Respond to the question assigned to you. Include the question at the beginning of your post. Then respond to the initial post of two other students. Ask probing questions. Always include citations and references in correct APA format. Ensure you reply to any follow-up questions by the professor. 1. In this weeks readings the Health Affairs article on Proposed Payer Mergers, what does the article say will happen to the commercial insurance market in insurers are allowed to merge?2. What conditions must exist for a firm to be able to price discriminate?3. What is the Herfindahl Index?4. What factors allow a firm to have monopoly profits?5. What are the pros and cons of merger activity? Why would the government want to prevent mergers?6. What are the characteristics of monopolistic competition?7. Why is understanding market structure important in health economics, what does it impact?8. What is a Nash Equilibrium?Assigned Question:Martin, Beverly Question #2
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Week 5: The Supply
Side: Alternative
Market Structures
UMUC HMGT 435
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Key Learning Objectives Week 5
Understand different market structures and impact on price and
quantity decisions for suppliers
Perfect Competition (last week)
Monopoly
Monopolistic Competition
Oligopoly
Understand when a firm can price discriminate
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Implications of Market Structure on Price and
Quantity
Market Structure is determined by:
Number of firms competing
Type of product sold
Firm Specific demand curve (market power)
Entry conditions (ability of other firms to enter the market)
Four Market Structures:
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Perfect Competition (discussed last week)
Monopolistic Competition
Oligopoly
Monopoly
The Market Structure Continuum
Perfect
Competition
Oligopoly
Monopoly
Monopolistic
Competition
Many Firms
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A few firms
One Firm
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Last Week We Looked at Perfectly
Competitive Firms
Characteristics of a perfectly competitive market:
Many sellers (large number of firms) and buyers
Homogeneous product (identical and no branding)
No barriers to entry
Price Charged:
Firms in Perfectly Competitive Market cannot control the price they
charge, must charge whatever the market determines
Long-Run Economic Profit = 0 as new firms enter
Examples in Healthcare: medical supplies
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Perfectly Competitive Markets Are Efficient
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Characteristics of a Monopoly
In contrast to perfect competition, a monopoly
market has the following features:
ONE seller
Homogeneous or differentiated product
Complete barriers to entry (e.g. patents, copyrights,
geography etc.)
Because there is only one firm, that firm faces
the market demand curve, which is downward
sloping
In other words, the firm is the market and
determines price
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What Price and Quantity
Does A Monopolist Choose
What is the profit-maximizing price and
quantity for a monopolist?
Recall that all firms will maximize profits
where MR=MC
We have already seen that the marginal cost
curve for a firm depends on its production
function and input prices
What does the firms MR curve look like?
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Dollars
per unit
Marginal Revenue For A Monopolist
MR
Demand
Quantity
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Monopoly Model (cont.)
We are now ready to find the profit-maximizing
output for a monopolist
The monopolist sets output at a level where
MR=MC
On a graph, find the level of Q where the MR and
MC curves intersect
To determine the price the monopolist will
charge, locate the price on the demand curve
at this same output level
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Monopoly Model (cont.)
Dollars
per unit
MC
P*
MR
Q*
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Demand
Quantity
Monopoly Model (cont.)
The monopolists level of profits can then be
determined by adding its average total cost
curve to the graph
Profits will be the difference between P* and
ATC, multiplied by Q*
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Monopoly Model (cont.)
Dollars
per unit
MC
P*
ATC
Profits
ATC*
MR
Q*
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Demand
Quantity
Contrast to Perfect Competition
Dollars
per unit
Under perfect competition,
the market equilibrium would
MC instead be where P=MC
ATC
PC
MR
QC
Demand
The higher price and lower output in a monopolized market is why economists claim that
competition is better for social welfare
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Quantity
Barriers to Entry in Monopoly
A monopoly only maintains its status if there
are no substitutes for the product it sells
There must be barriers to entry, so that
other firms cannot enter the market to
compete
The two most common barriers to entry:
Economies of scale (think Costco)
Legal restrictions (patents, copyrights)
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Economies of Scale
Economies of scale
If a monopoly is producing output at a level where
long run average costs are declining, then new
firms cannot compete on a cost basis
Example: A monopoly hospital in a small town may
have substantial economies of scale if it can meet
demand with only 40-50 beds
Unless a new hospital could take away a
substantial share of the existing hospitals
patients, it could not match the existing hospital
in costs (and therefore profits as well)
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Legal Restrictions Creating A Monopoly or
Market Power
Legal restrictions
Physicians require a license to
practice medicine
Many states require that providers
obtain a Certificate of Need to offer a
new service
Drug companies obtain patents for
new pharmaceutical products
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Distortions in Monopoly Market
The quantity (Q) produced by
a monopolist is less than
socially optimal
Creates a deadweight loss
(see graph to the right)
A higher Q (closer to a
perfectly competitive market)
would be more efficient
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The Market Structure Continuum
We have talked about 2 extremes of the
market structure continuum
Perfect Competition
Pure Monopoly
Along this continuum, there are 2 more
levels of competitiveness that we will
encounter in the health care sector
Monopolistic Competition
Oligopoly
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Monopolistic Competition
Many sellers
Differentiated product (due to branding)
No barriers to entry
Examples
Breakfast cereals
Ibuprofen (Advil, Motrin, etc.)
Cigarettes
Do not confuse this with perfect competition
or monopoly, this market structure is inbetween
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Monopolistic Competition (cont.)
Because products are differentiated across
firms, each seller has some ability to control
price
Each seller faces a slightly downward sloping
demand curve
Sellers have an incentive to differentiate their
product from competitors through branding
Doing so is likely to raise demand for their product
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Monopolistic Competition (cont.)
Dollars
per Unit
Demand under
monopolistic competition
Demand under
perfect competition
2 potential demand curves for an
individual firm
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Output
Monopolistic Competition (cont.)
How do sellers differentiate their product?
Advertising (creating a brand)
Is advertising bad for consumers?
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Creates imaginary or artificial wants
Persuasive, not informative
Business stealing, w/ no benefits to consumer
Habit buying is a barrier to entry
Monopolistic Competition (cont.)
Benefits of advertising
May convey important info on value of a good or
service
People benefit from real diversity & choice
Cheap info to customers to distinguish b/w products
May promote quality competition
Firms willing to invest in creating a brand name reputation
will work to keep it
May inform the consumer of good or service they
werent aware of
Shifts the D curve toward the right
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Oligopoly
Few, dominant sellers
Homogeneous or differentiated product
Substantial barriers to entry
Examples
Tertiary services at teaching hospitals
Many prescription drugs
Cable Internet Services
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Oligopoly
Because there are only a few dominant sellers,
actions of any one firm can change the overall
market price
Like monopoly, oligopoly will lead to lower
output and higher prices than would be
observed under perfect competition
?Regulators are concerned about consumer welfare
in oligopolistic markets
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Measures of Oligopoly
Measures of Market Concentration Using Market Share
Market share shows a firms sales relative to industry sales, higher
market share means that a firm has more influence in a market
Herfindahl-Hirshman Index (HHI) Take market share of each firm and
square them and add up across firms
Low HHI: market is competitive
High HHI: market is an oligopoly
Concentration Ratios The more market share is dominated by a few
firms the higher the concentration ratio.
Example: If the four-firm concentration ratio is 80%, than the four largest firms
have 80% of the market
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Oligopoly Pricing Based on Game Theory
Game Theory: Looks at the
outcomes of decisions made
when those decisions depends
upon the choices of others
Prisoners Dilemma when acting
separately two entities choose less
optimal result (e.g confess) which
is called the dominant strategy
But if they could collude they can
get a better outcome
If firms can act over time, they can
eventually reach an optimal price
through tacit collusion
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Prisoner A
CONFESS
KEEP QUIET
CONFESS
Both go to jail for
10 years
Prisoner B
gets life
imprison,
Prisoner A
goes free
KEEP
QUIET
Prisoner A gets life Both go to
imprison, Prisoner jail for one
B goes free
year
Prisoner
B
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Game Theory (continued)
Nash Equilibrium
a player has no incentive to independently change his course of action
in a game.
Each firm makes the best decision for themselves based on what they
think others will do
No firm can do better by changing their strategy
Each firm sets its P=MC and both firms earn profit = 0
Bertrand Competition: even with just two firms predicted outcome that
P=MC
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Price Discrimination
Firms with some market power can price discriminate and
charge different customers different prices for the same good or
service.
Example: Happy Hour in a Bar: Charge lower prices during off-peak
hours before dinner to generate demand.
Conditions Necessary to Be Able to Price Discriminate:
1. Some market power
2. Consumers cannot resell the product
3. Must be able to segment market into different groups of consumers
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Summary of Market Structures
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Market Structure
Number of
Firms
Type of Product
Firm Specific
Demand Curve
Entry Conditions
Perfect
Competition
Monopolistic
Competition
Many
Homogeneous
Perfectly Elastic
No Barriers
Many
Elastic but not
perfectly elastic
Oligopoly
Few
Differentiated by
Advertising/
Branding
Homogeneous or
Differentiated
Monopoly
One
Unique
Market demand
curve
Less Elastic
Examples in
Healthcare
Medical supplies
(e.g. latex gloves)
No Barriers
Pharmaceuticals
(e.g. Prilosex vs.
competitor)
Large Barriers
Health insurance
from Economies of industry in local
Scale or
markets
government
policies
Large barriers
Patented drugs
from economies of and local hospitals
scale or
government
policies
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