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Unformatted text preview: HEALTH ECONOMICS Handout 9 Models of Market Equilibrium As in all markets, competition affects how aggregate demand is translated into the demand curves faced by firms and thus how markets generate prices and quantities. For example, in perfect competition, the firm specific demand curve is perfectly elastic (flat). Health care markets are generally not perfectly competitive. Thus we will focus on equilibrium in models of imperfect competition. These are models in which firms do not face perfectly elastic demand curves. This could arise for all the standard reasons (too few firms, product differentiation), but may also reflect information and search. Search models of competition: Basics: Consumers do not know the prices charged by all physicians. If consumers were matched to physicians randomly and could not switch, the physician could charge the monopoly price. The more consumers search for better deals, the lower the physicians price must be (or the higher her quality must be) in order to keep the patient. With costless search, price would approximate competitive levels. The results of this model suggest that as a greater number of patients search, equilibrium prices fall. Another result of this model is price dispersion. Note if nobody searched, physicians with higher marginal costs could charge a greater amount (the monopoly price would be greater if MC was higher). About 60% of patients in one study had switched doctors for a variety of reasons, quality was cited most as a reason for switching, but some people, particularly low income people, cited price. Licensing may increase search because it reduces the probability that any physician will be below some quality floor. Search with insurance: From the physicians point of view, insurance makes demand curves less elastic. When demand curves are less elastic prices rise and price dispersion increases in response to cost differences. Insurance may decrease search based on price (because the insured do not care about price). But insurance may increase search based on quality. If raising quality is costly then this type of quality competition could drive up costs and hence prices. Advertising: One way to increase information and reduce search costs is to allow advertising. This would tend to force doctors to compete on price and potentially lower prices. However because of information problems, advertising might also feed poor information to people 1 and induce them to make poor choices. (For example the PSA test) and various pharmaceuticals. For eyeglasses (a product very different than most physician services) prices were lower in areas where advertising was allowed (by about 25%). Firms were also bigger in areas where advertising was allowed, presumably to take advantage of economies of scale....
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This note was uploaded on 04/09/2008 for the course HMP 661 taught by Professor Michaelchernew during the Winter '06 term at University of Michigan.
- Winter '06