Supply Side Market Competition

What are the three basic market structures, and how does the structure (e.g., the number of suppliers) influence market equilibrium?

• Perfect Competition: Many small firms, identical products. Equilibrium has lower prices (P=MC) and higher quantity.

• Monopoly: Single seller. Equilibrium has higher prices (P>MC) and lower quantity.

• Oligopoly: A few large sellers. Prices and quantity fall between perfect competition and monopoly.

• Influence: The number of suppliers determines the market power; fewer suppliers generally lead to higher prices and lower output.

What are the two types of suppliers in healthcare markets?

• Medical Providers: Physicians and hospitals (who sell services to patients/insurers).

• Health Insurers: Private insurance companies (who sell coverage to individuals/employers).

Are provider and health insurance markets in the U.S. monopolistic or perfectly competitive?

• They are neither. They are typically Oligopolies.

• Most hospital and insurer markets are highly concentrated (few firms dominate).

Why is (near) perfect competition rare in healthcare?

• Barriers to entry: High fixed costs (building hospitals), regulations, and licensing requirements make it hard for new firms to enter.

• Product Differentiation: Services are not identical (location, quality, reputation), so firms are not perfect substitutes.

How is the Herfindahl–Hirschman Index (HHI) defined, and how do you interpret it?

• Definition: HHI is the sum of the squared market shares of all firms in the market: HHI =\sum(s_i)^2

• Interpretation:

  • HHI ranges from close to 0 (perfect competition) to 10,000 (monopoly).

  • Higher HHI means higher market concentration.

What are the DOJ/FTC guidelines for interpreting market consolidation based on HHI?

• Unconcentrated: HHI < 1,500.

• Moderately Concentrated: HHI between 1,500 and 2,500.

• Highly Concentrated: HHI > 2,500.

• Transactions that increase HHI by more than 200 points in highly concentrated markets are presumed likely to enhance market power.

What is the incentive for medical providers to consolidate in a single-payer system with fixed reimbursement rates?

• Economies of Scale: To reduce average costs by spreading fixed costs over a larger volume of patients.

• Since prices are fixed, they cannot consolidate to raise prices; they consolidate to become more efficient.

How about in the U.S. healthcare system? What are key incentives for providers and insurers to pursue consolidation?

Bargaining Power: To increase leverage in price negotiations.

• Providers: Consolidate to demand higher reimbursement rates from insurers.

• Insurers: Consolidate to negotiate lower reimbursement rates from providers (countervailing power)

What two outcomes do insurer–provider negotiations determine in U.S. healthcare?

1. Reimbursement Rate (Price): The price the insurer pays the provider for services.

2. Network Inclusion: Whether the provider is "in-network" for the insurer's plan.

Why do in-network providers receive lower reimbursement rates compared to out-of-network providers?

• Volume-Price Trade-off: In-network providers accept lower rates in exchange for a higher volume of patients directed to them by the insurer.

• Out-of-network providers charge higher rates but see fewer patients from that insurer.

Review the two examples of price negotiation in Lecture 8. Which player in each example obtains greater bargaining power, and why?

• Example 1 (Insurer Power): The insurer has power because the provider needs the insurer's patients more than the insurer needs that specific provider (e.g., there are other substitute providers). The insurer can threaten to exclude the provider.

• Example 2 (Provider Power): The provider (e.g., a "Must-Have" hospital) has power because the insurer cannot sell a marketable plan without this provider. The provider can threaten to walk away, causing the insurer to lose customers.

How do providers and insurers consolidate?

• Horizontal Consolidation: Mergers between competitors (e.g., two hospitals merging).

• Vertical Integration: Mergers between firms at different stages of the supply chain (e.g., an insurer buying a physician group).

What does the literature find about the impact of provider and insurer market consolidation on negotiated reimbursement rates?

• Provider Consolidation: Leads to higher reimbursement rates (prices).

• Insurer Consolidation: Leads to lower reimbursement rates (paid to providers).

What is additional motivation for insurers to consolidate that is not shared by providers

Countervailing Power: Insurers consolidate specifically to counteract the market power of large provider systems and negotiate lower prices.

What are the reasons insurers are not always able to exercise market power to raise premiums

• Medical Loss Ratio (MLR) Regulation: The ACA requires insurers to spend at least 80-85% of premiums on medical care, capping their profit margins.

• Competition: Even with consolidation, the threat of potential entry or remaining competitors can keep premiums in check.

What does the countervailing power of insurers mean?

It refers to the ability of large insurers to negotiate lower prices from monopolistic providers, potentially passing those savings on to consumers (though this depends on the insurer's market power in the consumer market).

What does vertical integration mean?

An entity controlling multiple stages of the production process (e.g., UnitedHealth Group acquiring physician practices).

What benefits do insurers gain by vertically integrating with providers

• Eliminate "Double Marginalization": Reduces inefficiencies where both firms mark up prices.

• Better Control: Insurers can better manage utilization and costs.

• Steering: Can direct patients to their own cost-effective providers.