In The Wealth of Nations, Adam Smith observed that “people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” As we will see, Smith’s warning has stood the test of time. Over 240 years later, we find such conspiracies among physicians, hospitals, pharmaceutical manufacturers, medical device producers, and health insurers. Their contrivances to raise prices add billions of dollars to our expenditures on health care. In this chapter, we introduce an economic model of a price-fixing cartel and discuss the deleterious effects on price, quantity, and social welfare. Using health care examples, we discuss collusion among physicians to deny staff privileges, noncompete agreements among hospitals, and market division schemes in the health insurance sector.

When a patent on a pharmaceutical product expires, therapeutically equivalent generic versions of the drug rapidly enter the market. Competition among the generic producers ordinarily causes the price of drugs to plummet. This, of course, is socially beneficial since consumers are considerably better off. Health insurers are also better off because the costs of insurance claims fall. Nearly everyone gains – except for the pioneer firm whose patent monopoly has expired. For many generic drugs, however, this scenario has failed to materialize because the generic producers allegedly decided to collude rather than compete. Various state attorneys general have filed complaints against 30 well-known generic drug manufacturers for their alleged collusion of more than 160 pharmaceutical drugs. The complaints allege that a large-scale cartel engaged in price fixing, customer allocation, and bid rigging in the market for generic drugs, leading to higher prices and lower sales.