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Supply and Demand of Physician Services. Econ 737.01. Supply and Demand of Physician Services: Outline. A. General Models B . Forms of Compensation C. Physician-Induced Demand. General Models: Outline. I. Supply of Physicians II. Supply of Physician Services

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Supply and demand of physician services outline l.jpg
Supply and Demand of Physician Services: Outline

  • A. General Models

  • B. Forms of Compensation

  • C. Physician-Induced Demand


General models outline l.jpg
General Models: Outline

  • I. Supply of Physicians

  • II. Supply of Physician Services

    • a. Model with Complete Information

    • b. Incomplete Information

    • c. Objectives Besides Income


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I. Supply of Physicians

  • Summary Statistics (U.S.; 1994)

    • 126 medical schools

    • 16,000 graduates per year

    • 550,000 practicing physicians

    • 254 physicians per 100,000 residents

    • Average net income : $182,400

    • Average work hours: 55/week

    • Physicians work a lot and make a lot

      • Market forces or shortage?


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I. Supply of Physicians

  • Market distortions

    • Barriers to entry

      • Educational and licensing requirements

      • AMA controls these; incentive to restrict supply too much?

      • This would reduce supply below socially optimal level

    • Medical school subsidies

      • Could raise supply above socially optimal level


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I. Supply of Physicians

  • Empirical Evidence

    • Difficult to measure physician shortages or excess returns on investments in medical education

    • 1900-1950

      • Supply side: new medical school graduates constant

      • Demand side: average age, real per capita GDP, and insurance coverage all increased dramatically

      • Consistent with excessively restricted entry

    • More recently

      • Output of medical schools has expanded dramatically in last 10-20 years

      • Weeks et al. (1994): returns to education for physicians, lawyers, dentists, and MBAs all similar


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II. Supply of Physician Servicesa. Model with Complete Information

  • Monopolistic Competition

    • Many sellers

    • Differentiated products (physicians are imperfect substitutes)

    • Some market power

  • Demand exogenous from physician’s perspective

  • Perfect information on both sides

  • Physicians maximize profit

  • Nonretradablegoods


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II. Supply of Physician Servicesa. Model with Complete Information

  • Physician makes “all or nothing” offer to patient, who would prefer to consume less care at the given price

  • Physician can price discriminate

  • If price set by demand side (i.e. insurance companies/Medicare), physician responds by increasing quantity

  • Quality of service is another dimension to consider


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II. Supply of Physician Servicesb. Incomplete Information

  • Punch line from part a: Even with perfect information, the differentiated and nonretradable nature of medical goods can keep medical expenditures above competitive levels.

  • Relaxing the assumption of perfect information further enhances our understanding of why medical expenditures are so high.


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II. Supply of Physician Servicesb. Incomplete Information

  • 1) Irreducible uncertainty

    • Doctors and patients have imperfect information about the underlying condition and effectiveness of treatments

    • Most doctors and patients are risk averse

    • => increased test frequency and treatment intensity


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II. Supply of Physician Servicesb. Incomplete Information

  • 2) Principal-agent problem

    • Principal: patient

    • Agent: doctor

    • Doctors know more than patients about appropriate level of care (asymmetric information)

    • Outcomes are often difficult for patient to observe

    • Often gray areas about appropriate treatment

    • => Could lead to excessive provision of care

    • “Induced demand”


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II. Supply of Physician Servicesb. Incomplete Information

  • 3) Unobservable physician quality

    • Large fixed cost with trying a new physician

    • Information asymmetry makes it hard to observe physician quality

    • => Prices may not fully adjust to an increase in competition


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II. Supply of Physician Servicesc. Objectives Besides Income

  • Parts a and b assume that physicians act to maximize income. Other considerations:

    • 1) Medical ethics: legal and moral constraints

    • 2) Patient’s best interest (patient’s utility enters into doctor’s utility function)

      • Patient’s utility, not society’s utility. Why is this an important distinction?

    • 3) Target income


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II. Supply of Physician Servicesc. Objectives Besides Income

  • 3) Target income

    • Motivation: explain positive association between physicians per capita and prices of services, negative association between fees paid and quantity supplied

    • Physicians aim to maintain a “target income”

    • If increased competition lowers their income, they take advantage of their market power by raising prices or inducing demand to keep income relatively stable

    • What does this say about physician behavior before the increase in competition?


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II. Supply of Physician Servicesc. Objectives Besides Income

  • 3) Target income

    • Taken seriously for a long time

    • Generally rejected now, though still subject of debate in literature

    • If target income hypothesis is true, there should be large income effects on supply (identified using non-labor income), and this doesn’t seem to be the case

  • Can you think of other explanations for the apparent paradoxes?


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Forms of Compensation

  • I. Fee-for-service

  • II. Capitation

  • III. Salary

  • IV. Pay-for-performance


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I. Fee-for-service

  • Physicians are paid an additional amount of money for each service they provide

  • Would expect this to increase the amount of care provided

  • Open question how much these additional services would improve health

  • Schuster et al. (1998) estimate up to 30% of services are not medically necessary

  • Often supplemented with incentives to economize


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I. Fee-for-service

  • Who sets the fees?

    • Used to be physicians

    • In response to incentive problems, insurance plans began negotiating fees and Medicare began setting fees

    • These groups can do this because they are large enough that they have market power (monopsony)

    • How does this tie into the “public option” debate?


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II. Capitation

  • Physicians receive fixed amount of money for providing services to a patient for a particular period of time

  • Incentive to keep long patient roster but give them each as little attention as possible

  • Could lead to higher referral rates

    • Various schemes to makes physicians share in financial risk

  • Still need to provide enough care to attract and retain patients

  • Incentive to select healthy patients (cream skimming; cherry picking)

    • Fee for a patient is “risk adjusted” based on expected utilization

    • This adjustment only accounts for 10% of variation

  • Often supplemented with incentives to ensure sufficient quality of care

  • Could be combined with ffs in a “mixed” system


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II. Capitation

  • Quantity

    • Capitation seems to be effective in reducing quantity and expenditures (is this good?)

    • Stearns et al. (1992)

      • Group of WI employees enrolled in IPA

      • Change from ffs to capitation system where physicians shared in financial risk of hospitatlization and specialty costs

      • Increased primary care visits by 18%

      • Decreased specialist visits by 45%, hospital visits by 16%, and length of stay by 12%


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II. Capitation

  • Quantity

    • Ogden et al. (1990)

      • Group of IL employees enrolled in IPA

      • Switched from ffs to capitation with shared financial risk

      • Specialist costs increased 2% compared to 12% the previous year

      • Hospital outpatient costs dropped 7% compared to increasing 12% the previous year

      • Little change in inpatient hospital utilization


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II. Capitation

  • Quantity

    • Mooney (1994)

      • GPs in Copenhagen, Denmark switched from capitation to mixed capitation-ffs

      • Provision of services that provided extra fees increased dramatically

      • Decrease in referrals to specialists and hospitals


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II. Capitation

  • Quality

    • Sorbero et al. (2003): patients 36% more likely to switch physicians under capitation than ffs

    • Shen et al. (2004): survey with hypothetical treatment decisions; physicians more “bothered” by their decisions under capitation than ffs


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II. Capitation

  • Referral rate

    • Capitation does seem to lead to more referrals on the margin, both theoretically and empirically, if the GP does not share in the financial risk

      • Theoretical: Barros and Martinez-Giralt (2003); Iverson and Luras (2000b)

      • Empirical: Forrest et al. (2003); Carlsen and Norheim (2003)


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III. Salary

  • Provides fixed income to physician over a particular time period

  • Ex. in US: Staff HMOs

  • Incentive to do as little as possible to keep job

  • Often supplemented with incentives to ensure reasonable quantity and quality of care

  • Less common than others, but do see it in national health systems like UK and staff HMOs in US


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IV. Pay-for-performance

  • Ties part of physician or hospital reimbursement to meeting performance thresholds (clinical outcomes, patient satisfaction, etc.)

  • New and largely untested

  • >20 million in US covered (Rosenthal et al., 2004)

  • Difficult to measure “performance”

  • What incentive problems might result from paying on the basis of outcomes?


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Physician-Induced Demand

  • I. Theory

  • II. Evidence from Increased Competition

  • III. Evidence from Decreased Fees

  • IV. Summary


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I. Theory

  • Physician-induced demand (PIP): “when the physician influences a patient’s demand for care against the physician’s interpretation of the best interest of the patient” (Handbook, p. 504)

  • Physician exploits role as agent to alter the patient’s demand curve

  • Distinctions that make PID challenging to identify empirically (not enough to just look at quantity)

    • Useful agency v. inducement

    • Demand shifting v. quantity setting


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I. Theory

  • Model

  • Where Y=income, I=inducement, N=number of patients, m=margin, x=quantity, i=inducement

  • Solving yields


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I. Theory

  • Testable prediction 1

    • N down => Y down and I down => UI less negative and UY up => -UI/UY down => x1’ and x2’ down => i1 and i2 up.

    • So, increased competition for patients should increase the per-patient quantity of services

      • Supply side: more physicians in market

      • Demand side: less need for services

    • Depends on changing tradeoff between I and Y as income changes (income effect)


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I. Theory

  • Testable prediction 2

    • m1 down => UY up => -UI/UY down => i1 and i2 up

      • Income effect

    • m1 down => lower return to inducement in sector 1 => i1 down and i2 up

      • Substitution effect

    • Net effect on i1 ambiguous; net effect on i2 down

    • So, a drop in fees from one payer should increase quantity among patients with another payer


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II. Evidence from Increased Competition

  • Effect of increase in per capita number of physicians on quantity

  • Problems

    • Really tests joint hypothesis of induced demand and income effects

    • Endogeneity of number of physicians (likely a response to demand)


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II. Evidence from Increased Competition

  • Fuchs (1978)

    • Effect of supply of surgeons on surgeries

    • 22 metropolitan areas, pooled cross sections from 1963 and 1970

    • IVs: metro area, hotel receipts, percent white

    • 10% increase in surgeons => 3% increase in surgeries

  • Cromwell and Mitchell (1986)

    • More years, more areas, better controls

    • Same identification strategy

    • Same sign, smaller effect

  • Birch (1988) and Grytten el at. (1990)

    • More dentists per capita => more dental visits


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II. Evidence from Increased Competition

  • Rossiter and Wilensky (1983, 1984); Scott and Shell (1997)

    • Small effects of physician density on quantity for some procedures

  • Dranove and Wehner (1994)

    • Falsification test: estimated “effect” of number of obstetricians on volume of births

    • Similar IV methodology to Fuchs and Cromwell and Mitchell

    • Found positive effect; suggests methodology is suspect


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II. Evidence from Increased Competition

  • Gruber and Owings (1996)

    • 13.5% fall in fertility from 1970-1982 represents exogenous shock to incomes of OB/GYNs

    • Exploited between-state over-time variation in fertility rates to identify effect on Caesarian section deliveries (more lucrative)

    • 10% drop in fertility => 0.6% increase in P(C-section)


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II. Evidence from Increased Competition

  • Pauly (1980)

    • Used large individual-level dataset

    • Least informed patients should be the most susceptible to demand inducement

    • Poor patients in big cities should be the least informed

    • Found (small) effect of number of physicians on quantity of ambulatory care for this group


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III. Evidence from Decreased Fees

  • Hadley and Lee (1978); Mitchell et al (1989)

    • Medicare price freezes during 1970s and 1980s led to increased utilization

  • Hurley et al. (1990); Hurley and Labelle (1995); Escarce (1993b)

    • No clear evidence of effect of own-fee changes on utilization

    • Not surprising; theoretical prediction ambiguous

  • Rochaix (1993)

    • GPs in Quebec changed mix of services in response to lowering of fees


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III. Evidence from Decreased Fees

  • Rice (1983)

    • 1977: Medicare began setting fees in Colorado based on state-wide averages

    • Reduced fees in Denver-Boulder area; increased them in other areas

    • Physicians facing declining rates increased provision of surgery, medical services, and tests


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III. Evidence from Decreased Fees

  • Nguyen and Derrick (1997)

    • Impact of Medicare fee reductions for “overpriced procedures”

    • For 20% of physicians who experienced the largest price reductions, 1% reduction in price => 0.4% increase in volume.

  • Yip (1998)

    • Reductions in Medicare fees for thoracic surgeons led to large increases in volume

    • Surgeons recouped 70% of lost income


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IV. Summary

  • There is no perfect test for demand inducement, but theory generates predictions that lead to tests that are suggestive.

  • “It appears that, in response to economic considerations … physicians can induce demand for their services, they sometimes do induce demand, but that such responses are nether automatic nor unrestrained” (Elgar p. 265, citing Hurley and Lebelle, 1995).


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