Eco 550 Market Model Patterns Of Change

1723 words - 7 pages

Market Model Patterns of Change

ECO 550
January 26, 2012

The restructuring of the health care industry refers to a sweeping array of changes in the organization, ownership, and regulation of health care providers and in the delivery of services. Cost concerns, increasing competition, influence of investor priorities, technological advances, changing social attitudes, and an aging and increasingly diverse population are factors that will sustain this dynamic situation.
The health insurance industry in the United States is fast paced, and characterized by rapid growth. Health insurance providers are numerous, and choices ...view middle of the document...

The result is a demand curve for the firm that is kinked at the current equilibrium price [ (Department of Economics) ]. Taking the assumption into consideration, a single firm which tries to raise price will be left in the dark by the other firms and will lose market share, suffering a huge loss in demand because its competitors’ prices remain low. Conversely, a single firm that cuts prices will only see a small increase in demand and no increase in market share, as all of its competitors match the price reduction. As a result, a firm will have a kinked demand curve. The curve will be flat above the current price, since a price hike results in a loss of market share. The curve will be steep below the current price, since a price reduction results in no increase in market share. Changes in cost do not impact output and prices, as long as marginal cost remains in the vertical portion of marginal revenue.
In the short-run, firms may operate at a profit, if demand for the product is high relative to costs. The firm may shut down if it can’t generate enough revenue to even cover the variable costs, or may operate at a loss, if it can't generate enough revenue to cover all of its costs.
Hence the model predicts that prices in the long run should be fairly rigid in an oligopoly. The kinked demand theory suggests that there will be price stickiness in these markets and that firms will rely more on non-price competition to boost sales, revenue and profits [ (Kinked demand curve under Oligopoly) ]. The result is no gain in market share and relative small increases in quantity demanded [ (AmosWEB Encyclonomic WEB*pedia) ]. In the health insurance industry, this could indicate that insurance premiums will remain fairly stable.

In the health insurance industry, transaction cost could arise from process outsourcing, enforcement and compliance costs, and increased product complexity.
When firms in the insurance industry grow and consolidate in due time (due to mergers, high fixed costs), outsourcing of processes may become a necessity. As firms gather up more and more customers, the current workforce will no longer be able to handle jobs. For firms, hiring more employees could be very costly because of increasing market salaries, therefore outsourcing could be the only option. If outsourcing does occur, firms will have to pay additional expenses to outsourcing firms that process application, and provide customer service, leading to transaction cost.
As firms seek to increase its customer base, customer contract compliances especially for insurers can lead to transactions costs because firms will have to add more expenses in order to hire new employees to monitor and check compliance with contracts. Such a cost does not occur if a firm is small, because it is easier to manage a smaller customer base. On top of enforcing contracts, legal action against non compliance can also lead to...

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