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Are Invisible Hands Good Hands? Moral Hazard, Competition, and the Second Best in Health Care Markets

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  • Martin Gaynor
  • Deborah Haas-Wilson
  • William B. Vogt

Abstract

The nature, and normative properties, of competition in health care markets has long been the subject of much debate. In particular, policymakers have exhibited a great deal of reservation toward competition in health care markets, as demonstrated by the plethora of regulations governing the health care sector. Currently, as consolidation rapidly occurs in health care markets, concern about reduced competition has arisen. This concern, however, cannot be properly evaluated without a normative standard. In this paper we consider what the optimal benchmark is in the presence of moral hazard effects on consumption due to health insurance. Moral hazard is widely recognized as one of the most important distortions in health care markets. Moral hazard due to health insurance leads to excess consumption, therefore it is not obvious that competition is second best optimal given this distortion. Intuitively, it seems that imperfect competition in the health care market may constrain this moral hazard by increasing prices. We show that this intuition cannot be correct if insurance markets are competitive. A competitive insurance market will always produce a contract that leaves consumers at least as well off under lower prices as under higher prices. Thus, imperfect competition in health care markets can not have efficiency enhancing effects if the only distortion is due to moral hazard.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6865.

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Date of creation: Dec 1998
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Publication status: published as Journal of Political Economy, Vol. 108, no. 5, (October 2000): 992-1005
Handle: RePEc:nbr:nberwo:6865

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  1. Feldman, Roger & Dowd, Bryan, 1991. "A New Estimate of the Welfare Loss of Excess Health Insurance," American Economic Review, American Economic Association, American Economic Association, vol. 81(1), pages 297-301, March.
  2. Richard Arnott & Joseph Stiglitz, 1991. "Equilibrium in Competitive Insurance Markets with Moral Hazard," NBER Working Papers 3588, National Bureau of Economic Research, Inc.
  3. Martin Gaynor & Deborah Haas-Wilson, . "Change, Consolidation, and Competition in Health Care Markets," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1999-E31, Carnegie Mellon University, Tepper School of Business.
  4. Ma, Ching-to Albert & McGuire, Thomas G, 1997. "Optimal Health Insurance and Provider Payment," American Economic Review, American Economic Association, American Economic Association, vol. 87(4), pages 685-704, September.
  5. Milgrom, Paul & Shannon, Chris, 1994. "Monotone Comparative Statics," Econometrica, Econometric Society, Econometric Society, vol. 62(1), pages 157-80, January.
  6. Feldstein, Martin S, 1973. "The Welfare Loss of Excess Health Insurance," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(2), pages 251-80, Part I, M.
  7. Ching-To Albert Ma & Michael H. Riordan, 2002. "Health Insurance, Moral Hazard, and Managed Care," Journal of Economics & Management Strategy, Wiley Blackwell, Wiley Blackwell, vol. 11(1), pages 81-107, 03.
  8. A. Mitchell Polinsky & William P. Rogerson, 1982. "Products Liability, Consumer Misperceptions, and Market Power," NBER Working Papers 0937, National Bureau of Economic Research, Inc.
  9. Frech, H E, III, 1979. "Market Power in Health Insurance, Effects on Insurance and Medical Markets," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 28(1), pages 55-72, September.
  10. Robinson, James C. & Luft, Harold S., 1985. "The impact of hospital market structure on patient volume, average length of stay, and the cost of care," Journal of Health Economics, Elsevier, Elsevier, vol. 4(4), pages 333-356, December.
  11. Buchanan, James M, 1969. "External Diseconomies, Corrective Taxes, and Market Structure," American Economic Review, American Economic Association, American Economic Association, vol. 59(1), pages 174-77, March.
  12. Pauly, Mark V, 1974. "Overinsurance and Public Provision of Insurance: The Roles of Moral Hazard and Adverse Selection," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 88(1), pages 44-62, February.
  13. Carl Shapiro, 1982. "Consumer Information, Product Quality, and Seller Reputation," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 13(1), pages 20-35, Spring.
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