1. Describe the industry and explain the general pattern of change of the particular market model Health insurance in the United States providers represent competitive market because they are numerous, variety of choices, and no single entity has much power over prices. The health insurance can be considered as rapid growth industry. Recently, this industry is transforming in a rapid way and evolving into an oligopoly. Insurance markets in many states are eventually controlled and dominated by a few large firms.
There were more than five hundred health insurers involved mergers between 1998 and 2008 (Bakhtiari, 2010). Although there are hundreds of small insurance companies operating in the market, the industry Led by WellPoint, 12 health plans cover two-thirds of the enrollment in the U.S. commercial-insurance market (Bloomberg News, 2010). An analyst’s report cited in the article predicts there will be 100 insurers with around 200,000 members could be forced out of business. Smaller insurers are increasingly unable to invest in the infrastructure and technology to effectively manage care (Bakhtiari, 2010). However, mergers have been the main power rather than small insurers going out of business.
2. Hypothesize the basic short-run and long-run behaviors of the model in the industry you have chosen in a “market economy” This paper uses Kinked-Demand theory of oligopoly; there is no single theory that explains oligopoly behavior. The kinked demand model assumes that if one firm raises the prices, other firms will not follow to increase. If the firm reduces its price, it is assumed that its competitors will follow suit and reduce their prices as well. The result is a demand curve for the firm that is kinked at the current equilibrium price (Low, 2000).
Taking this as assumption, a single health insurer that tries to raise price will lose market share mainly just because other insurers are not following, it will suffer a loss in demand because the competitors’ prices remain low. In contract, if a single firm that cuts prices, all of its competitors will follow to reduce the price. As a result, a firm will have a kinked demand curve.
Firms may operate at a profit in the short-run if demand for the product is high relative to costs. The firm may force to go out of business if it can’t generate enough revenue to even cover the variable costs.
Hence the model predicts that prices in the long run should be fairly rigid in an oligopoly. This could indicate that insurance premiums will remain fairly stable in the health insurance industry. The kinked demand theory suggests there will be price in these markets and the firms will rely more on non-price competition to boost sales, revenue and profits. The result in market share is no gain and relative small increases in quantity demanded (Low, 2000).
3. Analyze at least three (3) possible areas for the industry that could lead to transaction costs, and explain each in detail In the health insurance industry, transaction cost could arise from acquisition expenses, process outsourcing, and increased product complexity.Acquisition is the expense of soliciting and placing new insurance business on a company’s books. It includes agent’s underwriting expenses, medical and credit, report fees, commissions, and marketing support services. The significant efforts are made by insurance companies to lower acquisition costs because of the competition.
Outsourcing of processes may become a necessity when firms gather up more and more customers due to mergers, the current workforce will no longer be able to handle jobs. Sometime, hiring more employees could be very costly for some firms because of increasing market salaries; outsourcing could be the better option. Firms will have to pay additional expenses to outsourcing firms that process application and provide customer service. This lead to transaction cost.
Transaction costs may also arise from increase product complexity due to firms grow, merge and consolidation. Products become more complex catering to more segments due to gathering more customer; firms increase product lines. Hence, customers will have to incur transaction costs in searching or inquiring for the best product, and in estimating the quality of the service.
4. Speculate about the behavior that could result from these transactions and propose at least two (2) strategies for dealing with them It affects consumers’ behavior for reconsidering the health plan when transaction costs arise from product complexity. Any uncertainty arises from product uncertainty; it refers to the difficulties in determining the quality of purchased products (Thompson, 2004). Consumers are likely to inquire more information if purchased services will meet their expectations before they purchase. Consumers rely on the quality examination that insurance agents or references. This product uncertainty may increase transaction cost. This can be dealt with by reinforcing product quality through advertising about the products and services, meeting with potential customers, and providing training to employees to meet better expectation.
When transaction costs arise from enforcement and monitoring, behavioral results are uncertainty. Behavioral uncertainty refers to the inherent difficulties faced by buyers in accurately evaluating the contractual performance of insurance companies (Thompson, 2004). This increases transaction cost as consumers spend more time thinking about buying insurance because the claims may against them or excessive policy. This can be dealt with by ensuring that potential customers understand the nature of the contract.
5. Collect costs, revenue data, or other data from the industry you deem relevant. Explain how you would modify the data in order to make it relevant to decisions a manager must make Base of the data from Austin & Hungerford, health insurance markets in many local areas are highly concentrated and the exercise of market power in concentrated markets generally leads to higher prices and reduced output. In the data, medical loss ratios among major insurers range from a low of 70.7% to almost 89%. Some major commercial insurers have had significant decreases in medical expense ratios in the past decade. For example, CIGNA HealthCare’s medical loss ratio, 86.3% in 2001, fell to 70.7% in 2008 (Austin & Hungerford, 2009). In general, medical loss ratios can change dramatically from one year to another. This explained by unexpectedly high medical costs or by aggressive pricing intended to increase market share.
The above data help managers understand industry characteristics better than an individual. It is relevant to managers by consolidating all of the medical loss ratio, and combining them in an industry average. The managers have a better feel for industry averages and trends.
6. Explain the major factors that affect the degree of competitiveness in your industry. Use the data to develop at least three (3) measures (e.g., productivity measures) to show how the industry is evolving
The first factor is the number of firms on the market. If there are large number of firms operate in industry, overall prices will be reduced. The second factor is government regulation which affects the degree of competitiveness of the health insurance industry. The third is government provides health insurance. This can change the entire game plan for health industry. Private firms may be unable to compete against government’s insurance plans. That will affect the overall competitiveness of the industry.
These measures to show how the industry is evolving include average prices of health insurance plans, potential buyers, and overall average medical costs. Average price of health insurance will show the industry’s evolution by examining patterns of profit growth in relation to health insurance costs. The number of health insurance buyers will help understand the growth patterns in customer base, and demand for health insurance plans. Medical costs will show the relationship between industry growths, inflation of costs, and increase in general medical care.
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