1. 317_L28, Mar 25 2008 J. Schaafsma 1 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

2. 317_L28, Mar 25 2008 J. Schaafsma 2 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. 1 st degree price discriminating monopolist 4. Cartel and joint profit maximization these 4 models assume: demand exogenous and profit maximization. ///

3. 317_L28, Mar 25 2008 J. Schaafsma 3 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)

4. 317_L28, Mar 25 2008 J. Schaafsma 4 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 ///

5. 317_L28, Mar 25 2008 J. Schaafsma 5 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. ///

6. 317_L28, Mar 25 2008 J. Schaafsma 6 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 ///

7. 317_L28, Mar 25 2008 J. Schaafsma 7 Monopoly Model 3: 1 st 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 ///

8. 317_L28, Mar 25 2008 J. Schaafsma 8 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 ///

9. 317_L28, Mar 25 2008 J. Schaafsma 9 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. ///

10. 317_L28, Mar 25 2008 J. Schaafsma 10 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 ///

11. 317_L28, Mar 25 2008 J. Schaafsma 11 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. ///

12. 317_L28, Mar 25 2008 J. Schaafsma 12 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 1 st degree price discrimination by a monopolist///

13. 317_L28, Mar 25 2008 J. Schaafsma 13 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. ///

14. 317_L28, Mar 25 2008 J. Schaafsma 14 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