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.