Competition and Consumer Choice in Option Demand Markets
Yet, the theoretical work on competition in option demand markets is scarce.
The present work analyzes two-dimensional spatial competition in option demand markets - over the geographic dimension and the products-line dimension. Medical providers sell their products through health insurance to consumers who know their exact geographic location (address) and the distribution of their possible medical needs. The exact medical need of each consumer reveals only after getting sick. This uncertainty regarding future medical needs generates option demand for multiple providers. That is demand for including both providers under insurance coverage, although each consumer will eventually attend only one of them.
I show that this market can yield two types of equilibrium, and it may provide efficient, excessive, or insufficient level of consumer choice in terms of product differentiation and geographic dispersion. However, regulating providers' geographic locations properly can always support the first best market outcome.
There is substantial theoretical literature on competition between differentiated medical providers under insurance sales. Horizontal differentiation is interpreted in terms of geographic distance and (or) distinctive products characteristics - e.g. hospitals area of specialization.
Beside few exceptions this literature assumed consumers know their preferred medical provider before getting sick.
This assumption seems realistic with respect to the geographic dimension, as consumers know their address and distance from each provider before getting sick. However, when thinking of horizontal differentiation in terms of product characteristics it seems more plausible that consumers do not know their preferred product before getting sick[1].
The few papers that accounted for consumers' ex-ante uncertainty regarding future medical needs assumed exogenous horizontal differentiation over one dimension only, and focused on the implications of exclusionary contract between insurers and hospitals on consumers’ welfare. Such contracts restrict insurance subscribers' accessibility to a network of selected health care providers.
However, the value of having access to multiple providers depends on their geographic dispersion and product differentiation. Hence, the novelty of this paper is in endogenizing providers differentiation choices along two prime-dimensions of health care markets: the geographic dimension where consumers know their location before getting sick and the products line (medical needs) dimension where consumer's preferred product reveals only after getting sick.
Reference
Capps C, Dranove D., Satterthwaite M., 2003. Competition and market power in option demand markets. RAND Journal of Economics 34, 737—763
Town, R., Vistnes, G., 2001. Hospital competition in HMO networks. Journal of Health Economics 20, 733 752
[1] As stressed by Capps et al.(2003): "Patients commit to a network of medical providers at the time they purchase their health insurance, but before they know their specific medical needs" (p.737).