| Should the government subsidize entry to promote competition? In theory, free entry does not guarantee the socially optimum number of entrants. In differentiated product markets, free entry can result either in excessive or insufficient entry. Quantifying this inefficiency and identifying the optimal subsidy level require an empirical framework that combines the entry literature and demand models of a differentiated product market. Such a combination has not been well studied to date. In this research, I propose a comprehensive welfare analysis framework to address these issues with a case study of the Medicare HMO market for 2003 and 2004. The empirical model allows me to perform counterfactual welfare simulations with various market settings. Payment rate simulations suggest the optimal level of payment rates. To further understand welfare changes in the payment simulations, I decompose the welfare change into entry effect, market power effect, and subsidy effect, by simulating entry and market power settings. To determine whether the entry level is excessive or insufficient, entry simulations are performed. I also conduct a geographic analysis to discuss the regional distribution of welfare and an appropriate level of payment rates. Finally, I simulate the pool of potential entrants in order to evaluate the welfare values of HMO chains. |
