Quality provision in hospital markets with demand inertia: The role of patient expectations

Abstract

Switching costs and persistent preferences generate demand inertia and link current and future choices of hospital. Using a model of hospital competition with demand inertia, we investigate the effect of patient expectations on quality. We consider three types of expectations. Myopic patients choose a hospital based on current variables alone, forward-looking but naïve patients consider the future but assume that quality remains constant, and forward-looking and rational patients foresee the evolution of quality. We rank quality provision and show that it is higher under naïve than myopic expectations, while quality under rational expectations may be highest or lowest. This result also holds for patients’ health gains, suggesting that rationality may hurt patients. Additionally, policies to reduce switching costs lead to lower quality, possibly unless patients are rational and cost substitutability between output and quality is sufficiently strong. Finally, we show how optimal price regulation depends on expectations and switching costs.