Market Structure In the Healthcare Industry by dk02121

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									         Market Structure In the Healthcare

                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
   Defining perfect competition

   The market structure continuum
     Monopoly
     Monopolistic   competition
     Oligopoly

   The market for organs
Characteristics of Perfect Competition

   Consumers pay the full price of the
     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
        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
Characteristics of Perfect Competition (cont.)

      No barriers to entry or exit exist
        New   firms can enter the industry
      All economic agents possess perfect
        Consumers    and firms can make informed
      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
     Oneseller
     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
 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.)
per unit

                   MR     Demand

           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
     Ona 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.)
per unit


                       MR   Demand

                  Q*                 Quantity
           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.)
per unit


                               MR   Demand

                          Q*                   Quantity
       Contrast to Perfect Competition
Dollars                                Under perfect competition,
per unit                               the market equilibrium would
                                    MC instead be where P=MC


                        MR           Demand

                           QC                  Quantity
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
     The two most common barriers to entry:
        Economies of scale
        Legal restrictions
              Monopoly Model (cont.)

   Economies of scale
     Ifa 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 hospital’s
           patients, it could not match the existing hospital
           in costs (and therefore profits as well)
           Monopoly Model (cont.)

   Legal restrictions
     Physicians   require a license to practice
     Many states require that providers obtain a
      Certificate of Need to offer a new service
     Drug companies obtain patents for new
      pharmaceutical products
     The Market Structure Continuum

   We have talked about 2 extremes of the
    market structure continuum
     Perfect
     Pure Monopoly

   Along this continuum, there are 2 more
    levels of competitiveness that we will
    encounter in the health care sector
         The Market Structure Continuum

Competition                  Oligopoly

              Monopolistic               Monopoly
         Monopolistic Competition

 Many sellers
 Differentiated product
 No barriers to entry

   Examples
     Breakfast cereals
     Ibuprofen (Advil, Motrin, etc.)
     Cigarettes
      Monopolistic Competition (cont.)

   Because products are differentiated across
    firms, each seller has some ability to control
     Eachseller 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.)
    per Unit
                                   Demand under
                                   monopolistic competition

                                   Demand under
                                   perfect competition

2 potential demand curves for an            Output
individual firm
      Monopolistic Competition (cont.)

   How do sellers differentiate their
     Advertising

   Is advertising bad for consumers?
     Creates imaginary or artificial wants
     Persuasive, not informative
     Business stealing, w/ no benefits to
     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
     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
             DTC Drug Advertising

   August 1997, FDA permitted brand-
    specific direct-to-consumer (DTC)
    advertising w/o “brief summary” of drug
    effectiveness, side effects, and

   DTC advertising rose from $800m in
    1996 to $2.5b in 2000
     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
     Survey  indicates whether a drug was
      prescribed during the visit, and for what
           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 product
 Substantial barriers to entry

   Examples
             services at teaching hospitals
     Tertiary
     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
     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
 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
            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 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
      Time Lost During Recovery

   Assume donor earns $35,000 / year

   Loses 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

Live donors raise total price 15,200 / 160,000 = 9.5%,
    but supply is perfectly elastic.
              Markets for Organs

   13,500 kidney transplants in 2005,
    8000 on waiting list
    => excess demand = 21,500
   Assume εD for organ transplants = -1
       price 9.5% => demand 9.5%
   9.5% x 21,500 = 2,043

   Demand = 21,500 – 2043 = 19,457, but all would be
   Equilibrium transplants rise from 13,500 to 19,457 =
Excess Demand if Sales are Banned





                    # Transplants
   Market for Organs

      $            S

                       e*          S*



                    Q0 Q1
               # Transplants
           Markets for Organs

   Under a range of assumptions, allowing
    the sale of live donor organs
    substantially raises the # of transplants.

   See Table 3, Becker.

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