Transcript L28_Mar 25_08

Review of the Last Lecture
• Have finished our discussion of program evaluation in healthcare
• Began section VII(1): The Practitioner Firm (PF)
• Noted some fundamental similarities and differences between the
practitioner firm and the firm in intro micro theory
• Will be looking at three generations of models of the PF:
1) monopoly power, profit maximization, exogenous demand
2) monopoly power, utility maximization, exogenous demand
3) monopoly power, utility max., endogenous demand
• Discussed the source of monopoly power for the PF => licensure
(plus three other conditions need to be met)
• Today look at four versions of the first generation models of the PF
and their policy implications
317_L28, Mar 25 2008
J. Schaafsma
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Four Models Based on Restricted
Supply and Monopoly Power
• will look at four models that stress restricted entry and monopoly
power:
1. Competition behind the barrier to entry
2. Monopolistic competition
3. 1st degree price discriminating monopolist
4. Cartel and joint profit maximization
• these 4 models assume: demand exogenous and profit
maximization. ///
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Monopoly Model 1: Competition
Behind the Barrier to Entry
• profession restricts entry
• practitioner firms compete behind barrier to entry (diagram)
• supply curve sits more to the left than if free entry
• consequences  welfare loss (consumer surplus and producer
surplus components) & higher producer surplus to physicians who do
get past the barrier at the expense of consumer surplus (diagram)
allocative inefficiency
• Technical efficiency (guaranteed by competition and profit
maximization)
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Possible Barriers to Entry
• excessively high grade requirement
• excessive educational requirements
• marginally relevant but very challenging courses (e.g. dissecting an
entire human cadaver in an optometry program)
• high fees for board exams
• exceptionally difficult board exams ///
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Monopoly Model 2:
Monopolistic Competition
• there are many firms competing against each other
• yet each firm has a downward sloping demand curve, i.e., firm is
not a price taker  can select own price  monopoly power
• what is the basis of this monopoly power?  product
differentiation  e.g. hair salons all provide perms but price varies
across salons, why?  different perceived quality and/or customer
loyalty based on service
• how do physicians differentiate their product?  trust
relationship, bed side manner. ///
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Diagram for Monopolistic
Competition
• draw diagram  P = average cost  no monopoly profits
• how do we know that there will be no monopoly profits? 
monopoly profits will attract new practitioners  lowers the demand
curves for existing practitioners by taking away some of their
customers  eliminates monopoly profits
• NB. P > MC  inefficient  welfare loss, i.e. we are willing to pay
more for the next unit than it costs to produce.
• show welfare loss relative to marginal cost pricing (diagram)
• note  at marginal cost pricing firm incurs a loss ///
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Monopoly Model 3: 1st Degree
Price Discrimination
• charge what traffic will bear to maximize profits (perfect price
discrimination  by market and quantity  extract consumer surplus
• price varies inversely with price elasticity of demand, high P where P
elasticity is low and low P where P elasticity is high.
• this model predicts that patients with high incomes will be charged
more than patients with low incomes, and that the price will drop for
additional units.
• note constraint on price discrimination  if too aggressive  lose
patients to other providers ///
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Monopoly Model 4: Joint Profit
Maximization (Cartel)
• here profession is postulated to act as a single monopoly  sets a
fee structure that maximizes joint profits
• to avoid breakdown of the cartel  need to allocate output or
regulate behaviour to minimize competition.
• we do see the medical profession set suggested fee schedules and
we do see advertising restrictions
• this behaviour is consistent with joint profit maximization but also
with protection of the patient  limit competition and thus protect
service quality
• technical efficiency (since profit max) but allocative inefficiency
due to
restriction of output ///
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J. Schaafsma
Implications of the Monopoly
Power Models
• allocative inefficiency  P > MC (except if perfect price
discrimination):
- not enough healthcare
- welfare loss  foregone consumer & producer surplus
since P too high
• transfer of wealth to healthcare practitioners
• NB: there is technical efficiency, i.e., the output that is produced
can’t be produced at any lower cost  how do we know? => it
follows from the assumption that the P-F is a profit maximizer 
thus a cost-minimizer. ///
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Policy Response if Monopoly
Power Model is Correct
• if the monopoly power model is the correct view of the P-F  main
problem  allocative inefficiency  undersupply of HC
• Policy response  reduce/eliminate monopoly power of the
professions  - lower barriers to entry
- expand supply of competing professions ///
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J. Schaafsma
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Evidence in Support of Monopoly
Power Models for the P-F
1. Are high earnings evidence of monopoly power?
•
Earnings of doctors and dentists typically at top of professional
earnings  evidence of monopoly power? Not necessarily  need to
compensate for long period of training
•
In the U.S. the real rate of return to a medical education is about 14%
compared to about 7% for a law degree  evidence of monopoly
power?  would expect rates to be equalized across occupations if
ceteris paribus  however, long and inconvenient hours of medical
work & hazards associated with the work could result in a premium.
•
high earnings and/or high rate of return is inconclusive evidence of
monopoly power being exercised. ///
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Evidence in Support of Monopoly
Power Models for the P-F: Cont’d
• Unsatisfied demand for entry into medical school by qualified
applicants  combination of monetary and non-benefits associated
with a medical degree is higher than it needs to be to fill medical
schools  suggests restricted entry and monopoly power.
• trade restrictions  professional associations discourage P
competition and place restrictions on who may own a practice (only
HC professionals), and on advertising
• before widespread insurance, GP’s practiced price discrimination
by
(a) person  high income patients paid more
(b) by units of care consumed P  as # of units 
• consistent with 1st degree price discrimination by a monopolist///
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J. Schaafsma
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Evidence in Support of Monopoly
Power Models for the P-F: Concluded
• fee schedules set by the profession, e.g. B.C. College of Dental
Surgeons has a suggested fee schedule, followed by most dentists
• fee schedule could be defended on grounds of patient protection against
price competition and resulting reduced quality
• fee schedule also consistent with cartel behaviour and joint profit max.
///
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J. Schaafsma
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Inadequacies of the Monopoly
Power Models
1. Demand curve assumed exogenous  ignores agency role which is
fundamental to why licensure exists (info asymmetry)  if consumer is
fully informed (demand exogenous ) no social justification for licensure
 can’t accept licensure as valid and also assume demand exogenous.
2. Assumption of profit maximization is also inconsistent with the
agency role (motivated by well-being of patient not by profits) => if no
profit maximization no guarantee of cost-minimization => there is real
world evidence that the P-F is not technically efficient (i.e no cost
minimization. ///
• will look at 3 pieces of evidence that the P-F is not technically
efficient
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