Profits, Market Structure, and Market Power in Healthcare assignment help

Solution.pdf

1. Perfectly Competitive Market

Globally, the role of the private sector in the provision of healthcare services is growing. Healthcare, as a whole, is undergoing transformation as a result of technological advancement. Also, healthcare services are now available outside the hospital setting. There are now growing services, such as specialty care, home-based care, independent laboratories, and small clinics. In 2016, the share of personal healthcare expenditures in hospitals, expenditures on goods and services that are directly related to patient care, was only 38.2% (National Center for Health Statistics, 2017). Home care service delivery is the fastest- growing industry within the healthcare sector. It employs over two million people, and its growth is supported by the aging population, the prevalence of chronic diseases, growing physician acceptance of home care, medical advancements, smart medical technologies, and a search for cost-efficient options (IBISWorld, 2019).

Click to enlarge.

Figure: Personal Healthcare Expenditures

National Center for Health Statistics [NCHS], 2018

NOTE: Personal healthcare expenditures are outlays for goods and services relating directly to patient care. Personal health care expenditures are in current dollars and are not adjusted for inflation.

For providers operating within such a vast sector, it is important that they understand the nature of the market and market characteristics that define the structure of the markets. In a market-structured economy, there are four market types: perfectly competitive, monopolistic competition, oligopolistic, and monopoly. Let's look at the first market type, perfectly competitive.

The characteristics of a perfectly competitive market are:

• A large number of small producers: All producers contribute insignificantly to the market, and their own production levels do not change the supply curve.

• Products are homogeneous: The characteristics of a good or service do not vary between suppliers.

• Producers enter and exit the market freely.

• Both buyers and sellers have perfect information about the price, utility, quality, and production methods of the products.

• No transaction costs: Buyers and sellers do not incur costs in making an exchange of goods.

• Producers earn zero economic profits in the long run (Lumen, n.d.; BCcampus, n.d.).

Producers in a perfectly competitive market are price takers. They do not have any individual influence on the market outcomes, and they adopt the price that prevails in the market. If a producer attempts to raise its price, consumers will shift to other sellers. Remember, perfectly elastic! To maximize profit, a producer only needs to decide the quantity to be supplied based on the prevailing price in the market. In the long run, producers earn zero economic profits due to free entry and exit.

This market structure results in pareto-efficient allocation of resources. However, few industries exist that meet all the criteria for a perfectly competitive market. Recent disruptive changes in the healthcare sector could eventually lead to the full realization of perfectly competitive industries (Guzick, 2017).

2. Monopolistic Competition Market

The characteristics of monopolistic competition market are:

• Many are small producers.

• Products are highly differentiated, either due to real or perceived quality and other characteristics.

• Producers can freely enter and exit the market.

• Producers make independent decisions about price and output, based on its product, the market, and its cost of production.

• Buyers (and producers) have imperfect information (Lumen, n.d.; BCcampus, n.d.).

Because of its characteristics, the companies in a monopolistic competitive market have some degree of market power. This market power is mostly about the localized niche that a producer is able to create by virtue of product differentiation. There are four ways a firm can successfully differentiate its product:

• Physical aspects (size, design, features)

• Marketing (highlight uniqueness and value)

• Selling location (mail, Internet, storefront)

• Intangible aspects (skill of employees, uniforms).

In the healthcare market, examples of products (services) that are considered monopolistic competition include: physician services within the same specialization, dental care, basic lab work, and home-based care (Kumpmann, 2009; BCcampus, n.d.).

Firms make pricing and product decisions to maximize their profit. Due to differentiation, there is a downward sloping demand curve and firms can mark up prices, which is slightly higher than the competitive price as a reward for differentiating a product. However, due to competition and the availability of close substitutes, the profit margin is small in this market type. In the long run, there is zero economic profit if firms fail to maintain the attributes that distinguish their product from others.

While the perfectly competitive market operates on the premise of access to full and complete information by consumers, the monopolistic competition market provides incomplete information to consumers. Even when there is a slight degree of imperfection, it gives producers a leverage to influence prices. This results in less than pareto-optimal (inefficient) allocation of resources. The following table captures a comparison of perfectly competitive versus the monopolistic competition markets.

3. Oligopolistic Market

In countries with significant private sector involvement in healthcare services, the sector is dominated by a few, yet large key players, particularly in pharmaceuticals, hospital networks, and insurance, and medical equipment suppliers.

The oligopolistic market structure has these unique characteristics:

• Few and large producers

• Significant barriers to entry and exit

• Homogeneous or differentiated products

• Imperfect information on both buyers (and sellers)

• Non-price competition, such as advertising, service warranties, and loyalty programs

• High degree of interdependence between producers (Toppr, n.d.).

Firms in an oligopoly market compete for market share. Due to significant market shares, firms can influence price, and they have a high degree of leverage. However, since there is this high degree of interdependence, pricing and output decisions vary based on the firm's strategic goals.

A 2014 U.S. government report showed that three of the largest insurers in 37 states controlled at least 80% of total enrollment in the individual, small-group, and large-group segments (Herman, 2014).

Generally, oligopolistic firms can be either collusive or non-collusive in their pricing behaviors. Collusion, illegal in the United States, could help businesses act as a united body. A non-collusive oligopoly leads to rivalry to undercut each other in price and non-price competition. At the extreme, this could lead to price wars (or predatory pricing). In between collusive and non-collusive behaviors there is a time period where prices could be stable due to healthy competition or the firms focusing on non-price competition until a disruption occurs.

Overall, the prices charged by oligopolistic firms are higher than the marginal cost, which implies that there is a high degree of inefficiency in resource allocation. There are two types of inefficiency generated by an oligopolistic market structure: allocative inefficiency and productive inefficiency (Moore-Stanley, n.d.). The allocative inefficiency is the fact that prices are higher than the marginal cost, and the productive inefficiency is that the firms will not be able to combine their resources seamlessly to maximize production at the lowest average cost per unit.

Oligopolistic markets require significant government oversight due to the size of the market share firms own, and potentially could become a monopoly based on technological or capital superiority.

Consequently, in most countries, mergers and acquisitions are scrutinized for their potential impact to the welfare of consumers, to maintain competition in the market, and to penalize unfair trade practices (LaPointe, 2019).

Watch the video to learn more about oligopoly markets.

Oligopoly/Microeconomics

http://www.youtube.com/watch?v=9G7PsF-XEku

Professor Jadrian Wooten of Penn State University details how oligopolies, such as duopolies and cartels, dominate markets.

4. Monopoly Market

The final market structure is the monopoly. Healthcare services in some industries are dominated by a single or dominant player in the market. Even when we look at the nature of the healthcare sector globally, there is a significant presence of monopolistic power that firms exercise in hospital care, specialty services, supplies of medical equipment, information technology, or pharmaceuticals.

A monopoly market is characterized by:

• High barriers to entry: Other sellers are unable to enter a monopoly market.

• Single seller: The entire market is served by a single firm. For practical purposes, the firm is the same as the industry.

• Lack of (close) substitutes: The product that a monopolist produces does not have a close substitute, either because of geographical limitations or technological superiority.

• Incomplete information: In a monopoly, there is a higher degree of information imperfection as compared to oligopoly and monopolistic competition.

• Price discrimination: The firm can charge different prices to customers based on market segmentation and consumers' socioeconomic profile (Lumen, n.d.; Intelligent Economist, n.d.).

Because of these characteristics, a monopolist is a price maker. It decides the price of the good or product being sold. However, it doesn't mean that a monopolist charges the highest price possible. The price is set by determining the quantity in order to get the price desired by the firm to maximize revenue (BCcampus, n.d.).

So, why a monopoly? How is it created or maintained? There are four sources of monopoly power:

• Technological superiority (patent)

• Economies of scale due to capital requirement

• Legal barriers (single authorized supplier)

• Network externality (Lumen, n.d.; Herper, 2017; BCcampus, n.d.).

In the healthcare market, the monopoly power can be exercised on both sides. Watch this video to see how a monopoly operates to maximize profits.

Maximizing Profit Under Monopoly

http://www.youtube.com/watch?v=IEjcTLPtTIY

In this video, learn how patent rights have created a monopoly in the U.S. market for AIDS medication. In other countries, however, such as India, which does not recognize patents on AIDS medication, prices remain low. Using this example, we go over how monopolies use market power to increase prices.

Producers of healthcare services, such as drugs, medical equipment, and even hospitals in remote areas, do exercise monopoly power (Drummond, n.d.). On the other hand, the government is the largest single buyer of healthcare services. Consequently, a government can exercise monopoly power as a single provider/buyer (NBER, 2019). Saudi Arabia has a universal healthcare system and is able to negotiate prices with providers. This enables it to lower the overall cost of healthcare and improve consumer welfare. In the United States, Medicaid, as a single large buyer, has the power to negotiate with providers and lower the cost of healthcare services.

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