The Erosion of the Medical Marketplace

by Joseph P. Newhouse


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Describes and tests possible sources of market failure in medical care due to structure of current health insurance policies that make reimbursement a function of total expenditure. Such policies raise the rate at which prices and expenditures increase, because the consumer has little incentive to find efficient suppliers. Evidence is presented to support this view. Specifically, variation in prices over time is consistent with the competitive model for drug, dental, and physician services, where insurance is less prevalent; and not consistent with it for hospital services, where insurance is widespread. Possible courses of action include doing nothing, or regulating or altering the structure of insurance policies to enhance price competition. The present version of the report respecifies and reestimates the model described in the original version of August 1977, which it supersedes. In particular, the theoretically appropriate variable, the coinsurance rate, replaces its complement, which was used in the original version. The qualitative conclusions remain unchanged.

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