In recent years, states have undertaken numerous efforts to curtail the rapidly rising costs of Medicaid, the federal/ state program of health insurance for the poor. Some of these efforts have centered on increasing the level of competition in medical care markets in the hope of bringing down prices for services. Others, such as Medicare diagnosis-related groups (DRGs), have focused on redefining the unit of service in an effort to increase efficiency and reduce costs. A major purchaser of health services, the government wields considerable market power, which in recent years it has begun to use. In particular, numerous states have decided to implement some form of competitive bidding among providers as a means of setting prices for services rendered to Medicaid beneficiaries. In some states, this competitive bid process has been used to set prices and award contracts for specific services such as laboratory services and eyeglasses. California has used a type of bid process to set a price per day of hospital care rendered to Medicaid beneficiaries. Wisconsin has implemented a bid process in Milwaukee and Dane County to set a capitation rate for Medicaid eligibles. Generally, the results have been favorable. States report considerable savings in Medicaid costs after implementing these bid processes. However, whether these savings are short-lived or actually lead to a long-run reduction in Medicaid cost inflation has not been assessed. From a policy perspective, this is a major concern. The issue is particularly critical when the use of competitive bidding results in the awarding of one or only a few contracts and if the cost for potential participants to enter the competitive market is high. When this occurs, the use of competitive bidding, particularly if the contracts awarded are for multiyear periods, may lead to a long-run decline in competition and an eventual increase