Wednesday, August 29, 2012

Economies of Scale vs. Monopoly Power

The Wall Street Journal (behind subscription paywall) says that hospitals are rapidly buying up small physician's practices because hospitals can negotiate a higher price from insurers for exactly the same services that the the doctors had been doing.  The title of the story is Same Doctor Visit, Double the Cost, and it tells about David Hubbard who, "underwent a routine echocardiogram at his cardiologist's office last year, [and] was surprised to learn that the heart scan cost his insurer $1,605. That was more than four times the $373 it paid when the 61-year-old optometrist from Reno, Nev., had the same procedure at the same office just six months earlier."  The reason was that his doctor's practice had been acquired by a hospital that was better at negotiating a higher price from insurers because of its economies of scale in bargaining clout! David was upset that he had to pay the extra thousand dollars himself because of his high-deductible health plan.  And it isn't just private insurance.  Big hospitals are also able to negotiate higher payment from Medicare too.  
This is kind of like an economy of scale.  Walmart has been able to lower its average costs as it has grown bigger simply because a larger buyer has more leverage to squeeze down supplier prices through monopsony power.  Monopsony power is not the textbooks example of an economy of scale because it is a market failure and economists usually think of economies of scale as being efficient, but monopsony power does meet the textbook definition.   In the above case, doctors offices are able to increase their seller power (monopoly power) by getting larger.  This has the same effect as an economy of scale: It increases the size of organizations because smaller organizations cannot compete. 

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