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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: Sep 1990
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Publication status: published as Southern Economic Journal, Volume 60(4), April 1994, pp. 815-831
Handle: RePEc:nbr:nberwo:3430

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  1. 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, Wiley Blackwell, vol. 30(3), pages 305-18, March.
  2. Burdett, Kenneth & Judd, Kenneth L, 1983. "Equilibrium Price Dispersion," Econometrica, Econometric Society, Econometric Society, vol. 51(4), pages 955-69, July.
  3. 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.
  4. Russell Davidson & James G. MacKinnon, 1981. "Tests for Model Specification in the Presence of Alternative Hypotheses: Some Further Results," Working Papers, Queen's University, Department of Economics 430, Queen's University, Department of Economics.
  5. Dionne, Georges, 1984. "Search and Insurance," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(2), pages 357-67, June.
  6. Mathewson, G Frank, 1983. "Information, Search, and Price Variability of Individual Life Insurance Contracts," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 32(2), pages 131-48, December.
  7. Benham, Lee, 1972. "The Effect of Advertising on the Price of Eyeglasses," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 15(2), pages 337-52, October.
  8. Van Hoomissen, Theresa, 1988. "Price Dispersion and Inflation: Evidence from Israel," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(6), pages 1303-14, December.
  9. Marvel, Howard P, 1976. "The Economics of Information and Retail Gasoline Price Behavior: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(5), pages 1033-60, October.
  10. Fred Goldman & Michael Grossman, 1979. "The Demand for Pediatric Care: An Hedonic Approach," NBER Working Papers 0134, National Bureau of Economic Research, Inc.
  11. Pratt, John W & Wise, David A & Zeckhauser, Richard, 1979. "Price Differences in Almost Competitive Markets," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 93(2), pages 189-211, May.
  12. Marquis, M. Susan, 1985. "Cost-sharing and provider choice," Journal of Health Economics, Elsevier, Elsevier, vol. 4(2), pages 137-157, June.
  13. Cady, John F, 1976. "An Estimate of the Price Effects of Restrictions on Drug Price Advertising," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 14(4), pages 493-510, December.
  14. Axel, Bo, 1977. " Search Market Equilibrium," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 79(1), pages 20-40.
  15. Dahlby, Bev & West, Douglas S, 1986. "Price Dispersion in an Automobile Insurance Market," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(2), pages 418-38, April.
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Cited by:
  1. Martin Gaynor & Deborah Haas-Wilson, 1998. "Change, Consolidation, and Competition in Health Care Markets," HEW, EconWPA 9809001, EconWPA.
  2. Darren Grant, 2005. "Information and sorting in the market for obstetrical services," Health Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 14(7), pages 703-719.
  3. 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).
  4. 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.
  5. John Robst & Kimmarie McGOLDRICK, 1999. "The Measurement of Firm Information About Product Demand," Review of Industrial Organization, Springer, Springer, vol. 15(2), pages 149-163, September.
  6. John Robst & Kimmarie Mcgoldrick, 1997. "Frontier estimation of changes in Workers' labor market information," Atlantic Economic Journal, International Atlantic Economic Society, International Atlantic Economic Society, vol. 25(4), pages 386-402, December.

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