Optimal Managed Competition Subsidies
When markets fail to provide socially optimal outcomes, governments often intervene through ‘managed competition’ where firms compete for per-consumer subsidies. Subsidies are generally set across geographies according to estimates of the cost of government provision, a method which may not be welfare-maximizing. We introduce a framework for determining the optimal subsidy schedule that features heterogeneity in consumer preferences and inertia, and firms with heterogeneous costs that can set prices and product characteristics in response to changes in the subsidy. We apply it to the Medicare Advantage program, which offers Medicare recipients private insurance that replaces Traditional Medicare. We calculate counterfactual equilibria as a function of the subsidies by estimating policy functions for product characteristics from the data and solving for Nash equilibria in prices. The optimal schedule increases consumer surplus by 30% over the current policy and is well-approximated with a linear rule using market-level observables.
The authors would like to thank Mark Colas, Francesco Decarolis, Clare Evans, David Evans, Gautam Gowrisankaran, Ben Hansen, Kendall Houghton, Van Kolpin, Scott Petty, Jeremy Piger, Christopher Snyder, Glen Waddell, Wes Wilson, and seminar and conference participants at the University of Oregon, the University of Minnesota, the University of Texas -Austin, the 2019 NBER Winter IO and Insurance Meetings, the International Industrial Organization Conference, North American and European Meetings of the Econometric Society, and the Asian Workshop on Econometrics and Health Economics for helpful comments and feedback. All errors are our own. We are grateful for support from the National Institute on Aging under grant P01 AG032952. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.