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MarketFailure 11 Farid Abolhassani Learning Objectives After
working through this chapter, you will be able to: Categorize and
describe the activities of government Describe why monopoly power,
externalities andinformation asymmetries constitute market failures
Explain the consequences for price, output andefficiency for each
market failure Explain how monopoly power, externalities
andinformation asymmetries manifest themselves in thehealth care
market Suggest some possible government strategies for eachhealth
care market failure Key Terms Adverse Selection When a party enters
into an agreement in which they can use their own private
information to the disadvantage of another party. Barriers to entry
Factors which prevent a firm from entering a market. Deadweight
loss The loss in allocative efficiency resulting from the loss of
consumer surplus is greater than the gain in producer surplus.
Externality Cost or benefit arising from an individuals production
or consumption decision which indirectly affects the well-being of
others. Fee-for-service A means of paying health care staff on the
basis of the actual items of care provided. Monopoly power Ability
of a monopoly to raise price by restricting output. Key Terms Moral
hazard A situation in which one of the parties to an agreement has
an incentive, after the agreement is made, to act in a manner that
brings additional benefits to themselves at the expense of the
other party. Natural monopoly A situation where one firm can meet
market demand at a lower average cost than two or more firms could
meet that demand. Price discrimination Offering the same product at
different prices to different people. Public good A good or service
that can be consumed simultaneously by everyone and from which no
one can be excluded. Social cost Private cost plus external cost.
Supplier-induced demand Increased demand as a result of a provider
(e.g. a doctor) exploiting an asymmetry of information. Transaction
costs The costs of engaging in trade i.e. the costs arising from
finding someone with whom to do business, of reaching an agreement
and of ensuring the terms of the agreement are fulfilled. Main
Areas of Government Activity
Redistribution of wealth and income; Stabilization of the
macro-economy (to keep unemployment, inflation and economic growth
at reasonable levels); Correction of microeconomic market failure.
Ensuring and protecting public goods; Controlling monopoly power;
Reducing externalities; Reducing asymmetry of information. Public
Good Is health care a public good?
A public good is a good or service that can be consumed
simultaneously by everyone and from which no individuals can be
excluded Is health care a public good? Perfect Competition Demand,
Price and Revenue in Perfect Competition Total Revenue, Total Cost
and Economic Profit Profit-maximizing Output Three Possible Profit
Outcomes in the Short-Run A Firms Supply Curve If a firm shuts down
and produces no output, it incurs an economic loss equal to its
total fixed cost. This loss is the largest that a firm need incur.
A firm shuts down if price falls below the minimum average variable
cost. Industry Supply Curve Short-run Equilibrium Entry and Exit
Monopoly Market Power Market power is the ability to influence the
market, and in particular the market price, by influencing the
total quantity offered for sale. Firms in perfect competition have
no market power Monopoly In monopoly, the firm is the
industry
A monopoly is a firm that produces a good or service for which no
close substitute exists and ; which is protected by a barrier that
prevents other firms from selling that good or service In monopoly,
the firm is the industry Barriers to Entry Legal barriers Natural
barriers Monopoly franchise
Government license Patent Copyright Natural barriers An industry in
which one firm can supply the entire market at a lower price than
two or more firms can Natural Monopoly LRAC: Long Run Average Cost
Monopoly Price-setting Strategies
Price discrimination Single price Price and Marginal Revenue
Marginal Revenue and Elasticity
A profit maximizing monopoly never produces an output in the
inelastic range of its demand curve A Monopolys Output and Price
Decision A Monopolys Output and Price
If firms in a perfectly competitive industry make a positive
profit, new firms enter. Look at the part (b) of the chart of this
slide. In a perfectly competitive market, the quantity demanded at
maximal profitable output, marginal revenue is below the demand
line. This means that at this marginal revenue (price in perfectly
competitive market) the quantity is more than the output of
existing firm. In other words there is room for other firms in the
market. In case of monopoly other firms are refrained from entering
the market and the existing one can sell its products at the price
that the demand curve necessitates. A monopoly produces the
profit-maximizing quantity and sells that quantity for the highest
price it can get Single-price Monopoly and Competition
Compared
What will happen if a single firm buys out all small firms and
creates a monopoly? Will the price rise or fall? Will the quantity
produced increase or decrease? Will economic profit increase or
decrease? Will either the original competitive situation or the new
monopoly situation be efficient? Monopolys Smaller Output and
Higher Price
Compared to a perfectly competitive industry, a single-price
monopoly restricts its output and charges a higher price.
Inefficiency of Monopoly The Effects of Monopoly on Consumer
Interests
It produces less It increases the cost of production It increases
the price above the increased cost of production Price
Discrimination Price discrimination is charging different prices
for a single good or service because of differences in buyers
willingness to pay and not because of differences in production
costs Requirements of Price Discrimination
To be able to price discriminate, a monopoly must: Identify and
separate different buyer types Sell a product that can not be
resold Price Discrimination Methods
Among units of a good: Charging each buyer a different price on
each unit of a good bought Among groups of buyers: Charging
different groups of buyers differently Price Discrimination among
Groups of Buyers Perfect Price Discrimination
The more perfectly the monopoly can price discriminate, the closer
its output gets to the competitive output and the more efficient is
the outcome. Gains from Monopoly Incentives to innovation
Economies of scale and economies of scope Regulating a Natural
Monopoly Externalities Definition Production Externality: A cost or
a benefit that arises from production of a good or service and
falls on someone other than the producer Consumption Externality: A
cost or benefit that arises from consumption of a good or service
and falls on someone other than the consumer Classification
Negative production externalities: Environmental pollution Positive
production externalities: Orange blossom honey production Negative
consumption externalities: Smoking Positive consumption
externalities: Vaccination An External Cost How is an external cost
valued? Inefficiency with an External Cost Property Rights Achieve
and Efficient Outcome Government Actions in the Face of External
Costs
Taxes: setting the tax rate equal to the marginal external cost
Emission Charges: setting a price per unit of pollution Marketable
Permits: issuing each firm a permit to emit a certain amount of
pollution, and firms can buy and sell these permits A Pollution Tax
An External Benefit Government Actions in the Face of External
Benefits
Public provision Private subsidies Vouchers Patents and copyrights
Public provision or Private Subsidy to Achieve an Efficient Outcome
Vouchers Achieve an Efficient Outcome Asymmetric Information
Asymmetry of Information
Asymmetry of information exists when one person in an economic
transaction has more relevant information than the other person. It
requires that the cost to the uninformed person of accessing this
information is prohibitively high Types of Asymmetrical
Information
Moral hazard exists when one of the parties to an agreement has an
incentive after the agreement is made to act in a way that brings
him or herself benefit at the expense of the other party Adverse
selection is the tendency for people to enter into agreements in
which their personal information can be used to their own advantage
over less informed parties Market Failure In Health Care Market
Failure in Health Care
Failure of the health insurance market Health care externalities
(already discussed) Failure of the health care market Failure of
the Health Insurance Market
Why is there a lack of competition in the health insurance market?
Economy of Scale What policies are used to counteract moral hazard
in the health insurance market? What groups of people are likely to
be without health insurance? Policies to Counteract Moral
Hazard
Consumer side: Co-payments Deductibles Putting an upper limit on
the payout Provider side: Prospective payments (HMOs) Building
protocols into their contracts Uninsured Groups Those who consider
themselves to be of low risk but cannot find an insurance policy
that reflects this low risk Those at high risk who cannot afford to
pay an actuarially fair premium Causes of Health Care Market
Failure
Barriers to entry and exit: Licensing Monopoly power even when
there are many providers Asymmetrical information Heterogeneous
services Unexpected Market Response
Price S S PE PE P1 QE Q1 QE Quantity Major Features of Health
Care
Uncertainty and risk Derived demand The health itself is invaluable
Asymmetrical information Supplier-induced demand Extreme importance
of equity Catastrophic health expenditure