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Measuring Ignorance in the Market: A New Method with an Application to Physician Services

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  • Martin Gaynor
  • Solomon Polachek

Abstract

Ever since Stigler's seminal piece on the economics of information, a great deal of research has been done investigating equilibrium in markets with imperfect information. While most of this research has been concerned with theoretically establishing the conditions under which there exists a distribution of prices in equilibrium, there is a small, but growing, body of empirical research in this area. This work has followed the suggestion of Stigler and utilized the dispersion of prices (usually the variance) as a measure of ignorance about price. There are two disadvantages to using the variance (or another measure of dispersion, such as the range) of prices as a measure of ignorance about price. The first reason, recognized by Stigler and others, is that price can vary for many reasons other than ignorance. Thus dispersion is not a pure measure of ignorance about prices. The second reason, which has not been commonly considered in the empirical literature, is that price dispersion can due to ignorance on the part of both buyers and of sellers. In this paper we propose a method for measuring ignorance about price in a market which builds on Stigler's original suggestion to use dispersion as a measure of ignorance. The innovation is to use a new frontier estimation technique containing a three component error term to separate observed price dispersion into purely random variation, variation due to buyer ignorance, and variation due to seller ignorance . We apply the technique to the physicians' service market. This supplies us with quantitative indices of price ignorance for different services and how the level of ignorance varies by buyer, seller, and market area characteristics. The results are striking. Buyer ignorance exceeds seller ignorance by roughly a factor of two in his market, and this gap is greater for services which are less frequently purchased, more heavily insured, or accompanied by greater severity of illness, as predicted by search theory.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3430.

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Date of creation: May 1994
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Handle: RePEc:nbr:nberwo:3430

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  1. Pratt, John W & Wise, David A & Zeckhauser, Richard, 1979. "Price Differences in Almost Competitive Markets," The Quarterly Journal of Economics, MIT Press, vol. 93(2), pages 189-211, May.
  2. Goldman, Fred & Grossman, Michael, 1978. "The Demand for Pediatric Care: An Hedonic Approach," Journal of Political Economy, University of Chicago Press, vol. 86(2), pages 259-80, April.
  3. Mathewson, G Frank, 1983. "Information, Search, and Price Variability of Individual Life Insurance Contracts," Journal of Industrial Economics, Wiley Blackwell, vol. 32(2), pages 131-48, December.
  4. Dionne, G., 1980. "Search and Insurance," Cahiers de recherche 8101, Universite de Montreal, Departement de sciences economiques.
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  6. Russell Davidson & James G. MacKinnon, 1981. "Tests for Model Specification in the Presence of Alternative Hypotheses: Some Further Results," Working Papers 430, Queen's University, Department of Economics.
  7. Polachek, Solomon W & Yoon, Bong Joon, 1987. "A Two-tiered Earnings Frontier Estimation of Employer and Employee Information in the Labor Market," The Review of Economics and Statistics, MIT Press, vol. 69(2), pages 296-302, May.
  8. Benham, Lee, 1972. "The Effect of Advertising on the Price of Eyeglasses," Journal of Law and Economics, University of Chicago Press, vol. 15(2), pages 337-52, October.
  9. Axel, Bo, 1977. " Search Market Equilibrium," Scandinavian Journal of Economics, Wiley Blackwell, vol. 79(1), pages 20-40.
  10. Marvel, Howard P, 1976. "The Economics of Information and Retail Gasoline Price Behavior: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 84(5), pages 1033-60, October.
  11. Cox, Steven R & DeSerpa, Allan C & Canby, William C, Jr, 1982. "Consumer Information and the Pricing of Legal Services," Journal of Industrial Economics, Wiley Blackwell, vol. 30(3), pages 305-18, March.
  12. Burdett, Kenneth & Judd, Kenneth L, 1983. "Equilibrium Price Dispersion," Econometrica, Econometric Society, vol. 51(4), pages 955-69, July.
  13. Mark V. Pauly & Mark A. Satterthwaite, 1981. "The Pricing of Primary Care Physicians' Services: A Test of the Role of Consumer Information," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 488-506, Autumn.
  14. Marquis, M. Susan, 1985. "Cost-sharing and provider choice," Journal of Health Economics, Elsevier, vol. 4(2), pages 137-157, June.
  15. Cady, John F, 1976. "An Estimate of the Price Effects of Restrictions on Drug Price Advertising," Economic Inquiry, Western Economic Association International, vol. 14(4), pages 493-510, December.
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Cited by:
  1. Martin Gaynor & Deborah Haas-Wilson, 1998. "Change, Consolidation, and Competition in Health Care Markets," HEW 9809001, EconWPA.
  2. John Robst & Kimmarie McGOLDRICK, 1999. "The Measurement of Firm Information About Product Demand," Review of Industrial Organization, Springer, vol. 15(2), pages 149-163, September.
  3. Paul Gertler & Roland Sturm & Bruce Davidson, 1994. "Information and the Demand for Supplemental Medicare Insurance," NBER Working Papers 4700, National Bureau of Economic Research, Inc.
  4. Polachek, Solomon & Xiang, Jun, 2005. "The Effects of Incomplete Employee Wage Information: A Cross-Country Analysis," IZA Discussion Papers 1735, Institute for the Study of Labor (IZA).
  5. John Robst & Kimmarie Mcgoldrick, 1997. "Frontier estimation of changes in Workers' labor market information," Atlantic Economic Journal, International Atlantic Economic Society, vol. 25(4), pages 386-402, December.
  6. Darren Grant, 2005. "Information and sorting in the market for obstetrical services," Health Economics, John Wiley & Sons, Ltd., vol. 14(7), pages 703-719.

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