Q
Quantity
12
Monopoly Model (cont.)

• The monopolists 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

13
Monopoly Model (cont.)
Dollars per unit
MC
P
ATC
Profits
ATC
Demand
MR
Q
Quantity
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Contrast to Perfect Competition
Dollars per unit
Under perfect competition, the market equilibrium
would instead be where PMC
MC
ATC
PC
Demand
MR
QC
Quantity
The higher price and lower output in a
monopolized market is why economists claim that
competition is better for social welfare
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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

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Monopoly Model (cont.)

• Economies of scale
• If a monopoly is producing output at a level
  where long run average costs are declining, then
  new firms cannot compete on a cost basis
• A monopoly hospital in a small town may have
  substantial economies of scale if it can meet
  demand with only 40-50 beds
• Unless a new hospital could take away a
  substantial share of the existing hospitals
  patients, it could not match the existing
  hospital in costs (and therefore profits as well)

17
Monopoly Model (cont.)

• Legal restrictions
• Physicians require a license to practice medicine
• Many states require that providers obtain a
  Certificate of Need to offer a new service
• Drug companies obtain patents for new
  pharmaceutical products

18
The Market Structure Continuum

• We have talked about 2 extremes of the market
  structure continuum
• Perfect Competition
• Pure Monopoly
• Along this continuum, there are 2 more levels of
  competitiveness that we will encounter in the
  health care sector

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The Market Structure Continuum
Perfect Competition
Oligopoly
Monopoly
Monopolistic Competition
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Monopolistic Competition

• Many sellers
• Differentiated product
• No barriers to entry
• Examples
• Breakfast cereals
• Ibuprofen (Advil, Motrin, etc.)
• Cigarettes

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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

22
Monopolistic Competition (cont.)
Dollars per Unit
Demand under monopolistic competition
Demand under perfect competition
Output
2 potential demand curves for an individual firm
23
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

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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
  werent aware of
• Shift the D curve out

25
DTC Drug Advertising

• August 1997, FDA permitted brand-specific
  direct-to-consumer (DTC) advertising w/o brief
  summary of drug effectiveness, side effects, and
  contraindications
• DTC advertising rose from 800m in 1996 to 2.5b
  in 2000
• What were the consequences?
• (Iizuka Jin, 2003)

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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

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DTC Drug Advertising

• Classes of drugs w/ heavy advertising had large ?
  in prescribing

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DTC Drug Advertising

• Classes of drugs w/ less advertising had no ?in
  prescriptions

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DTC Drug Advertising

• IV column After deregulation, each 1 ? in DTC
  Ads raises of visits w/ a prescription by .0464

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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/.046421.55
• Does DTC advertising look profitable to drug
  companies?

31
Oligopoly

• Few, dominant sellers
• Homogeneous or differentiated product
• Substantial barriers to entry
• Examples
• Tertiary services at teaching hospitals
• Many prescription drugs

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Oligopoly

• 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

33
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)

34
Markets for Organs
35
Markets for Organs
36
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.

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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

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Pricing Risk of Death

• risk of death x Value of a statistical life
• Estimated 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

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Time Lost During Recovery

• Assume donor earns 35,000 / year
• Loses 4 weeks of work while in recovery
• 35,000 x 4 weeks gt 2,700

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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.

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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.

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Markets for Organs

• 13,500 kidney transplants in 2005,
• 8000 on waiting list
• gt excess demand 21,500
• Assume eD for organ transplants -1
• price 9.5 gt demand 9.5
• 9.5 x 21,500 2,043
• Demand 21,500 2043 19,457, but all would be
  supplied.
• Equilibrium transplants rise from 13,500 to
  19,457 44

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Excess Demand if Sales are Banned
Excess Demand
D
Q0 Transplants
44
Market for Organs
S

e
S
175,200
160,000
D
Q0 Q1 Transplants
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Markets for Organs

• Under a range of assumptions, allowing the sale
  of live donor organs substantially raises the
  of transplants.
• See Table 3, Becker.