Kinh tế học - Market structure in the healthcare industry

Market Structure In the Healthcare IndustryProfessor Vivian HoHealth Economics Fall 2009These notes draw from material in Santerre & Neun, Health Economics, Theories, Insights and Industry Studies. Southwestern Cengate 20101OutlineDefining perfect competitionThe market structure continuumMonopolyMonopolistic competitionOligopolyThe market for organs2Characteristics of Perfect CompetitionConsumers pay the full price of the productConsumers will respond to differences in prices among sellersAll firms maximize profitsFirms have incentives to satisfy consumer wants and produce efficiently3Characteristics of Perfect Competition (cont.)There is a large number of buyers and sellers, each of which is small relative to the total marketNo one buyer or seller is powerful enough to influence or manipulate the market price of a productAll firms in the same industry produce a homogeneous productA consumer can easily find substitutes for the product of any given firm4Characteristics of Perfect Competition (cont.)No barriers to entry or exit existNew firms can enter the industryAll economic agents possess perfect informationConsumers and firms can make informed choicesAll firms face nondecreasing average costs of productionRules out a “natural monopoly”5Monopoly ModelIn contrast to perfect competition, a monopoly market has the following features:One seller Homogeneous or differentiated productComplete barriers to entryBecause there is only one firm, that firm faces the market demand curve, which is downward sloping6Monopoly Model (cont.)What is the profit-maximizing price and quantity for a monopolist?Recall that all firms will maximize profits where MR=MCWe have already seen that the marginal cost curve for a firm depends on its production function and input pricesWhat does the firm’s MR curve look like?7Monopoly Model (cont.)MR = P + Q • (P/Q)Because the second term in this formula represents a revenue loss, it is always negativeThus, at each level of output, marginal revenue is always lower than priceThe marginal revenue curve lies under the demand curve8Monopoly Model (cont.)QuantityDollars per unitDemandMR9Monopoly Model (cont.)We are now ready to find the profit-maximizing output for a monopolistThe monopolist sets output at a level where MR=MCOn a graph, find the level of Q where the MR and MC curves intersectTo determine the price the monopolist will charge, locate the price on the demand curve at this same output level10Monopoly Model (cont.)QuantityDollars per unitDemandMRMCP*Q*11Monopoly Model (cont.)The monopolist’s level of profits can then be determined by adding its average total cost curve to the graphProfits will be the difference between P* and ATC, multiplied by Q*12Monopoly Model (cont.)QuantityDollars per unitDemandMRMCP*Q*ATCATC*Profits13Contrast to Perfect CompetitionQuantityDollars per unitDemandMRMCPCQCATCUnder perfect competition, the market equilibrium would instead be where P=MCThe higher price and lower output in a monopolized market is why economists claim that competition is better for social welfare14Monopoly Model (cont.)A monopoly only maintains its status if there are no substitutes for the product it sellsThere must be barriers to entry, so that other firms cannot enter the market to competeThe two most common barriers to entry:Economies of scaleLegal restrictions15Monopoly Model (cont.)Economies of scaleIf a monopoly is producing output at a level where long run average costs are declining, then new firms cannot compete on a cost basisA monopoly hospital in a small town may have substantial economies of scale if it can meet demand with only 40-50 bedsUnless 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)16Monopoly Model (cont.)Legal restrictionsPhysicians require a license to practice medicineMany states require that providers obtain a Certificate of Need to offer a new serviceDrug companies obtain patents for new pharmaceutical products17The Market Structure ContinuumWe have talked about 2 extremes of the market structure continuumPerfect CompetitionPure MonopolyAlong this continuum, there are 2 more levels of competitiveness that we will encounter in the health care sector18The Market Structure ContinuumPerfect CompetitionMonopolistic CompetitionOligopolyMonopoly19Monopolistic CompetitionMany sellersDifferentiated productNo barriers to entryExamplesBreakfast cerealsIbuprofen (Advil, Motrin, etc.)Cigarettes20Monopolistic Competition (cont.)Because products are differentiated across firms, each seller has some ability to control priceEach seller faces a slightly downward sloping demand curveSellers have an incentive to “differentiate” their product from competitorsDoing so is likely to raise demand for their product21Monopolistic Competition (cont.)OutputDollars per UnitDemand under perfect competitionDemand under monopolistic competition2 potential demand curves for an individual firm22Monopolistic Competition (cont.)How do sellers differentiate their product? AdvertisingIs advertising bad for consumers?Creates imaginary or artificial wantsPersuasive, not informativeBusiness stealing, w/ no benefits to consumerHabit buying is a barrier to entry23Monopolistic Competition (cont.)Benefits of advertisingMay convey important info on value of a good or servicePeople benefit from real diversity & choiceCheap info to customers to distinguish b/w productsMay promote quality competitionFirms willing to invest in creating a brand name reputation will work to keep itMay inform the consumer of good or service they weren’t aware ofShift the D curve out24DTC Drug AdvertisingAugust 1997, FDA permitted brand-specific direct-to-consumer (DTC) advertising w/o “brief summary” of drug effectiveness, side effects, and contraindicationsDTC advertising rose from $800m in 1996 to $2.5b in 2000What were the consequences?(Iizuka & Jin, 2003)25DTC Drug AdvertisingIizuka & Jin track monthly expenditures on DTC advertising for 1994-2000They also track monthly visits to the doctor in a recurring national survey for 1994-2000Survey indicates whether a drug was prescribed during the visit, and for what class26DTC Drug AdvertisingClasses of drugs w/ heavy advertising had large ↑ in prescribing27DTC Drug AdvertisingClasses of drugs w/ less advertising had no ↑in prescriptions28DTC Drug AdvertisingIV column: After deregulation, each $1 ↑ in DTC Ads raises # of visits w/ a prescription by .046429DTC Drug AdvertisingIV column: After deregulation, each $1 ↑ in DTC Ads raises # of visits w/ a prescription by .0464How much ad spending is needed to get one extra prescription?1/.0464=$21.55Does DTC advertising look profitable to drug companies?30Oligopoly Few, dominant sellersHomogeneous or differentiated productSubstantial barriers to entryExamplesTertiary services at teaching hospitalsMany prescription drugs31Oligopoly Because there are only a few dominant sellers, actions of any one firm can change the overall market priceLike monopoly, oligopoly will lead to lower output and higher prices than would be observed under perfect competitionRegulators are concerned about consumer welfare in oligopolistic markets32Markets for OrgansShould 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) 33Markets for Organs34Markets for Organs35Markets for OrgansEstimate 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 2000.36The Price of an OrganHow much pay is required to induce an individual to sell an organ?Compensate individual for: Risk of deathTime lost during recoveryRisk of reduced quality of life37Pricing 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% = $5,00038Time Lost During RecoveryAssume donor earns $35,000 / yearLoses 4 weeks of work while in recovery$35,000 x 4 weeks => $2,70039Risk of Quality of LifeNo 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 $7,500.40Market for Organs Cost of Performing Kidney transplant surgery = $160K Risk of Death $5,000Time Lost in Recovery 2,700Risk of QOL 7,500 $15,200 Live donors raise total price 15,200 / 160,000 = 9.5%, but supply is perfectly elastic.41Markets for Organs13,500 kidney transplants in 2005, 8000 on waiting list => excess demand = 21,500Assume εD for organ transplants = -1 price 9.5% => demand 9.5%9.5% x 21,500 = 2,043Demand = 21,500 – 2043 = 19,457, but all would be supplied.Equilibrium transplants rise from 13,500 to 19,457 = 44%42Excess Demand if Sales are Banned$$160,000SDQ0# TransplantsExcessDemand43Market for Organs$$160,000SD Q0 Q1 # TransplantsS*$175,200e*44Markets for OrgansUnder a range of assumptions, allowing the sale of live donor organs substantially raises the # of transplants.See Table 3, Becker.45