The Problem with a Health Care Monopsony

Americans detest monopolies. And rightly so. Theoretically, monopolies represent an inefficient allocation of scarce resources. The monopolist is adept at converting consumer surplus into producer surplus since fewer goods are produced at a higher price. Remember long-distance telephone services? Under Ma Bell, prices were higher and services anemic. Today, the cost of long-distance telephone service is inconsequential. Americans tend to value increased competition and fear monopoly power.

The monopolist has the luxury of producing fewer goods or servi ces while charging a higher price. In this country, "uncompetitive" equates to "un-American." We not only desire competition; we expect it. The competitive free market produces a surplus that society has come to expect and enjoy in the United States.

But one man's surplus is the Leftists' excess. And to the Left, excess is to be avoided. Think greed, avarice, inefficient, unfair.

The rhetoric used against insurers in recent days makes it seem like the executive branch is back to monopoly-busting, giving the impression that they are performing a public service. But with over 1,300 health insurers in this country, rationality dictates that we describe the existing marketplace in terms that approach competitive rather than monopolistic.

In the six months since President Obama signed health reform into law, competition has decreased. Unable to meet health reform law requirements, smaller, regional health insurers have merged or have been acquired. As a result, fewer insurers exist today than six months ago. This outcome squarely contradicts what the administration claimed; fewer insurers mean less competition among insurers.

The health insurance marketplace will continue to contract. Witness last week's beat-down on insurers who dared justify 1% to 9% premium increases to compliance with the new law. Secretary Sebelius has a list and will be checking it twice! This unfriendly, adversarial relationship between the government and health insurers will eventually cause insurers to exit the marketplace altogether. Rather than be saddled with increased financial risks without the ability to price health policies accordingly, insurers will simply remove themsel ves from the spotlight of public humiliation and financial ruin.

In this new environment of fewer and fewer willing (and compliant) health insurers, what will happen to the cost of health services and health insurance? The answer lies not with the economics of a monopoly, but with the economics of monopsony power. A monopoly is the single seller of a well-defined good or service for which there are no close substitutes in the marketplace. A monopsony is the single buyer of a good or service. The accompanying graph illustrates the economic outcome of the monopsony model using inpatient hospital days as a basis for comparison.

Point C represents equilibrium in a competitive marketplace. Price PC is the market clearing price for quantity of inpatient hospital days demanded QC. With a single buyer of hospital inpatient services, the monopsonist must pay a higher price for all additional services as represented by the marginal factor cost curve (MFC) because he must negotiate the cost of inpatient days in advance. To compensate, our monopsonist reduces the price from PC to PM by reducing quantity supplied from QC to QM, otherwise known as "rationing." Monopsony power suggests a single buyer pays a lower price but purchases a lower quantity than the competitive marketplace would support. Who can argue with lower prices?

But will society actually see a price reduction in health insurance? This is doubtful. In the monopsonist model, we assumed demand and supply were static. Health reform will add some 30 million to the insured rolls, which will translate to increased demand. Health reform has also thinned the ranks of providers translating to decreased supply. Here's the monopsonist graph again with these two adjustments:

With supply reduced and demand increased, the competiti ve marketplace equilibrium shifts to point C*.  Marginal factor costs are still higher than the new supply curve, forcing the monopsonist to pay more hospital stays. To compensate, quantity is reduced from QC to QM*, reflecting the profit maximization price PM*. The net effect of ObamaCare will be fewer insurers leading to a government-run, single-payer monopsony health care system; fewer services provided by the system (with still fewer providers); and higher prices paid by all.

The societal cost of a single-payer health system is the dead-weight loss of the formerly enjoyed surplus provided by a competitive market compounded with increased costs. This outcome is identical to that of the monopoly: higher prices paid for fewer services from fewer providers. Adam Smith was right. Free markets provide the most societal good in the most efficient manner. This is why Americans detest monopolies. But you already knew that. What you didn't know is that Americans also hate monopsonies.
Americans detest monopolies. And rightly so. Theoretically, monopolies represent an inefficient allocation of scarce resources. The monopolist is adept at converting consumer surplus into producer surplus since fewer goods are produced at a higher price. Remember long-distance telephone services? Under Ma Bell, prices were higher and services anemic. Today, the cost of long-distance telephone service is inconsequential. Americans tend to value increased competition and fear monopoly power.

The monopolist has the luxury of producing fewer goods or servi ces while charging a higher price. In this country, "uncompetitive" equates to "un-American." We not only desire competition; we expect it. The competitive free market produces a surplus that society has come to expect and enjoy in the United States.

But one man's surplus is the Leftists' excess. And to the Left, excess is to be avoided. Think greed, avarice, inefficient, unfair.

The rhetoric used against insurers in recent days makes it seem like the executive branch is back to monopoly-busting, giving the impression that they are performing a public service. But with over 1,300 health insurers in this country, rationality dictates that we describe the existing marketplace in terms that approach competitive rather than monopolistic.

In the six months since President Obama signed health reform into law, competition has decreased. Unable to meet health reform law requirements, smaller, regional health insurers have merged or have been acquired. As a result, fewer insurers exist today than six months ago. This outcome squarely contradicts what the administration claimed; fewer insurers mean less competition among insurers.

The health insurance marketplace will continue to contract. Witness last week's beat-down on insurers who dared justify 1% to 9% premium increases to compliance with the new law. Secretary Sebelius has a list and will be checking it twice! This unfriendly, adversarial relationship between the government and health insurers will eventually cause insurers to exit the marketplace altogether. Rather than be saddled with increased financial risks without the ability to price health policies accordingly, insurers will simply remove themsel ves from the spotlight of public humiliation and financial ruin.

In this new environment of fewer and fewer willing (and compliant) health insurers, what will happen to the cost of health services and health insurance? The answer lies not with the economics of a monopoly, but with the economics of monopsony power. A monopoly is the single seller of a well-defined good or service for which there are no close substitutes in the marketplace. A monopsony is the single buyer of a good or service. The accompanying graph illustrates the economic outcome of the monopsony model using inpatient hospital days as a basis for comparison.

Point C represents equilibrium in a competitive marketplace. Price PC is the market clearing price for quantity of inpatient hospital days demanded QC. With a single buyer of hospital inpatient services, the monopsonist must pay a higher price for all additional services as represented by the marginal factor cost curve (MFC) because he must negotiate the cost of inpatient days in advance. To compensate, our monopsonist reduces the price from PC to PM by reducing quantity supplied from QC to QM, otherwise known as "rationing." Monopsony power suggests a single buyer pays a lower price but purchases a lower quantity than the competitive marketplace would support. Who can argue with lower prices?

But will society actually see a price reduction in health insurance? This is doubtful. In the monopsonist model, we assumed demand and supply were static. Health reform will add some 30 million to the insured rolls, which will translate to increased demand. Health reform has also thinned the ranks of providers translating to decreased supply. Here's the monopsonist graph again with these two adjustments:

With supply reduced and demand increased, the competiti ve marketplace equilibrium shifts to point C*.  Marginal factor costs are still higher than the new supply curve, forcing the monopsonist to pay more hospital stays. To compensate, quantity is reduced from QC to QM*, reflecting the profit maximization price PM*. The net effect of ObamaCare will be fewer insurers leading to a government-run, single-payer monopsony health care system; fewer services provided by the system (with still fewer providers); and higher prices paid by all.

The societal cost of a single-payer health system is the dead-weight loss of the formerly enjoyed surplus provided by a competitive market compounded with increased costs. This outcome is identical to that of the monopoly: higher prices paid for fewer services from fewer providers. Adam Smith was right. Free markets provide the most societal good in the most efficient manner. This is why Americans detest monopolies. But you already knew that. What you didn't know is that Americans also hate monopsonies.

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