Excess capacity and price competition in California hospital markets

This dissertation focuses on the role that excess capacity may play in influencing prices for inpatient hospital care. At a time when high excess capacity is standard and when hospital competition is widespread, a better understanding of the interaction between excess capacity and price formation is critical.; The first part of this dissertation explores a model of bargaining in which an insurance company chooses the sequence of bidding by capacity-constrained hospitals in a duopoly. The analysis is then extended to consider markets with more than two hospitals. Several testable, empirical predictions arise from this model. First, prices rise above marginal cost once occupancy rates rise above a threshold level. Second, below the threshold, prices are set to marginal cost. Third, holding total capacity constant, this threshold occupancy rate increases as the number of hospitals in a market increases.; The second part of this dissertation focuses on structural damage from the Northridge earthquake of 1994 as an exogenous shock to hospital capacity in the Los Angeles area. The exogenous shock allows us to identify the effect of reduced capacity on prices by avoiding the standard problem that market variables, such as prices and capacity, are typically determined endogenously. Hospitals in areas unaffected by the earthquake serve as a control group to establish expected prices in the absence of capacity changes. The findings are consistent with a significant positive price effect from the reduced capacity.; The third part of this dissertation explores how occupancy rates in hospital markets influence the outcome of negotiations between hospitals and insurers over prices for inpatient stay. The key innovation of this part is to unite the theoretical prediction of a threshold occupancy rate, above which hospitals in a market can raise their prices, with an empirical specification that tests for this threshold. A cross-sectional analysis of California hospitals supports the threshold hypothesis. Above the threshold, occupancy rates have a positive and significant influence on prices. Surprisingly, the results are consistent both with a large effect from the "medical arms race" and with a beneficial price-impact from hospital competition. These findings have important implications for hospital merger policy.