Market Equilibration

Introduction

Visual graphs/charts will be employed in explaining the law of demand and its determinants, and the law on supply and its determinants, which are crucial for the Blue Cross Insurance managers in making critical decisions on high operational costs on major medical insurance plan claims (“Blue Cross Insurance”, 2011).

The Problem Discussion

In order to understand the Blue Cross Insurance healthcare demand issues, it is important to understand the concept of income elasticity. For example, suppose the income elasticity of demand for the Blue Cross’s Major Medical Insurance Plan (MMIP) is +2 and the income elasticity for doctor’s services is +0.2. Compare the impact on the Blue Cross MMIP and doctor’s services of a recession that reduces consumer income by 10 percent.

Focusing on the above statement, when the income elasticity of demand for healthcare services is +2, the quantity of Blue Cross MMIP services demanded will reduce in response to the 10 percent reduction in consumers’ income. Since +2 is greater than 1, Blue Cross MMIP service is considered a luxury good. Thus consumers will cut their expenditure on it in the event of a reduction in their income. The doctor’s service is a necessity since its income elasticity of demand, +0.2, is less than 1. Thus unlike Blue Cross MMIP services, the quantity demand of doctor’s services is not likely to reduce in response to the 10 percent reduction in consumers’ income. The consumers are likely to reduce their expenditure on luxurious goods in order to continue consuming the same level of doctor’s services which is a necessity (Besenko & Braeutigam, 2010).

Moreover, the Blue Cross MMIP service price influences on the demand curve are represented by the movements along the demand curve. This is illustrated by figure 1a below. As the price of the MMIP services increases, the quantity demanded reduces as shown by the upward pointing arrow. The non price influences on demand curve include changes in income. Unlike price influences, non-price influences lead to a shift in the demand curve either to the right or to the left (Krugman, 2010). This is illustrated by figure 1b below.

The Blue Cross MMIP price influence results into movements along the supply curve as shown in figure 2a below. An increase in healthcare premium price leads to an increase in quantity supplied as indicated by the upward pointing arrow and vice versa. Non price influences include production technology, number of suppliers and price of substitutes. Unlike non-price influences, they lead to a shift in the supply curve either to the left or to the right as shown in figure 2b.

Cross insurance firm’s perfectly competitive equilibrium. The short run price equilibrium is determined by the demand and supply forces. P1 being the “market-clearing” price will be taken by all insurance firms in this industry. Since the Blue Cross MMIP price is assumed to be constant, the average revenue (AR) is equal to marginal revenue (MR) as shown in figure 3b. Profit is maximized at the point where MC=MR (Krugman, 2010). Thus the equilibrium or profit maximizing output will be Q1.

Summing up, in a perfectively competitive Blue Cross insurance firm, the supply will increase in the long run as more firms join this health insurance industry. This leads to a reduction in price and profits. Blue Cross Insurance Company will thus operate at the break even level. This means that the firms will be operating at point A where SRAC and LRAC are equal. Therefore, the equilibrium price and output will be P₀ and Q₀ respectively.