How does market competition affect supplier-induced demand? An experimental study.

Abstract

This study investigated the impact of competition on supplier-induced demand in medical markets theoretically and experimentally. We employed the framework of credence goods to describe the information asymmetry between physicians and patients, and theoretically derives predictions of physicians' behaviors in monopolistic and competitive markets. Then we conducted behavioral experiments to empirically test the hypotheses. The theoretical analysis revealed that an honest equilibrium would not exist in a monopolistic market, whereas price competition could induce physicians to reveal their types of treatment cost and provide honest treatments; thus, a competitive equilibrium is superior to that of a monopolistic market. The experimental results only partially supported the theoretical predictions, which showed that the cure rate of patients in a competitive environment was higher than that in a monopolistic market, although supplier-induced demand occurred more frequently. In the experiment, the main channel through which competition improved market efficiency was increased patient consultations through low pricing, as opposed to the theory, which stated that competition would lead to physicians' honest treatment of patients through fair prices. We discovered that the divergence between the theory and the experiment stemmed from the theory's reliance on the assumption that humans are rational and self-interested, which means that they are not as price-sensitive as predicted by theory.