ECO/HCM 504

1
ECO/HCM 504 Health Care Economics

• Lecture Notes Physician Services Market

2
Why do we have physician firms? (and what do
they do?)

• dual role of physician firms
• the physician as an input into the production of
  physician services
• Demand for physician services is a derived
  demand.
• Affected by Economic factors
• Prices, Income, insurance coverage, prices of
  competing goods
• Affected by Non-economic factors
• Age, Illness events, education, marriage, etc.
• the physician as owner and entrepreneur
• Supply of Physician Services is derived from
  other end of market (input markets) such as
• Physician Labor, nurses labor, technical
  assistants, etc.
• Capital and equipment

3

• the physician services firm vs. the market
• vertical and horizontal integration (what's
  that?)
• What is the alternative? Compare internal
  (integration) vs. external (market) systems.
• Health care has moved away from the market toward
  internal system with government regulation.
• possible goals of the physician firm
• profit
• leisure (of who?)
• patient's health
• What are the relationships?
• important issues to be addressed
• demand side or allocative efficiency
• supply side or technological efficiency
• public policy implications

4
Demand Side Performance

• Overriding issue is allocative efficiency but
  difficult to measure either benefits or costs gt
  How to assess allocative efficiency?
• variations in physicians' fees between
  areas/physicians
• how should fees vary in a perfectly competitive
  market?
• if patients have incomplete information and must
  search?
• if quality differences exist between physicians?
• empirical predictions
• Consider 2 different goods standardized
  glaucoma test vs. surgery for, say, prostate
  cancer Which would have the largest variation
  in fees even when the market is competitive (but
  with asymmetric information)?
• Glaucoma test why? Doesnt pay to search for
  the best deal for small budget item.

5

• is the market for physicians' services
  competitive? empirical results
• Conclusions ? Get large variation even for
  large budget items gt
• Evidence that the market is not competitive.

6

• increases in physicians' fees over time
• what should happen to fees in both short and
  long-run if the market is competitive?
• Short-run competitive firms can make profits gt
  prices and costs may vary independently.
• Long-run competitive firms can not make profits
  gt prices can only vary as costs vary.
• do fee increases over time reflect increased
  costs?
• Examine handout to answer question especially
  look at differences over time in how fees change
  compared to costs as measured by overall CPI.
• Conclusions
• Evidence of lack of competition in market
• More evidence of competition in recent past

7
Supply Side Performance

• the production of physician services
• how do you measure output
• physician visits? - advantages and disadvantages
• annual gross billings? - advantages and
  disadvantages
• what are the inputs in the production process?
• must be at least 1 physician (why?)
• other inputs? Nurses, technicians, etc.
• relationship between the inputs? Substitutes vs.
  complements?

8

• technological efficiency
• empirical studies of the use of aides by
  physicians
• Increases in price increase the optimal of
  aides
• Increases in wages decrease the optimal of
  aides
• Confirmation of economic theory on optimal use of
  inputs
• However, aides also found to be underutilized gt
  inefficient (see T 15.1 p. 239). What other
  inputs are underutilized?
• MP/w should be equal if inputs are correctly
  utilized
• If MP/w larger for a given input gt that input is
  underutilized and the reverse.
• Why are too few aides and other inputs used?
• Attempt by Dr. to give best possible care (Dr.s
  care) to patient?
• How to use a monopolized input (Drs) to maximize
  profit?

9

• group practice studies
• Group practices produce more at lower costs gt
  efficient.
• Recent increases in the use of group practice
  suggests efficiency as well
• Economies of scale exist and explain increasing
  size of physician firms.
• Incentive Problems in groups
• Shared profit leads to incentives to shirk. Why?
• As group size increase then incentives to shirk
  increases.
• If paid flat wage the incentive then still have
  incentive to shirk. Why?
• How does the firm monitor worker effort?
• referrals among physicians (why is this a
  concern?)
• fee splitting
• multi-specialty firms
• Conclusion increases in competition are forcing
  drs to take advantage of aides, economies of
  scale, etc. gt the market is non-competitive but
  the level of competition is increasing.

10
Models of Physician Pricing

• monopoly pricing model (collusive joint profit
  maximization model)
• the importance of entry barriers
• cheating on the cartel
• what happens, according to the model, when
  insurance coverage increases?
• Demand increases and becomes less elastic.
• Both cause price to increase. This prediction is
  supported by empirical evidence.
• why limit advertising by physicians?

11

• Supplier induced demand
• Two conditions lead to SID
• Assymetric Information
• Dr. as agent
• Based on empirical observation of correlation
  between things like
• Hospital beds and hospital utilization
• Drs and utilization of Drs services
• Two possible interpreations using D/S analysis

12
P
QS increases
Drs income falls
P and Q rise
P and Q rise
13

• Target income model
• The first graph is this model
• Notice that the second graph is simplier and
  evidence suggests it is more likely to explain
  the empirical observation.
• Price rigidities
• Difficult to change price quickly (why?)
• As input prices rise gt prices rise slower
• Leads to inducement but only enough to decrease
  the surplus
• Disapears over time
• Disutility of discretion model
• Problem with SID why are drs satisfied with a
  given target why not higher?
• Assume U U(Y, W, D)
• YDrs income, impact W Drs hours of work, -
  impact
• DDisutility caused by inducing demand, - impact
• Inducement causes tradeoff between extra income
  and more work and disutility from inducement.
• Therefore, a limit to inducement because of
  tradeoff

14

• Profit maximization
• SID has another potential tradeoff
• Increasing D increase profit but also increases
  costs (diminishing returns).
• Tradeoff between the two leads to some limit to
  SID
• Problems ? identification
• Causality See figures above
• Graph 1 says increase in S causes increase in D
• Graph 2 says increase in D causes increase in Qs
• Causality asks which comes first
• Empirical Evidence on SID
• Some evidence in favor of SID from price rigidity
  studies
• Is there evidence of SID caused by imperfect
  information and agency?
• Compare initial visits to Drs (patient initiated)
  vs followup visits (Dr. Initiated) gt find
  evidence of SID from differential impact of D.
• Some evidence exists of SID although not large
  impact

15

• Small Area Variation
• Figure 10.5 p. 216
• Shows variation in utilization between geographic
  areas. Why?
• Differences in level of competition
• Differences in information/practice styles of
  Drs.
• Figure 10.6 shows these differences which lead to
  different practice styles.
• How to test the model? How do we measure
  practice style?
• Studies show that education/feedback/surveillance
  of Drs changes practice style.
• Comparison of relatively homogenous areas still
  finds SAV.
• Multiple regression studies controlling for other
  factors still find SAV (although smaller).

16

• Public Policy
• conclusions about the level of competition in the
  physician services market
• Market is not competitive.
• The level of competition is increasing.
• possible public policy proposals to increase
  competition
• Regulation
• The source of much of the inefficiency in the
  market is regulation (e.g., licensing laws lead
  to non-optimal use of labor in health care
  markets) gt reduce regulation?
• Problems
• Medicare payment reform
• Others?

17

• The Physician as Labor
• why become a doctor? (what matters when making
  the decision?)
• the cost of becoming a doctor
• the benefits of becoming a doctor
• graphical

Earnings MD
Earnings BA/BS
0
Graduate with BA/BS
Graduate with MD
18
C
B
A

• Area A Direct costs of MD
• Area B Indirect costs of MD
• Area C Benefit of MD
• Invest if C gt A B not quite, also add
  discount rates
• Empirical Results see handout on rates of
  return for MD education
• empirical rates of return

19

• Why specialize?
• the cost and benefits of specialization
• empirical rates of return
• Why have licensing of health care professionals
• 3 theories
• Each focuses on a different group benefiting from
  licensing.
• Public Interest Theory
• Licensing benefits the public - consumers
• Capture Theory
• Licensing benefits the professionals being
  licensed.
• Political Economy Theory
• Licensing benefits the regulators gt sell
  licensing to highest bidder, sometimes public and
  sometimes professionals.
• Empirical Evidence tends to support political
  economy theory
• See T 15.4 p. 344 licensing varies by state gt
  test the impact of licensing on professional fees
  gt conclude sometimes fees increases but
  sometimes not.
• Quality if licensing increases quality gt
  supports public interest.
• Again sometimes find quality increased, sometimes
  decreased gt support for political economy
  theory.

20

• labor supply of physicians
• why do physicians supply labor?
• labor as a consumption good
• Work because it gives us utility gt implications?
• labor as an investment good
• Work because it gives us money gt implications
• the relationship between labor and leisure
• Leisure is what you do when youre not working or
  sleeping/eating/etc.
• Tradeoff between labor and leisure
• what is the wage rate?
• Wage rate equals the price paid for labor
• Wage rate also equals the opportunity cost of
  leisure

21

• what does an individual's supply of labor look
  like?
• Two effects of a wage increase
• Focus on the labor/leisure tradeoff gt when
  leisure ? or ? then labor ? or ?.
• substitution effect w ? gt consumption of
  leisure ? because leisure is now more costly (?
  opportunity cost of leisure) gt substitute less
  time intensive types of leisure for more time
  intensive types gt ? quantity supplied of labor.
• income effect w ? gt income rises (? price of
  labor) gt leisure is a normal good gt consumption
  of leisure ? gt ? quantity supplied of
  labor.
• Both effects occur simultaneously gt which is
  largest?
• Empirical question examine behavior as wages
  increase
• Empirical studies of physician labor supply shows
  the following

22
SL
Income Effect outweighs Substitution Effect
W
Theoretical Maximum 16x7
Substitution Effect outweighs Income Effect
112
23

• Do market labor supply curves also bend
  backwards?
• Empirical questions and answer no. Why not?
• New entry as w increases.
• Fixed components of labor supply
• One example is malpractice insurance, which
  induces drs not to reduce labor supply as wage
  increases.
• Physician Location Decisions
• Hotelling Model
• Say have a concession stand on a beach
• Where do you locate? Assume customers evenly
  distributed on beach.
• Why? Because it reduces travel time and
  maximizes demand and profit.
• Where does second, third, etc. firm locate?

24

• Same principle for new entry.
• Also same principle is true for Drs.
• Locate where they can have the maximum number of
  customers.
• Predictions from the model
• As the number of drs increases gt should see more
  communities with drs.
• Same is true of specialists.
• Empirical evidence supports these predictions.