Market%20Structure%20In%20the%20Healthcare%20Industry

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Market Structure In the Healthcare Industry

• Professor Vivian Ho
• Health Economics
• Fall 2007

These notes draw from material in Santerre
Neun, Health Economics, Theories, Insights and
Industry Studies. Dryden 2007
2
Outline

• Defining perfect competition
• Comparative statics
• The market structure continuum
• Monopoly
• Monopolistic competition
• Oligopoly

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

5
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
Comparative Statics

• How does the market react to events that
  influence the demand for or supply of medical
  services?
• Recall that changes in factors other than output
  price will cause the demand or supply curve to
  shift
• An increase in consumer income will cause the
  demand curve for physician visits to shift to the
  right
• An increase in the wage of nurses will cause the
  supply curve for hospital stays to shift to the
  left

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Comparative Statics

• These shifts in the demand or supply curves will
  lead to a change in equilibrium price and
  quantity
• Predicting such changes is referred to as
  comparative static analysis

8
Comparative Statics

• In the mid-1980s, the AIDs epidemic led to an
  increase in the demand for latex gloves among
  health care workers
• The epidemic led to a shift to the right in the
  demand curve for latex gloves
• Excess demand for gloves developed, leading to a
  temporary shortage of gloves

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Comparative Statics (Long run)
Dollars per pair
S
F
E
P0
D1
D0
Q0
Market output of latex gloves (Q)
Excess demand
10
Comparative Statics (Long run)

• The shortage of gloves led buyers to bid the
  price of gloves upwards
• As the price bid for gloves rose, sellers
  increased their quantity supplied of gloves
• This process continued until a new short-run
  equilibrium was reached
• From 1986 to 1990, annual sales of latex gloves
  increased by 58

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Comparative Statics (Long run)
Dollars per pair
S
P1
P0
D1
D0
Q0
Q1
Market output of latex gloves (Q)
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Comparative Statics (Long run)

• Before the epidemic, each glove maker was earning
  0 profits
• The increase in equilibrium price after the
  epidemic implies that all glove makers are
  earning positive profits
• ? (P1 x Q1) (Q1 x ATC(Q1))

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Comparative Statics (Long run)
Dollars per pair
MC
ATC
d1 MR1
P1
d0 MR0
P0
Q0
Q1
Market output of latex gloves (Q)
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Comparative Statics (Long run)

• Other medical suppliers made plans to build new
  manufacturing plants to make gloves, in the hopes
  of making profits
• In 1988, 116 permits were pending in Malaysia for
  building latex glove factories
• Entry of the new plants into the market increased
  the supply of latex gloves in the long run
• The supply curve for gloves shifted out

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Comparative Statics (Long run)
Dollars per pair
S0
S1
P1
P0
D1
D0
Q0
Q1
Q2
Market output of latex gloves (Q)
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Comparative Statics (Long run)

• As the supply curve for gloves shifts out, the
  price of gloves begins to fall
• Note that the quantity of gloves sold on the
  market also increases
• As the price of gloves fall, profits also fall
• The process continues, until the price of gloves
  falls back to P0, where profits for all glove
  makers are again equal to 0

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Comparative Statics (Long run)
Dollars per pair
MC
ATC
d1 MR1
P1
d0 MR0
P0
Q0
Q1
Market output of latex gloves (Q)
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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

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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?

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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
22
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
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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

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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)

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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

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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

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

36
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

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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?

43
Oligopoly

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

44
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