The RAND Journal of Economics

Published by RAND
Online ISSN: 1756-2171
Print ISSN: 0741-6261
Publications
We call markets in which intermediaries sell networks of suppliers to consumers who are uncertain about their needs "option demand markets." In these markets, suppliers may grant the intermediaries discounts in order to be admitted to their networks. We derive a measure of each supplier's market power within the network; the measure is based on the additional ex ante expected utility consumers obtain from the supplier's inclusion. We empirically validate the WTP measure by considering managed care purchases of hospital services in the San Diego market. Finally, we present three applications, including an analysis of hospital mergers in San Diego.
 
We analyze the productivity of information technology in emergency response systems. "Enhanced 911" (E911) is information technology that links caller identification to a location database and so speeds up emergency response. We assess the impact of E911 on health outcomes using Pennsylvania ambulance and hospital records between 1994 and 1996, a period of substantial adoption. We find that as a result of E911 adoption, patient health measured at the time of ambulance arrival improves, suggesting that E911 speeds up emergency response. Further analysis using hospital discharge data shows that E911 reduces mortality and hospital costs.
 
This article addresses the effect of hospital ownership on the delivery of service to uninsured patients. It compares the volume of uninsured patients treated in for-profit and nonprofit hospitals by regarding hospital ownership and service as endogenous. Instrumental variable estimates are used to predict the percentage of patients who are uninsured, controlling for hospital ownership and service. The study shows that when for-profit and nonprofit hospitals are located in the same area, they serve an equivalent number of uninsured patients, but for-profit hospitals indirectly avoid the uninsured by locating more often in better-insured areas.
 
Quality differentiation is especially important in the hospital industry, where the choices of Medicare patients are unaffected by prices. Unlike previous studies that use geographic market concentration to estimate hospital competitiveness, this article emphasizes the importance of quality differentiation in this spatially differentiated market. I estimate a random-coefficients discrete-choice model that predicts patient flow to different hospitals and find that demand responses to both distance and quality are substantial. The estimates suggest that patients do not substitute toward alternative hospitals in proportion to current market shares, implying that geographic market concentration is an inappropriate measure of hospital competitiveness.
 
We analyze admission and discharge decisions when hospitals become capacity constrained on high-demand days, and develop a test for discrimination that, under certain circumstances, does not require controls for differences across patient groups. On high-demand days, patients are discharged earlier than expected compared to those discharged on low-demand days. High demand creates no statistically significant differences in hospitals' admission behavior. Thus, hospitals appear to ration capacity by hastening discharges rather than by restricting admissions. We could not reject a null hypothesis of no discrimination against Medicaid patients in discharges
 
Managed care may influence technology diffusion in health care. This article empirically examines the relationship between HMO market share and the diffusion of neonatal intensive care units. Higher HMO market share is associated with slower adoption of mid-level units, but not with adoption of the most advanced high-level units. Opposite the common supposition that slowing technology growth will harm patients, results suggest that health outcomes for seriously ill newborns are better in higher-level units and that reduced availability of mid-level units may increase their chance of receiving care in a high-level center, so that slower mid-level growth could have benefitted patients.
 
This article examined the physician-patient agency relationship in the context of the prescription drug market in Japan. In this market, physicians often both prescribe and dispense drugs and can pocket profits in so doing. A concern is that, due to the incentive created by the mark-up, physicians' prescription decisions may be distorted. Empirical results using anti-hypertensive drugs suggest that physicians' prescription choices are influenced by the mark-up. However, physicians are also sensitive to the patient's out-of-pocket costs. Overall, although the mark-up affects prescription choices, physicians appear more responsive to the patient's out-of-pocket costs than their own profits from mark-up.
 
Despite the importance of principal-agent models in the development of modern economic theory, there are few estimations of these models. I recover the estimates of a principal-agent model and obtain an approximation to the optimal contract. The results show that out-of-pocket payments follow a concave profile with respect to costs of treatment. I estimate the welfare loss due to moral hazard, taking into account income effects. I also propose a new measure of moral hazard based on the conditional correlation between contractible and noncontractible variables.
 
Economic theorists have given little attention to health-related externalities, such as those involved in the spread of AIDS. One reason for this is the critical role played by psychological factors, such as fear of testing, in the continued spread of the disease. We develop a model of AIDS transmission that acknowledges this form of fear. In this context we design a mechanism that not only encourages testing but also slows the spread of the disease through voluntary transmission. Our larger agenda is to demonstrate the power of psychological incentives in the public health arena.
 
We identify an important class of economic problems that arise naturally in several applications: the allocation of multiple resources when there are uncertainties in demand or supply, unresponsive supplies (no inventories and fixed capacities), and significant demand indivisibilities (rigidities). Examples of such problems include: scheduling job shops, airports, or supercomputers; zero-inventory planning; and the allocation and pricing of NASA's planned Space Station. Using experimental methods, we show that the two most common organizations used to deal with this problem, markets and administrative procedures, can perform at very low efficiencies (60-65% efficiency in a seemingly robust example). Thus, there is a need to design new mechanisms that more efficiently allocate resources in these environments. We develop and analyze two mechanisms that arise naturally from auctions used to allocate single-dimensional goods. These new mechanisms involve computer-assisted coordination made possible by the existence of networked computers. Both mechanisms significantly improve on the performance of administrative and market procedures.
 
Estimated responses to report cards may reflect learning about quality that would have occurred in their absence ("market-based learning"). Using panel data on Medicare HMOs, we examine the relationship between enrollment and quality before and after report cards were mailed to 40 million Medicare beneficiaries in 1999 and 2000. We find consumers learn from both public report cards and market-based sources, with the latter having a larger impact. Consumers are especially sensitive to both sources of information when the variance in HMO quality is greater. The effect of report cards is driven by beneficiaries' responses to consumer satisfaction scores.
 
Adverse selection is perceived to be a major source of market failure in insurance markets. There is little empirical evidence on the extent of the problem. We estimate a structural model of health insurance and health care choices using data on single individuals from the NMES. A robust prediction of adverse-selection models is that riskier types buy more coverage and, on average, end up using more care. We test for unobservables linking health insurance status and health care consumption. We find no evidence of informational asymmetries.
 
We examine optimal individual and entity-level liability for negligence when expected accident costs depend on both the agent's level of expertise and the principal's level of authority. We consider these issues in the context of physician and managed care organization (MCO) liability for medical malpractice. Under current law, physicians generally are considered independent contractors and hence MCOs are not liable for negligent acts by physicians. We find that the practice of reviewing the medical decisions of physicians affects their incentives to take care, which in turn implies that it is efficient for MCOs to be held liable for the torts committed by their physicians.
 
Suppliers who are better informed than purchasers, such as physicians treating insured patients, often have discretion over what to provide. I show how, when the purchaser observes what is supplied but neither the recipient type nor the actual cost incurred, optimal provision differs from what would be efficient if the purchaser had full information, weather or not the supplier can extract informational rent. The analysis is applied to, among other things, data on tests for coronary artery disease and to Medicare diagnosis-related groups defined by the treatment given, not just the diagnosis, illustrating the biases in provision that result.
 
Integrating the health services and insurance industries, as health maintenance organizations (HMOs) do, could lower expenditure by reducing either the quantity of services or unit price or both. We compare the treatment of heart disease in HMOs and traditional insurance plans using two datasets from Massachusetts. The nature of these health problems should minimize selection. HMOs have 30% to 40% lower expenditures than traditional plans. Both actual treatments and health outcomes differ little; virtually all the difference in spending comes from lower unit prices. Managed care may yield substantial increases in measured productivity relative to traditional insurance.
 
In many countries, pharmacies receive high regulated markups and are protected from competition through geographic entry restrictions. We develop an empirical entry model for pharmacies and physicians with two features: entry restrictions and strategic complementarities. We find that the entry restrictions have directly reduced the number of pharmacies by more than 50%, and also indirectly reduced the number of physicians by about 7%. A removal of the entry restrictions, combined with a reduction in the regulated markups, would generate a large shift in rents to consumers, without reducing the availability of pharmacies. The public interest motivation for the current regime therefore has no empirical support.
 
We discuss the effects of managed care on the structure of the health care delivery system, focusing on managed-care-induced consolidation among health care providers. We empirically investigate the relationship between HMO market share and mammography providers. We find evidence of consolidation: increases in HMO activity are associated with reductions in the number of mammography providers and with increases in the number of services produced by remaining providers. We also find that increases in HMO market share are associated with reductions in costs for mammography and with increases in waiting times for appointments, but not with worse health outcomes.
 
This article identifies the impact of managed-care reforms on the utilization of medical services within the military health-services system. The data come from a recent demonstration project that substituted an HMO and PPO for traditional FFS arrangements. Results from a semiparametric model indicate that the generosity of benefits in the HMO increased demand for ambulatory services. Unlike the private-sector experience with managed care, aggressive utilization review did not significantly curtail inpatient stays. These results vitiate the presumed effectiveness of reform strategies that rely on large, geographically diffused managed-care networks to contain public-sector health costs.
 
A simple three-parameter description of medical technology is introduced to investigate the relationships between technical change, welfare, and type of insurance contract. The value of a particular change in technology depends on the existing form of contract. The marginal equilibrium expected utility to consumers of different types of technical change hinges on the manner in which the insurance arrangement is designed to mitigate moral hazard. These results open the way for a positive model of the effects of insurance arrangements on the types of technology that are adopted and the effects of technical changes on the prevalent forms of insurance contract.
 
We model demand for four cephalosporins and compute own- and cross-price elasticities between branded and generic versions of the four drugs. We model demand as a multistage budgeting problem, and we argue that such a model is appropriate to the multistage nature of the purchase of pharmaceutical products, in particular the prescribing and dispensing stages. We find quite high elasticities between generic substitutes and also significant elasticities between some therapeutic substitutes.
 
This article studies provision of charity care by private, nonprofit hospitals. We demonstrate that in the absence of large positive income effects on charity care supply, convex preferences for the nonprofit hospital imply crowding out by other private or government hospitals. Extending our model to include impure altruism (rivalry) provides a possible explanation for the previously reported empirical result that both crowding out and income effects on indigent care supply are often weak or insignificant. Empirical analysis of data for hospitals in Maryland provides evidence of rivalry on the supply of charity care.
 
I use data from the University of California to empirically examine the role of social learning in employees' choices of health plans. The basic empirical strategy starts with the observation that if social learning is important, health plan selections should appear to be correlated across employees within the same department. Estimates of discrete choice models in which individuals' perceived payoffs are influenced by coworkers' decisions reveal a significant (but not dominant) social effect. The strength of the effect depends on factors such as the department's size or the employee's demographic distance from her coworkers. The estimated effects are present even when the model allows for unobserved, department-specific heterogeneity in employee preferences, so the results cannot be explained away by unobservable characteristics that are common to employees of the same department.
 
Impediments to worker mobility serve to mitigate the attrition of healthy individuals from employer-sponsored insurance pools, thereby creating a de facto commitment mechanism that allows for more complete insurance of health risks than would be possible in the absence of such frictions. Using data on health insurance contracts obtained from the 1987 National Medical Expenditure Survey, we find that the quantity of insurance provided is positively related to the degree of worker commitment. These results illustrate the importance of commitment in the design of long-term contracts, and provide an additional rationale for the bundling of health insurance with employment.
 
Using data from the 1979 and 1987 National Health Interview Survey (NHIS), we test whether smokers alter their smoking habits in the face of higher taxes. Smokers in high-tax states are more likely to smoke cigarettes higher in tar and nicotine. Although taxes reduce the number of cigarettes consumed per day among remaining smokers, total daily tar and nicotine intake is unaffected. Young smokers, aged 18-24, are much more responsive to changes in taxes than are older smokers, and their total daily tar and nicotine intake actually increases after a tax hike. We illustrate that tax-induced compensating behavior may eliminate some health benefits generated by reduced smoking participation. A more appropriate tax might be based on the tar and nicotine content of cigarettes.
 
INFORMATION STRUCTURE  
Insurers can exploit the heterogeneity within risk-adjustment classes to select the good risks because they have more information than the regulator on the expected expenditures of individual insurees. To counteract this cream skimming, mixed systems combining capitation and cost-based payments have been adopted that do not, however, generally use the past expenditures of insurees as a risk adjuster. In this article, two symmetric insurers compete for clients by differentiating the quality of service offered to them according to some private information about their risk. In our setting it is always welfare improving to use prior expenditures as a risk adjuster.
 
We examine competition in the hospital industry, in particular the effect of ownership type (for-profit, not-for-profit, government). We estimate a structural model of demand and pricing in the hospital industry in California, then use the estimates to simulate the effect of a merger. California hospitals in 1995 face an average price elasticity of demand of -4.85. Not-for-profit hospitals face less elastic demand and act as if they have lower marginal costs. Their prices are lower than those of for-profits, but markups are higher. We simulate the effects of the 1997 merger of two hospital chains. In San Luis Obispo County, where the merger creates a near monopoly, prices rise by up to 53%, and the predicted price increase would not be substantially smaller were the chains not-for-profit.
 
Recent work on the economics of the firm and other organizations has emphasized the importance of internal organization and incentives. The issue of competition within the firm has not arisen, however. In this article I construct a model of nonprice competition among members of a professional partnership and test the model with data on medical group practice. The empirical results are consistent with the hypothesis of nonprice competition among members of the firm.
 
Descriptive Statistics for Independent Variables 
Probit Results: Demand Coefficients 
Bias in HERF When FRINGEPOP and DISTANCE are Omitted Full FRINGEPOP and Service Model DISTANCE Omitted Bias 
Recent attention has been given to the hypothesis that local hospital competition takes the form of costly duplication of specialized services--the "medical arms race." This contrasts with the hypothesis that the supply of specialized services is determined solely by "the extent of the market." We develop a model predicting the provision of specialized services in local markets. Our analysis of California hospitals provides minimal support for the medical arms race hypothesis while suggesting substantial scale economies for many services. Our results emphasize the importance of properly specifying the extent of the market. Failure to do so leads one to overestimate the importance of competition.
 
Competition and prospective payment have been widely used to control health care costs but may together provide incentives to selectively reduce expenditures on high-cost relative to low-cost patients. We use patient discharge and hospital financial data from California to examine the effects of competition on costs for high- and low-cost admissions in the 12 largest Diagnosis-Related Groups before and after the Medicare Prospective Payment System (PPS). We find that competition increased costs before PPS, but that this effect decreased afterward, especially inpatients with the highest costs. We conclude that competition and PPS selectively reduced spending among the most expensive patients and that careful assessment of these patients' outcomes is important.
 
I examine Health Maintenance Organizations' (HMOs) voluntary disclosure of product quality, which is not as complete as unraveling theories predict. After controlling for cost and demand factors, I find that HMOs use voluntary disclosure to differentiate from competitors, with lower disclosure rates in highly competitive markets. These findings are consistent with product differentiation, but challenge the intuition that competition should lead to more provision of quality information.
 
This article examines the use of prices and warranties as signals of product quality to consumers who choose how to maintain their purchases. The seller's incentives are strongly affected by the interaction of quality and maintenance in determining product reliability. Two different assumptions about this interaction are made. A separating equilibrium in which high quality is signalled with a low warranty and low price is shown to be possible in both cases.
 
This article presents a model of procurement contracting with asymmetric cost information and investigates whether two of the model's predictions are consistent with actual contracts between hospitals and California's Medicaid program. The article first tests for the presence of a fixed-price payment region where Medicaid's payments are independent of hospitals' actual (but unobservable) production costs and then tests whether the size of the fixed-price region depends upon expectations about hospitals' costs. To conduct these tests, the article must first estimate hospitals' "unobservable" costs attributable to Medicaid patients. The article finds evidence of a fixed-price region but cannot confirm that the size of the fixed-price region depends upon expectations about hospitals' costs.
 
We examine how changes in hospital ownership to and from for-profit status affect quality and Medicare payments per hospital stay. We hypothesize that hospitals converting to for-profit ownership boost post acquisition profitability by reducing dimensions of quality not readily observed by patients and by raising prices. We find that 1-2 years after conversion to for-profit status, mortality of patients, which is difficult for outsiders to monitor, increases while hospital profitability rises markedly and staffing decreases. Thereafter, the decline in quality is much lower. A similar decline in quality is not observed after hospitals switch from for-profit to government or private nonprofit status.
 
We investigate the effects of political activity on pharmaceutical prices, focusing on the health care reform period in the early 1990s.We characterize firms based on their vulnerability to future price regulation and find that the more vulnerable firms were more likely to take various actions to forestall regulation, most notably coordinating on a specific percentage price increase during 1993. Since moderating price increases could have averted regulation, the coordination appears to be the industry's response to a collective action problem.
 
Increases in the cost of providing health insurance must have some effect on labor markets, either in lower wages, changes in the composition of employment, or both. Despite a presumption that most of this effect will be in the form of lower wages, we document a significant effect on work hours as well. Using data from the Current Population Survey (CPS) and the Survey of Income and Program Participation (SIPP), we show that rising health insurance costs during the 1980s increased the hours worked by those with health insurance by up to 3%. We argue that this occurs because health insurance is a fixed cost, and as it becomes more expensive to provide, firms face an incentive to substitute hours per worker for the number of workers employed.
 
In 1991 a most-favored customer (MFC) rule was adopted to govern pharmaceutical prices paid by Medicaid. Theoretical models show that an MFC rule commits a firm to compete less aggressively in prices. I find that the price of branded products facing generic competition rose (4% on average). Brands protected by patents did not significantly increase in price. Generics in concentrated markets should display a strategic response to the brand's adoption of the MFC; I find that generic firms raise price more as their markets become concentrated. Hospital prices show little change. The results suggest that the MFC rule caused higher prices for some pharmaceutical customers.
 
I examine the importance of physicians in the process by which patients receive either trade-name or generic drugs. Using a dataset on physicians, their patients, and the multisource drugs prescribed, I find that almost all physicians prescribe both types of drugs to their patients, but some physicians are more likely to prescribe generic drugs while other physicians are more likely to prescribe trade-name drugs. Very little of the prescription decision can be explained by observable characteristics of individual patients, but all of the evidence indicates that physicians are indeed an important agent in determining whether patients receive either trade-name or generic drugs.
 
We examine the relationship between firm size and research productivity in the pharmaceutical industry. Using detailed internal firm data, we find that larger research efforts are more productive, not only because they enjoy economies of scale, but also because they realize economies of scope by sustaining diverse portfolios of research projects that capture internal and external knowledge spillovers. In pharmaceuticals, economies of scope in research are important in shaping the boundaries of the firm, and it may be worth tolerating the static efficiency loss attributable to the market power of large firms in exchange for their superior innovative performance.
 
New data on medical malpractice claims against a single hospital in which a direct measure of the quality of medical care is available are used to investigate the roles of the negligence rule and incomplete information in the dispute settlement process in medical malpractice. We find that the quality of medical care (negligence) is an extremely important determinant of defendants' medical malpractice liability. More generally, we find that the data are consistent with a model in which plaintiffs are poorly informed ex ante about whether there has been negligence, file suit to gather information, and either drop the case if they find that negligence was unlikely or settle for a positive payoff if they find that negligence was likely. We also find that the cases are resolved earlier in the litigation process when the parties are more certain, one way or the other, about the likelihood of negligence.
 
Despite the importance of patient insurance in the market for prescription pharmaceuticals, little is known about the impact of patient reimbursement on the pricing behavior of pharmaceutical firms. I examine the link between potential patient out-of-pocket expenses and pharmaceutical pricing using a unique policy experiment from Germany. Starting in 1989, a maximum reimbursement for a given medicine replaced a flat prescription fee. This change in reimbursement exposes the patient to the price of a prescribed product. Using a product-level panel data set covering several therapeutic categories before and after the policy change, I find that producers significantly decrease prices after the change in potential patient out-of-pocket expenses. Price declines are most pronounced for brand-name products. Moreover, branded products that face more generic competitors reduce prices more.
 
Despite the popularity of pay-for-performance (P4P) among health policymakers and private insurers as a tool for improving quality of care, there is little empirical basis for its effectiveness. We use data from published performance reports of physician medical groups contracting with a large network HMO to compare clinical quality before and after the implementation of P4P, relative to a control group. We consider the effect of P4P on both rewarded and unrewarded dimensions of quality. In the end, we fail to find evidence that a large P4P initiative either resulted in major improvement in quality or notable disruption in care.
 
We estimate the welfare associated with the Medicare HMO program, now known as Medicare+Choice (M+C). We find that the creation of the M+C program resulted in approximately $15.6 billion in consumer surplus and $52 billion in profits from 1993 to 2000 (in 2000 dollars). This program most likely generated significant net social welfare. However, we find that consumer surplus is geographically unevenly distributed. Prescription drug coverage accounts for approximately 45% of the estimated consumer surplus for 2000. Consumer surplus increases in the number of plans in a county, and most of the increase in welfare is due to increased premium competition.
 
To develop new evidence on how hospital ownership and other aspects of hospital market composition affect health care productivity, we analyze longitudinal data on the medical expenditures and health outcomes of the vast majority of nonrural elderly Medicare beneficiaries hospitalized for new heart attacks over the period 1985-1996. We find that the effects of ownership status are quantitatively important. Areas with a presence of for-profit hospitals have approximately 2.4% lower levels of hospital expenditures, but virtually the same patient health outcomes. We conclude that for-profit hospitals have important spillover benefits for medical productivity.
 
I exploit a change in hospital financial incentives to examine whether the behavior of private not-for-profit hospitals is systematically related to the share of nearby hospitals organized as for-profit firms. My findings demonstrate that not-for-profit hospitals in for-profit intensive areas are significantly more responsive to the change than their counterparts in areas served by few for-profit providers. Differences in financial constraints and other observable factors correlated with for-profit hospital penetration do not explain the heterogeneous response. The findings suggest that not-for-profit hospitals mimic the behavior of private for-profit providers when they actively compete with them.
 
Legal penalties and liability insurance seem to have counteracting effects on the incentives of a potential injurer to take due care. However, if legal penalties are set efficiently and implemented perfectly, unrestricted access to insurance can be optimal. In contract, if the standards of guilt assessment are uncertain, the size of the legal penalties may act as a spur to litigation. Therefore, the penalties required to maintain incentives when access to insurance is unlimited may provoke too much litigation, and as a consequence, the costs of ensuring due care may decline when insurance is restricted by mandate.
 
In this article the voluntary sharing of information prior to settlement negotiations is studied in a model where one type of litigant--plaintiffs, to be exact--possesses private information. In equilibrium, plaintiffs whose expected judgments would exceed a certain threshold will reveal their information (if they can credibly establish it) and settle for higher amounts than if they were silent; plaintiffs with lower expected judgments will remain silent and settle. The effect of the legal right of "discovery" is also examined.
 
There has been much discussion about the timing of moves in games. However, one assumption usually goes unquestioned, namely, that of an irrevocable commitment of the first mover. In many cases this is not realistic, since final commitments are often preceded by actions that are binding only to a limited degree: partial commitments. An example is the announcements of price changes. I analyze a game in which the degree of a partial commitment is endogenized. In the case of strategic complements, a player profitably makes use of the possibility to commit partly. She chooses a role somewhere between first and second mover, which gives her a 1.5th-mover advantage.
 
This article investigates how the tying of complementary products can be used to preserve and create monopoly positions. We first show how a monopolist of a product in the current period can use tying to preserve its monopoly in the future. We then show how a monopolist in one market can employ tying to extend its monopoly into a newly emerging market. Our analysis explains how a dominant firm can use tying to remain dominant in an industry undergoing rapid technological change. The analysis focuses on entry costs and network externalities. We also relate our analysis to the Microsoft case.
 
This article concerns the economic incidence of the Interstate Commerce Act of 1887 (ICA). Our focus is the short-haul pricing constraint, a provision of the ICA that prohibited railroads from charging higher rates to isolated, primarily agrarian shippers than it charged to intercity shippers of similar commodities. Utilizing the event study methodology, we find that the impending passage of the ICA generated a distribution of abnormal returns to railroads and shipping firms that is consistent with the theoretical implications of our analysis of the short-haul pricing constraint (SHPC). However, early interpretations of the SHPC by the Interstate Commerce Commission reduced some of the abnormal returns to railroads in a manner that is inconsistent with the hypothesis that the short-haul pricing constraint was an important mechanism of early railroad regulation. The analysis does support a multiple-interest interpretation of the Interstate Commerce Act and has implications for the positive theory of regulation.
 
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