The Effect of Price Shopping in Medical Markets: Hospital Responses to PPOs in California

The last ten years have seen the introduction of price shopping into medical markets which were previously dominated by price insensitive consumers. Price shopping has been facilitated by the advent of the Preferred Provider Organization (PPO), which coordinates the demand of a large number of individual health care buyers, thereby gaining market rower which it uses to obtain Sleep discounts off list prices from providers. I study hospital responses to the advent of price competition in California over the 1984-1988 period. I note that, due to the nature of hospital bargaining with PPOs, hospitals should face more competitive pressure in hospital markets that arc more competitive ex-ante. This hypothesis is supported by the fact that hospital net prices declined in more ex-ante competitive areas in California after the arrival of PPOs. Hospital average costs did not decline in more competitive areas, however, indicating that there was a reduction in hospital markups. Care to the uninsured by hospitals. which is financed out of markups, fell substantially as competitive pressure grew; there was a 50 cent reduction in uncompensated care for every one dollar rise in discounts to private payers.