Competition in Networks: An Analysis of Hospital Pricing Behavior

In this paper we develop a framework for analyzing the behavior of hospitals under selective contracting. We use a unique data set on hospitals in the Southern California region from 1990?1993 to estimate the factors affecting the actual negotiated prices paid to hospitals by two major HMOs. We find that a hospital?s bargaining power, and hence its price, decreases in the ability of the HMO to construct alternative networks that exclude the hospital. Our findings also indicate that hospitals should not be given free reign to merge as some hospital mergers, even in urban areas, can lead to anti-competitive price increases for inpatient services. Beyond hospitals, our methodology can also be applied to other industries where firms contract with multiple suppliers.