Week 10 Flashcards
- identify the suppliers, the demanders, and the product under the simple monopoly model.
a. A supplier has monopoly in a market when it is the sole source of supply in that market. In a monopolistic market, the demanders do not have any close substitutes for the service, and there are barriers to the entry of new sellers
b. The monopoly model will be developed in the context of a supposed monopolistic market, the market for pediatric ambulatory services. It is assumed that, in this market, there is a single group practice. The product is defined as quality-constant pediatric visits.
The simple monopoly model consists of demand, cost, and behavioral assumptions.
describe demand and revenue conditions for the monopolist.
As one moves down the demand curve, one moves through elastic, unit elastic, and inelastic portions of the demand curve, and the total revenue (TR) will increase, level off, and decrease.
The marginal revenue (MR) is falling throughout, although it is positive when it is associated with the elastic portion of the demand curve and zero at the unit elastic point on the demand curve. For the provider, the MR represents the additional TR that it will receive by lowering the price enough to sell one more visit.
identify cost conditions and behavioral assumptions for a simple monopoly.
a. The monopolist has the ability to set prices at any level it wishes. This ability represents the ultimate degree in market power. (Of course, the price it sets will influence the quantity demanded, something the monopolist will want to keep in mind when setting the price.)
b. Our cost assumptions are that the total fixed cost (TFC) is $30 and that the total variable cost (TVC) is increasing in such a way that marginal cost (MC) increases as output expands
Profits (column 7) are equal to TR – TC, and they initially increase and then decrease as output expands.
predict price and quantity for a monopoly producer, given the demand curve, cost conditions, and behavioral assumptions.
a. Let us now see what the model implies. First, the provider will set the price at that point on the demand curve above where the MR and MC curves intersect. Because MC is positive, MR must also be positive (because MR = MC at the profit-maximizing point). It should be noted that MR is positive only at those quantities that correspond to the elastic portion of the demand curve. Therefore, a monopolist will set the price only on the elastic portion of its demand curve. Indeed, if the price was set on the inelastic portion of the curve, say at $30, MR would be negative, meaning that a reduction in output coming from a price increase would raise total revenues. At the same time, a reduction in output would reduce TC. Profits would therefore always be greater at a higher price (one on the elastic portion of the demand curve).
b. In addition, because the most profitable level of output is determined by MR and MC alone, and because MC is unaffected by fixed costs, the profit-maximizing price will similarly be unaffected by changes in fixed costs.
This important result implies that if the provider’s fixed costs increase (e.g., because of an increase in mortgage rates), it cannot do anything about it. If it tries to pass on these added fixed costs to the consumer by raising the price, it will only be moving away from the profit-maximizing position; in raising the price, it will sell less, and total revenue will decrease more than total cost. This of course is not true for an increase in variable costs (i.e., MC).
define market segmentation, and describe how this phenomenon changes market conditions.
a. Suppose, for example, there were two groups of people, one rich and one poor, and the elasticity for the rich people was lower than for the poor. The monopolist could charge a higher price to the rich, if the market could be segmented. Following are two conditions for segmentation:
i. The product demand for each group must be different (different elasticities), otherwise there would not be any reason for segmentation.
ii. The different consuming groups cannot resell the products to each other. If they could do so, it would take away the ability of the monopolist to discriminate.
There are many possible situations in which this model can be used in the Canadian health care system. In some cases, sellers face different groups of consumers. Some consumers will have private health insurance coverage; others will not. For any services not insured under the Canada Health Act, suppliers could potentially charge different prices for these services. Examples of such services include eye examinations (in some provinces), drugs, physiotherapy, and nursing home care.
predict price and quantity in submarkets under the price discrimination model.
a. Under some conditions, a monopolist can further increase its profits by charging different prices for the same product to different buyers. This is called price discrimination, which can be practiced only when there is market segmentation and the product or service in the lower price market cannot be resold (a secondary exchange) in the higher price market. In addition, the demand elasticities in the two markets have to be different to make the practice worthwhile.
b. In doing so, we must rely on the equimarginal principle of maximization. To maximize profits, the provider will set the price (and therefore the quantity) in each market, so that (1) the MR earned by lowering (raising) the price in all markets is the same; and (2) overall the MR in each market is equal to the MC of producing that total level of output.
c. The curve MC shows the provider’s marginal cost for all units provided (it does not have a separate cost for each market), and the curve SMR shows the quantity that would be supplied overall, when the firm allocated output to each market according to the specific level of MR. SMR is thus the sum of quantities in both markets at a given level of MR. Given the MR curves for the poor and the rich markets (MRp and MRr) at an MR level in both markets of $40, the corresponding quantities in the markets are 4 and 2, respectively.
The firm’s maximum profit position will be determined by equating MC with the MR in each market. Overall, this occurs when MC = SMR (at quantity 6). The corresponding outputs in each market are 4 and 2, and the prices in the two markets that equate the MRs are $80 and $60, respectively. Profits, which are equal to the sum of TR in each market less TC, will be greater than if the same price was set in all markets.
predict price and quantity in the private and public sectors when the same product is provided in both sectors.
On an individual-case basis, physicians were allowed to accept Medicare assignment of their patients. A physician who accepted the reasonable fee in full (i.e., who accepted assignment) for a specific patient receives 80% of the fee directly from Medicare and could bill the patient for the copayment. If the physician did not accept assignment for that patient, he or she could bill the patient whatever fee he or she chose. In this case, Medicare would reimburse the patient directly for 80% of its reasonable fee, and the physician would collect the entire charge from the patient. The acceptance by physicians of assignment relieves patients from the financial risks associated with higher physician fees.
Currently, physicians can no longer decide to accept assignment on a case-by-case basis. Instead, the physician must choose to accept the Medicare-approved amount as payment in full on all claims or none. When the physician agrees to accept assignment, then the patient may only be billed for the deductible and coinsurance amounts.
The physician is assumed to be a monopolist facing two submarkets: one with private patients and one with patients in a public program. (The extra billing is ignored in this analysis.) The output is defined as patients served. Dp is the demand curve for private patients, and MRp is the related MR curve. The public agency reimburses the physicians for its patients at a fee level of Fm; because the fee level is fixed, Fm is also the physician’s MR for public patients. Assume that the physician’s MC curve is at MC1. Finally, assume that the physician is a profit maximizer.
A lower public fee would lower the supply to the public patients (it would also cause the physician to lower his or her private fee because the physician will now move down the MRp curve). A physician facing the same demand curve, but with a higher MC (say, MC2), will not supply any services to public patients and will set a private fee of Pn. This analysis demonstrates that the public and private sectors are interdependent. A public program that lowers fees will reduce the supply to the public market and will also affect the private market.
equimarginal principle
the physician will supply services to Q private and (Q3 – Q1) public patients because at this output MRp = Fm and both are equal to MC1. The private patients will be charged a price of Pm. To attract any additional private patients, the physician would have to lower the price to private patients below Pm, which would imply an MR for private patients below that for public patients. A profit-maximizing physician will thus prefer to serve additional public patients for which the MR is constant at a level Fm rather than lower his or her price and have a marginal revenue below Fm.
Nursing Home Care
g. Care provided in nursing homes generally enhances quality of life rather than curing a particular problem. The demand for long-term care reflects a basic demand rather than a derived demand. Generally in this market, there are two major groups of payers: self-pay (relatively uninsured) patients and state Medicaid agencies. Many Medicaid agencies pay nursing homes a flat rate, whereas self-pay patients are charged according to market conditions. With Medicaid agencies being economy minded and having the power to set rates, one option they have in pursuing the goal of budget containment is to set low rates. In doing so, they must recognize the tradeoffs involved.
From a structural perspective, nursing home markets resemble a monopolistically competitive industry. The nursing home provider basically faces three market segments. One segment reflects the private-pay market for residents paying more than the state-set Medicaid rate. This segment faces a downward-sloping demand curve. The second segment is the Medicaid-eligible people in the market, and because Medicaid pays a single rate, the demand curve is horizontal. The nursing home cannot impact the price received for these residents. The remaining supply is provided to private-pay residents who pay less than the Medicaid rate. As long as the nursing home has excess capacity and the price received covers fixed costs and some variable costs, nursing homes will sell services to this downward-sloping demand.
define supplier-induced demand [SID], and identify suppliers and demanders under the SID model.
a. The amount of shift in the demand for services resulting from the suppliers’ influence on consumers’ tastes (intensity of desire for the services).
b. However, principal−agent relationships are such that the agent (physician) may not behave in the best interests of the principal (patient). A deviation of the agent from the principal’s own interests is called supplier-induced demand.
c. However, when the principal uses the services of the agent, he or she, in effect, has entered into an agreement that the agent will meet the principal’s needs. Problems with the relationship will arise when there is uncertainty and information asymmetry that makes it difficult for the two parties to agree on a fixed price, agree on a predetermined service that the agent will provide, and develop an adequate mechanism to monitor and enforce the agreement.
Supplier-induced demand may be encouraged by certain payment mechanisms that provide incentives to physicians to deliver more services, such as fee-for-service. Under fee-for-service, the physician is paid for each unit of service performed, and so one of the conditions needed for principal−agent problems to arise—the divergence of interests—will be present. Monitoring and enforcement costs may be very high for the patient, therefore the physician has both the incentive and the ability to engage in demand inducing practices.
describe the supply, the demand, and the market conditions under the SID model.
a. The basic theory of the demand for health promotion activities presents a systematic view of how certain underlying variables—tastes, wealth, the cost of health promotion, the likelihood of an illness, and the loss resulting from the illness—can influence the decision to engage in these activities. The assumptions of the model are as follows:
i. 1. Time frame. All activities and consequences occur in the current time period.
ii. 2. Level of wealth. Our second assumption is that our individual initially has a level of wealth of $1,000.
iii. Consumer tastes. We assume that, when an illness occurs, it leads to medical care expenses that constitute a loss of wealth. To specify what this loss means to the individual, we must introduce a concept to characterize the individual’s well-being at alternative levels of wealth—the concept of utility. Utility is a measure of consumer satisfaction and reflects the maximum amount of resources (money) an individual will exchange for a particular bundle of goods and services. One hypothetical individual’s taste for wealth is presented in the form of an index of utility in Table 4-1. This index shows the level of utility that is associated with each specific level of wealth.
iv. 4. Medical expenses in the event of illness. Our fourth assumption is that, if the individual becomes sick, he or she will face medical expenses of $150. This expenditure is assumed to restore the loss in health fully so that $150 is the full value of the loss when the individual is sick.
v. 5. The cost of health promotion activities. The consumer uses up resources when engaging in health promotion, including time, professional services, and supplies. In our example, we will assume that these costs total $20.
vi. 6. Likelihood of illness. A sixth assumption concerns the element of uncertainty. We will assume that we can assign probabilities to the various possible health states the individual may experience. Let us say that, without any health promotion activities, there is a 0.3 probability of illness (i.e., of 10 people in similar circumstances, 3 will become ill) and a 0.7 probability the individual will remain well and will not incur any medical costs. These are the only two possibilities, so the sum of the probabilities equals 1. With health promotion activities, the probability of being healthy increases to 0.9 and the probability of being ill falls to 0.1.
7. Behavioral assumption. The final assumption is that the individual wants to maximize the expected value of his or her utility. Thus, the individual will choose that course of action from which he or she can expect to receive the highest level of utility.
predict quantity demanded in response to changes in physician supply under an SID model.
a. Having specified the demand characteristics of the model, we now turn to the supply side of the market. With regard to physician behavior, the following assumptions are made:
i. • Each physician has an upward-sloping marginal cost (MC) curve (i.e., as more services are provided, marginal costs increase).
• The price of services is fixed by a fee schedule and so fees are beyond physician control.
c. Now consider two new situations, one without SID and one with SID. In the first situation, without SID, assume an increase in the number of eye doctors in the market, with no change in the number or health status of the demanders. In a competitive market, price will fall and quantity demanded will increase to Quantity 2. Note that quantity utilized has increased in response to an increase in suppliers, because the price has fallen. There has been no increase in supplier-induced demand. This is the standard prediction of the competitive model.
Now change the situation and allow for SID to generate Demand 2. In this case, price also falls and utilization increases to Quantity 3, both in response to a lower price and a shift in demand. This is the SID result.
compare predictions of utilization in response to changes in physician supply under an SID model with those of a competitive market model.
a. Thus, it is not always possible to distinguish between the two models: their predictions are often the same. Because the purpose of economic models is to provide predictions about how economic variables such as price and quantity will behave, this situation presents us with a dilemma, that is, the models may not help us understand the underlying forces that influence resource allocation.
b. In this article, the author compares the standard textbook model of the supply and demand for physicians’ services with a model in which he specifies that suppliers (physicians) can induce shifts in the demand curves for medical care. In his hypothesis, Evans specifies a model in which suppliers seek a target income. They will adjust their own workloads to meet this income level by shifting the demand curves of their patients. This model does not deal with issues such as limitations to the generation of demand.
