Boundedly Rational Bargaining in Option Demand Markets: An Empirical Application

Abstract:     
In this study, we develop and estimate a model of sophisticated bargaining between hospitals and insurers, based on a model of intrafirm bargaining set out by Stole and Zwiebel (1996). When an insurer decides whether to include a hospital in its network, it must take into account the fact that excluding the hospital gives the hospitals already in the network additional bargaining power, allowing them to negotiate for higher prices. The hospital is aware of this problem and will also account for this inframarginal effect. Although in theory both parties should take into account all possible hospital networks, in practice it is unlikely that any hospital or insurer will be this sophisticated. We therefore estimate parameters for hospital prices, the fraction of consumer surplus going to the hospitals, and the level of rationality of both parties. Using hospital financial records and patient discharge records, we estimate this model for the hospitals in Bakersfield, California and San Diego, California.

Keywords: hospitals, bargaining, health care

JEL Classification: I11, L13

working papers series