Healthcare Players in the Market

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a) Distinguish between the concentration ratio and the herfindahi-hirschman index (HHI). What are the limitations of these measures within the context of the pharmaceutical industry?

The two measures have a fair amount of correlation as both are indicators of firm size, calculated in different way.

Herfindahl-Hirschman Index

The Herfindahl-Hirschman Index or HHI, is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them It is defined as the sum of the squares of the market shares of the 50 largest firms (or summed over all the firms if there are fewer than 50)[1] within the industry, where the market shares are expressed as percentages. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 10,000, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate moving towards being a monopoly and therefore a decrease in competition and an increase of market power, whereas decreases indicate the opposite. The major benefit of the Herfindahl index in relationship to such measures as the concentration ratio is that it gives more weight to larger firms, like the pharmaceutical companies. The usefulness of this statistic to detect and stop harmful monopolies however is directly dependent on a proper definition of a particular market (which hinges primarily on the notion of substitutability), and this function would, perhaps have limited use on the pharmaceutical industry. (http://www.investopedia.com/terms/h/hhi.asp)

Concentration Ratio

Economists use market concentration ratio, the market share controlled by the largest producers, to measure the degree of competition in the market (http://www.epa.gov/guide/pharm/econanal/econ-ch3.pdf), and often only use the top four firms in the industry, whereas the Herfindahl-Hirschman Index looks at all the firms.

The concentration ratio is calculated as the sum of the percent market share of the top n industries. One commonly used concentration ratios the four-firm concentration ratio, or C4, which consists of the market share, as a percentage, of the four largest firms in the industry. Concentration ratio Cn is the total percentage of market output generated by the n largest firms in the industry. If the top 5 companies own 20%, 15%, 10%, 5%, and 3%, C3 = 45%, and C5 = 53% (http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=market+share). Market forms can often be classified by their concentration ratio. The concentration ratio is limited information on the number and size distribution of firms. For example, if the four largest pharmaceutical firms accounted for 15% of the drug sales C=0.15. The more competitive the market the lower the C. In the case of oligopoly, with very few firms, the c would be close to 1.00, and it will be 1.00 for a monopoly.

Listed, in ascending firm size, they are:

1. Perfect competition, with a very low concentration ratio,
2. Monopolistic competition, below 40% for the four-firm measurement,
3. Oligopoly, above 60% for the four-firm measurement, (Example automobile manufacturers)
4. Monopoly, with a near-100% four-firm measurement.

In other words, the concentration ratio indicates whether an industry is comprised of a few large firms or many small firms. The four-firm concentration ratio, which consists of the market share (expressed as a percentage) of the four largest firms in an industry, is a commonly used concentration ratio. The Herfindahl index, another indicator of firm size, has a fair amount of correlation to the concentration ratio. http://www.investopedia.com/terms/c/concentrationratio.asp

b) If the interest group theory applies to hospitals, why doesn't it also apply to nursing homes?

There are opposing theories that predict different things. Let's look at the opposing their first to aid understanding of the two competing theories. My research suggests opposite, that the interest group theory does apply to nursing homes.

(1) "Public Interest theory?

Ideally, there would be perfect competition, and when there is imbalance, the government often intervene, as proposed by the "public interest theory?( opposing theory: the "special interest group theory? The criteria for perfect competition are:

1. All firms and consumers are price takers.
2. Consumers and firms have perfect information.
3. All firms produce an identical product.
4. Firms can freely enter an exit an industry.(1)

However, market imperfections may lead to inefficient or inequitable distribution of resources which determine the governmental interventions.

1. Imperfect consumer information
2. Monopoly
3. Externalities (1)

Then, we have a government intervention to restore efficiency and/or equity as predicted by the "Public interest theory?

(2) Special Interest Group Theory

Opposing theory: The amount and types of government intervention are determined by supply and demand. Special interest group theory claims that special interest groups gain at the expense of the general public. This more likely applies to nursing homes, where the ...