Chapter 8Structure, Conduct, Performance,and Market Analysis.docx

Chapter 8
Structure, Conduct, Performance,
and Market Analysis
(c) 2012 Cengage Learning. All Rights Reserved. May not be
copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product
or service or otherwise on a password-protected website for
classroom use.
Structure, Conduct, and Performance Paradigm
Industrial organization (IO)
Behavior of firms and markets
The IO triad: SCP paradigm
Market structure
The field of operation of each firm
Market conduct
Pricing, promotion, and research and development activities
Market performance
the degree of production and allocative efficiencies, equity, and
technological progress
classroom use.
Figure 8.1 - The Industrial Organization Triad

Basic Conditions
Supply
Technology
Unionization
Legal environment
Economies of scale
Demand
Price elasticity
Demand conditions
Market Structure
Number, type, and size distribution of sellers and payers
Type of product; Information asymmetry
Barriers to entry (licenses, patents, cost structure)
Objectives
Profit maximization
Quantity maximization
Quality maximization
Discretionary spending
Other
Public Policies
Taxes and subsidies
Antitrust regulations
Price regulations
Certificate of need laws
Peer review organizations
Conduct
Pricing behavior
Product promotion
Research and development

Performance
Production and allocation efficiency
Equity; Technological progress
classroom use.
The IO triad predicts
The structure of an industry
In conjunction with the objectives of firms
Determines the conduct of the firms
Which in turn influences market performance
Significant feedback effects exist among the three elements
The structure of the market indirectly affects industrial
performance through its impact on the market conduct of
individual firms
classroom use.
If markets do not produce desired levels of performance
Public policies should be aimed at correcting this failure of the
market
Market power

Firm’s ability to restrict output (or quality) and thereby raise
price.
classroom use.
Table 8.1 - Market Structure and Market PowerDegree of
Market Power 0% . . .
100%CharacteristicsPerfect
CompetitionMonopolistic
CompetitionOligopolyPure
MonopolyNumber of sellersManyManyFew, dominantOne
Individual firm’s
market shareTinySmallLarge100%Type of
productHomogeneousDifferentiatedHomogeneous
or differentiatedHomogeneous
by definitionBarriers to
entryNoneNoneSubstantialCompleteBuyer
informationPerfectSlightly
imperfectPerfect or
imperfectPerfect or
imperfect
classroom use.

Is a Perfectly Competitive Market Relevant to Medical Care?
Features of health care industries not abiding assumptions of a
perfectly competitive market structure
Not-for-profit medical enterprises
Physician licensure
Insurance coverage
Consumers lack perfect information
classroom use.
A Model of Supply and Demand
Perfectly competitive market
Buyers and sellers are price takers
Buyer maximizes utility
Marginal private benefit equals market price
Firm maximizes profit
Market price equals marginal private cost
Market clearing price
Acts as a coordination device
Reduces shortages and surpluses
At the point of intersection of demand and supply

classroom use.
Figure 8.2 - The Perfectly Competitive Outcome
9
Quantity (Q)
Q0
Price per unit (P)
D = MPB
A
S = MPC
G
C
P0
Market demand, D, represents the marginal private benefit,
MPB, associated with the consumption of various units of a
good. MPB is downward sloping to reflect the law of
diminishing marginal utility.
Market supply, S, reflects the marginal private cost, MPC, of
production and is upward sloping to reflect the law of
diminishing marginal productivity.
classroom use.
Perfectly competitive market
Consumer surplus (Area P0AC in Figure 8–2)
Difference between what the consumer would be willing to pay
and what the consumer actually has to pay

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Producer surplus (Area P0CG in in Figure 8–2)
Difference between the actual price received by the seller and
the required price as reflected in the marginal costs of
production
Total net gains from trade = consumer surplus + producer
surplus
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Allocative efficiency
If demand represents full marginal social benefit
MPB = MSB
And supply represents full marginal social cost
MPC = MSC
Inefficient allocation of resources
If others, in addition to market participants, are affected either
beneficially or adversely by a market exchange

classroom use.
Comparative Static Analysis
Changes in market conditions
Influence the positions of the demand and supply curves
Cause the equilibrium levels of price and output to adjust
Comparative static analysis
Examines the changes in market conditions and the consequent
effects
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Comparative Static Analysis
Factors that change the demand
Number of buyers, consumer tastes, income, and the prices of
substitutes and complements
Factors that change the supply
Input prices and technology
Greater buyer income
Higher price and quantity
Cost-saving technology
Decline in price; increase in quantity

classroom use.
Figure 8.4 - Effects of an Increase in Supply
Quantity of generic aspirin (Q)
Q0
Price per unit (P)
D
S0
P0
P1
Q1
S1
B
A
Eventually price decreases in the market from P0 to P1 in
response to the increase in demand. Quantity increases from Q0
to Q1.
Supply increases from S0 to S1. As a result, a temporary surplus
of horizontal distance AB is created in the market at the
existing price of P0.
classroom use.

Long-Run Entry and Exit
in a Perfectly Competitive Market
Long-run entry of a new firm
Shifts short-run market supply curve to the right
Lowers price and eliminates excess profits
Long-run exit of an existing firm
Shifts short-run market supply to the left
Raises price and eliminates economic losses
classroom use.
Long-Run Entry and Exit
in a Perfectly Competitive Market
Typical perfectly competitive firm
Earns just enough revenues to cover opportunity cost of every
input (normal profits) in the long run
classroom use.
Using Supply and Demand to Explain Rising Health Care Costs
Rising income, an aging population, and a falling out-of-pocket
price
Demand shifts to the right

Higher price and quantity of medical care demanded
Wage increase in medical care industry unmatched with
increases in productivity
Supply shifts to the left
Price of medical care increased
Higher health care expenditures
classroom use.
Using Supply and Demand to Explain Rising Health Care Costs
Cost-enhancing technologies
Higher quality of medical care
Supply curve shifts to the left
Demand curve shifts to the right
Higher medical care expenditures
classroom use.
The Monopoly Model of Market Behavior and Performance
Monopoly
Least competitive market structure
One firm is the sole provider of a product
Perfect barriers to entry
Potential for market power: socially undesirable

Price can be influenced by reducing quantity
Downward sloping market demand curve
Marginal revenue (MR) is less than price (P)
classroom use.
Monopoly versus Perfect Competition
Monopolist
Charges a higher price and produces less
Smaller consumer surplus
Bigger producer surplus
Smaller total surplus
Deadweight loss
Perfectly competitive firm
Charges a lower price and produces more
Larger consumer surplus
Smaller producer surplus
Greater total surplus
No deadweight loss

classroom use.
Figure 8.5 - The Monopoly Outcome
Quantity of generic aspirin (Q)
QC
Price per unit (P)
D = MPB
A
S = MPC
G
C
PC
MR
F
QM
K
PM
M
A monopoly produces at QM where MR = MC and charges price
PM. Reflecting that society’s scarce resources are misallocated,
a deadweight loss of area MCF is created by the monopolist.
The perfectly competitive outcome is represented by point C.
Consumer surplus is larger (the area APCC compared to the area
APMM in case of monopoly).
classroom use.
Barriers to Entry
Barriers to entry
Make it costly for new firms to enter market

Probable reasons
Exclusive control over a necessary input
Presence of sunk costs
Absolute cost advantage
Limit pricing
Legal restrictions
Licenses
classroom use.
Figure 8.6 - Scale Economies as an Entry Barrier
Quantity of medical care (q)
qE
Costs of
medical
care
CE
ATC
qX
CX
An entrant with a relatively small volume of output of qE
produces at a cost of CE. Because of the scale economies, an
existing firm can charge a price slightly below CE and
discourage the entry from actually entering the market.
The declining average total cost curve, ATC reflects scale
economies in production. An existing firm producing a large
volume of output at qX produces at a cost of CX.

classroom use.
The Buyer Side of the Market
Real world scenario
Buyers can possess varying degrees of market power
Exact outcome depends upon the relative bargaining power of
the buyers and sellers
Monopsony: market with a single buyer
classroom use.
Monopolistic Competition and
Product Differentiation
Monopolistic competition
Many sellers with relatively small market shares
Somewhat differentiated product
Advertising, quality differences, location preferences
classroom use.

No barriers to entry
Slightly asymmetric information among buyers
Highly elastic market demand curve
More differentiated product: less elastic demand
Some market power over output
Brand loyalty
classroom use.
Short run
A firm may earn economic profit
P > ATC, at the level of output where MC = MR
Other firms are attracted to the industry
Long run
Market share for each firm diminishes
Demand faced by each firm falls
Economic profits becomes zero
More elastic demand than in the short run

classroom use.
Figure 8.7 - Long-Run Equilibrium for a Monopolistically
Competitive Firm
Quantity (q)
q0
Price per unit (P)
d
P0
MR
ATC
MC
In the long run, the representative monopolistically competitive
firm produces at q0 where MR = MC and charges a price equal
to average total costs.
Because there are no meaningful entry barriers, firms continue
to enter the market until the representative firm earns only a
normal profit.
classroom use.
Pro-competitive and Anticompetitive Aspects of Product
Differentiation
Pro-competitive
Advertising
Promotes lower prices and higher quality
Brand names and trademarks

Anticompetitive
Advertising
Promotional activities to establish brand loyalty
Product differentiation
Influences consumer demand and preferences
Creates barriers to entry
classroom use.
Oligopoly
Market structure
Few dominant firms
Substantial barriers to entry
Market power: individually or collectively
Mutual interdependence
Dominant firms must be sufficiently sized and limited
The behavior of any one firm influences the pricing and output
decisions of the other major firms in the market
classroom use.
Collusive Oligopoly
All the firms in the industry cooperate

Joint profits maximization
Deadweight loss: misallocation of resources
Overt collusion
Representatives of the firms formally meet
To coordinate prices and divide up markets
Tacit collusion
Firms informally coordinate their prices
Price leadership model
classroom use.
Collusive Oligopoly
Difficulties associated with collusion
Sherman Antitrust Act
Informal tacit collusion
Hard to interpret the motive (s) behind the price adjustments
made by the industry leader
Cost differences
Low entry barriers
More firms in the industry
Incentives to cheat on the agreement
classroom use.

Competitive Oligopoly
Firms in a competitive oligopoly
Rivals may not coordinate their behavior
Aggressively seek to individually maximize their own profits
Each firm has an incentive to lower its price to marginal cost
Market output
Price equals marginal cost
Resources are efficiently allocated
classroom use.
Collusive or Competitive Oligopoly?
Conjectural variations
Reaction of rivals to a firm’s output decision
Determine market output and price
Depend on firm characteristics and the market conditions
Matching behavior
Fewer firms; high barriers to entry
Social and historical ties
Closer proximity
Bounded rationality
classroom use.

Oligopolistic Behavior in Medical Care Markets
Blood banking industry
Two dominant not-for-profit firms ($2 billion industry)
American Red Cross: 46% market share
America’s Blood Centers (ABC): 47% market share
In 1998, American Red Cross increased its national market
share to 65%
Competitive oligopoly model
Lower price prevailed in the regions where both firms coexisted
than in the regions where only one firm operated
classroom use.
Oligopolistic Behavior in Medical Care Markets
Stent market
Johnson and Johnson (J&J)
In 1997, stent market: $600 million; J&J held 95%
In 1998, stent market: $1 billion; J&J held 8%
J&J angered key customers
Rigid pricing and denying discounts
Pressure on Food and Drug Administration (FDA) to approve
new stents as quickly as possible
Guidant Corporation
Approval of patent (took 45 days)
Market share: 70%

classroom use.
Defining Relevant Market, Measuring Concentration &
Identifying Market Power
Better understand & predict market behavior and performance
Determine precise boundaries of a market
Determine precise product being bought & sold
Identify the number of sellers in a market area
Theoretical issues and practical limitations when defining
markets
How market concentration and market power are measured in
practice
classroom use.
The Relevant Product and Geographical Markets
Two dimensions of market
Relevant product market (RPM)
Substitutability of goods and services
Relevant geographical market (RGM)
Establishes the spatial boundaries in which a set of buyers
purchase their products
Different levels can be local, regional, national, or international
Includes all of the seller locations to which buyers might switch

classroom use.
Measuring Market Concentration
Concentration ratio
Percentage of industry output produced by the largest firms in
an industry
CR4 = sum of market shares of four largest firms
Ranges between 0 and 100%
CR4 ≥ 60%: tightly oligopolistic
CR4 between 40% and 60%: loose oligopoly
CR4 ≤ 40%: reasonably competitive
Shortcoming: fails to reveal the distribution of industry output
among the largest firms
classroom use.
Measuring Market Concentration
Herfindahl-Hirschman index (HHI)
Sum the squared market shares of all the firms in the relevant
market
HHI = Σ Si2 = S12 + … + SN2
Si: percentage market share of the ith firm
0< HHI ≤ 10,000
HHI = 10,000
Market is dominated by one firm
HHI is closer to zero

Industry is less concentrated or more structurally competitive
classroom use.
Lerner index of monopoly power (L)
Monopoly - market power
Measured by how high price (P) can be elevated above the
marginal costs (MC) of production
L = (P –MC) / P = 1 / |EM|
EM: price elasticity of demand
L = 0: perfectly competitive firm
EM = ∞: perfectly elastic demand curve
L = π / TR
Higher ratio of economic profits (π) to total revenues (TR) or
sales means higher market power
classroom use.
Drawing inferences about market power from profit data
Reported rates represent accounting and not economic profits
Even perfectly competitive firms earn a normal, economic profit

rate
Investments in some industries are riskier than others
A perfectly competitive industry earns a normal rate of return in
the long run
classroom use.
APA Requirement Details:
The U.S. Health Care Presentation: Part 1 Assignment
· Must be seven to nine slides in length (not including title and
references slides) and formatted according to APA style as
outlined in the Ashford Writing Center’s How to Make a
PowerPoint Presentation (Links to an external site.)Links to an
external site..
· Must include a separate title slide with the following:
· Title of presentation
· Student’s name
· Course name and number
· Instructor’s name
· Date submitted
For further assistance with the formatting and the title page,
refer to APA Formatting for Word 2013 (Links to an external
site.)Links to an external site..
· Must utilize academic voice. See the Academic Voice (Links
to an external site.)Links to an external site. resource for
additional guidance.
· Must use at least two scholarly or credible sources (a least one
should be from the Ashford University Library).
· The Scholarly, Peer-Reviewed, and Other Credible

Sources (Links to an external site.)Links to an external
site. table offers additional guidance on appropriate source
types. If you have questions about whether a specific source is
appropriate for this assignment, please contact your instructor.
Your instructor has the final say about the appropriateness of a
specific source for a particular assignment.
· Must document any information used from sources in APA
style as outlined in the Ashford Writing Center’s Citing Within
Your Paper (Links to an external site.)Links to an external site..
· Must include a separate reference slide that is formatted
according to APA style as outlined in the Ashford Writing
Center. See the Formatting Your References List (Links to an
external site.)Links to an external site. resource in the Ashford
Writing Center for specifications
For this assignment, you will provide an overview of the U.S.
health care system. Follow the instructions below to complete
the assignment:
· TITLE SLIDE-Begin your presentation by including a title
slide (see specifics below).
· In the speaker’s notes of the title slide, include your
introductory information, which will include your degree plan
and any health care experience you have had or share your
qualifications related to the information you are presenting. If
you have no health care experience, you can be creative with
professional experience.
· FIRST SLIDE-Create an overview slide that describes the
required components to be covered within the presentation. Add
bulleted points for each of the topics being covered. Briefly
describe each bulleted point in the speaker’s notes.
· REMAINING SLIDES- Choose one revolutionary factor
fromeach of the centuries(17th, 18th, 19th, 20th, and 21st)
found in your textbook and time line.
· Describe each revolutionary factor.

· Explain how the revolutionary factors changed the health care
system.
· Refer to the time line simulation Global Perspectives: Shifts in
Science and Medicine That Changed Healthcare (Links to an
external site.)Links to an external site. Good resource for this
part of the presentation as well.
· Identify at least one major development from each of the
following perspectives: financial, legal, ethical, regulatory, and
social
· Discuss how each development transformed the system into
what it is today. For more perspective, you may want to review
the time line simulation Global Perspectives: Shifts in Science
and Medicine That Changed Healthcare (Links to an external
site.)Links to an external site..
· Choose three different stakeholdersthat haveaffected the
health care system (e.g., health care professionals [physicians,
nurses, etc.], clients [patients], health insurance plans [Blue
Cross Blue Shield, managed care organizations (MCOs), etc.],
federal or state governments, health care professional
organizations [American Medical Association (AMA), American
Nurses Association (ANA), etc.] and health care accreditation
agencies [Centers for Medicare and Medicaid Services (CMS),
The Joint Commission, National Committee for Quality
Assurance (NCQA), etc.]).
· Explain each stakeholder’s effect on the health care system by
discussing their purpose and impact.
· Include examples of both positive and negative impacts made
by your chosen stakeholders (e.g., a negative contribution is
when a patient uses the emergency room for nonurgent care).
TEXTBOOK:
Batnitzky, A., Hayes, D., & Vinall, P. E. (2018). The U.S.
healthcare system: An introduction. Retrieved from
https://content.ashford.edu

United States Department of Labor, Bureau of Labor Statistics.
(n.d.). Occupational outlook handbook: Healthcare
occupations (Links to an external site.)Links to an external
site.. Retrieved from
http://www.bls.gov/ooh/healthcare/home.htm
PBS. (n.d.). Healthcare timeline (Links to an external
site.)Links to an external site.. Retrieved from
http://www.pbs.org/healthcarecrisis/history.htm
Physicians for a National Health Program. (n.d.). A brief
history: Universal health care efforts in the US (Links to an
external site.)Links to an external site.. Retrieved from
http://www.pnhp.org/facts/a-brief-history-universal-health-care-
efforts-in-the-us
Reading Study Chapter 8 of the text. Review the PowerPoint
lesson for Chapter 8 Assignments The following Assignments
should be completed and submitted to the course faculty via the
learning platform for evaluation and grading. Submit your
responses to these questions in one WORD document. List the
question first, and then your response. Be sure to properly site
your sources, both in-text and with a reference list at the
conclusion. If you use an online source to support your answers,
you must provide a properly formatted link to the source. You
should use APA citation format and make sure your sources are
credible. In most cases, your responses should be no more than
400 words.
1. Suppose the supply curve of medical services is perfectly
inelastic. Analyze the impact of an increase in consumer income
on the market price and quantity of medical services. Next,
assume the demand for medical services is perfectly inelastic
while the supply curve is upward sloping. Explain the impact of
an increase in input prices on the market price and quantity of
medical services.
2. In the country of Drazah Larom (moral hazard spelled

backward), health insurance is nonexistent and all medical
markets are perfectly competitive. Use supply and demand
analysis to explain the impact of the following changes on the
price and output of physician services. a. A decrease in the
wage of clinic-based nurses b. The adoption of cost-enhancing
medical technologies c. An aging population and a
correspondingly more severe patient case-mix d. Declining
consumer income e. A lower market price for physician services
(be careful here!) 20 BUS508 – Economics of Health and
Medical Care Course Syllabus
3. In the 1980s, a shortage of registered nurses in the United
States led to an increase of almost 21 percent in the real average
hourly earnings of RNs from 1981 to 1989 (Pope and Menke,
1990). This increase was the highest of any occupational group.
Use supply and demand theory to show the shortage and explain
why a dramatic rise in the wage rate occurred.
4. Using supply and demand analysis, show graphically and
explain verbally some of the factors that may have led to rising
health care costs in the United States from 1960 to the present
day. 5. In the mid-1980s, female nurses became increasingly
aware that a relatively large number of attractive job
opportunities existed outside the medical services industry. In
fact, a large number of colleges offered life and transfer credits
for nurses so that they could change careers at less cost. Using
an equilibrium model of the market for nurses, show what
impact this market change had on the wage rate and employment
of nurses. Work through the comparative static analysis and
explain whether a temporary shortage or surplus occurred and
the various market adjustments that took place as a result of the
temporary imbalance.
6. Assume the sale of human organs is legalized and a free
market develops. Furthermore, assume the market is in
equilibrium. Trace through the price and output effects of the
following: a. An increase in the incomes of potential buyers of
human kidneys. b. A decrease in the price of kidney dialysis. c.
The development of a new drug that leaves the immune system

intact while preventing transplant rejection (Waldholz, 1992). d.
A greater willingness by individuals to supply human kidneys.
7. Explain why economic profits are zero under monopolistic
competition in the long run.
8. Explain the economic reasoning underlying the following
statement: “People often fail to acquire information about the
price they pay for medical services because of health
insurance.” 9. Explain why it is also important to analyze the
structural aspects of the buyer-side of the market.
10. Identify the theoretical underpinnings associated with using
profit rate as a mea-sure of market power. What adjustments
must be made to reported profit rates for economic reasons?

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