Physicians as Providers of

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Chapter 7

• Physicians as Providers of
• Health Care

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A. Market Structure of Physician Practices

• The market for physician services is best
  characterized as
• monopolistically competitive, although there are
  examples of
• monopoly (cartels).
• This market is one in which physician practices
  are not perfect
• substitutes for each other, but in which there is
  competition in most
• communities. Thus, we can think of physician
  practices as being
• characterized by downward sloping demand curves.

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A. Market Structure of Physician Practices

• Figure 7.1 A Monopolistically Competitive
  Physician Firm

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B. Behavior of Physician Practices (Firms)

• The market for physician services is known to be
  one in which price
• discrimination is employed.
• Does price discrimination result from altruism or
  does it result from
• rational economic motivation, e.g. an attempt to
  profit maximize?
• Historically, there was much anecdotal evidence
  that physicians
• were motivated by altruism and would accept
  whatever people
• could pay.
• We can explain this by noting that physicians
  utility function may
• take the form of
• U f (I, L, A)
• where I income, L leisure and A altruism.

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B. Behavior of Physician Practices (Firms)

• Price discrimination may also result from an
  economically motivated
• strategy to maximize profits.
• Economically motivated price discrimination can
  occur where
• (a) markets can be segmented by price elasticity
  of demand
• (b) products or services cannot be resold.
• Both of these conditions apply in the market
  place for physicians
• services.

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B. Behavior of Physician Practices (Firms)

• Profit-Maximizing Price Discrimination
• Use the general rule of setting marginal cost
  (MC) equal to marginal
• revenue (MR) in each sub-market.
• To understand how this leads to profit-maximizing
  price
• discrimination, we must understand the
  relationship between
• marginal revenue (MR), price elasticity of demand
  (?) and price (P)
• MR P (1 1/?)
• To maximize profits, the firm sets the marginal
  cost equal to the
• marginal revenue in each sub-market
• MC MR1 MR2
• MC P1 (1 1/?1) P2 (1 1/?2)

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B. Behavior of Physician Practices (Firms)

• Figure 7.2 Two-Way Price Discrimination

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B. Behavior of Physician Practices (Firms)

• Cost-Shifting
• Cost shifting occurs when firms charge higher
  prices to one group of
• consumers in order to offset lower payments from
  others.
• Many people think that physicians (and hospitals)
  do this in order to
• compensate for charity care lower payments from
  Medicare,
• Medicaid, or managed care third-party payers.
• Cost-shifting is only profitable if firms are not
  already charging the
• profit maximizing price to the unconstrained part
  of the market, e.g.
• charging a price lt p in the following diagram.

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B. Behavior of Physician Practices (Firms)

• Figure 7.3 Limits to Cost Shifting

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C. Alternative Model of Physician Practices

• A model proposed by Thomas McGuire (2000) treats
  physicians as
• quantity setters rather than price setters. It
  has a great deal of
• plausibility in an age of managed care, and when
  Medicare and
• Medicaid set rates of reimbursement.
• It treats consumers (patients) as having marginal
  benefit rather than
• demand functions for services purchased.
• Total benefit is a function of quantity of
  service received, B(x),
• where x is the unit of service.
• If price of a unit of service p, Net benefit
  is
• NB(x) B(x) p(x).

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C. Alternative Model of Physician Practices

• In this model patients do have choices among
  physicians.
• In order to remain with the same physician
  practice, a patient must
• receive a minimum level of net benefit, NB0.
• A physician can satisfy this condition while
  providing varying
• amounts of service since some care is perceived
  as having positive
• value while other care is perceived as having
  negative value. Figure
• 7.4 illustrates this.

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C. Alternative Model of Physician Practices

• Figure 7.4 The McGuire Model

Based on McGuire, T.G., Physician Agency in
Handbook of Health Economics, Vol. 1A, A.K.
Culyer and J.P. Newhouse, eds., (Amsterdam,
Elsevier, 2000) Fig 3, p. 480
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D. Physicians as Agents

• Because of asymmetric information, in which
  physicians specialized
• knowledge gives them an advantage in diagnosing
  and
• recommending treatment, patients delegate
  authority to physicians
• to make decisions about their health care. This
  creates the potential
• for principal/agent problems.
• Physicians can either be perfect or imperfect
  agents. If they behave
• as perfect agents, they act in the patients best
  interest in
• recommending treatment. In the case of imperfect
  agency,
• physicians substitute their own self-interest.

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D. Physicians as Agents

• Physicians who are perfect agents will tend to
  recommend the same
• treatment, regardless of the way in which they
  are reimbursed.
• Imperfect agency will manifest itself differently
  depending upon
• whether physicians are reimbursed on a fee-for
  service basis,
• salaried, or paid on a capitation basis.

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D. Physicians as Agents

• Imperfect Agency in a Fee-for-Service Regime may
  take the form of
• Physician Induced Demand (PID).
• This can be illustrated, using Figure 7.4, as
  providing the quantity of
• service, (x - x0) when it is deemed by the
  physician to be medically
• unnecessary.
• Figure 7.4 also allows for the possibility that a
  physician is acting as
• a perfect agent in prescribing x amount of
  treatment, since his/her
• superior information may cause the physician to
  understand the
• advantage of treatment which the patient may
  prefer to avoid.

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D. Physicians as Agents

• Imperfect Agency, when physicians are either
  salaried or paid on a
• capitation basis, is likely to be manifested in
  skimping rather than
• providing unnecessary treatment.
• Imperfect Agency is likely to enter into a
  physicians utility function
• as a negative term since it directly conflicts
  with professional ethics.
• The disutility associated with inducing demand is
  a limiting factor.
• (Robert Evans).
• It can be argued that skimping on care would also
  involve disutility.
• Moreover, the need to satisfy patients NB0
  limits imperfect agency.

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E. Malpractice and Defensive Medicine

• The main aim of medical malpractice law is to
  reduce medical
• mistakes resulting from carelessness or
  incompetence.
• However, it also leads to increases in cost of
  medical care due to
• (a) the high cost of malpractice insurance
• (b) the practice of defensive medicine
• This is fear-of-liability-induced changes in
  medical practice. It
• may be hard to distinguish in practice from
  physician-induced
• demand, which is motivated by enhancing physician
  income. Both
• are easier to do when patients have generous
  health insurance or
• are not cost-conscious.