health economics- lecture ch15

8/3/2019 Health Economics- Lecture Ch15

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The Physicians Practice

Dr. Katherine Sauer

Metropolitan State College of Denver

Health Economics


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Chapter Outline:

I. A Model of the Physicians PracticeII. Supplier-Induced Demand

III. Small Area Variations

IV. Other Issues


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I. A Model of the Physicians Practice

McGuire and Pauly (1991) describe physicians as utility

maximizers which means that physicians value items

besides profit.

In this model, the physician gets utility from

net income and leisure,

and disutility frominducement, (the physicians own efforts to induce

patients to buy more care than appears medically

necessary.)


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U =f( , L, I)

is net income

L is leisureI is inducement


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Hours of Leisure

Hours of Labor

Income

24

Assume working returns

constant revenue.

- working for one

more hour means yourincome increases by

w and you get one

less hour of leisure.

A. The income leisure tradeoff:


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Hours of Leisure

Hours of Labor

Income

24

As the wage increases, the

income line gets steeper.

income w1income w2

income w3

The physicians optimalbalance between labor and

income changes.


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wage

Hours of

Labor

w3

w2

w1

Initially, the physicians

income effect dominates the

substitution effect.- higher wage leads

him to work more

There comes a point wherethe substitution effect

dominates.

- higher wage leads

him to work less

An increase or decrease in income causes the physician

to reevaluate the choice of how much to work

L1 L2

L3


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B. The income inducement tradeoff:

- disutility from inducement

U1

U2

Inducement

Income


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Inducement

Income

A certain level of

income will be

achieved evenwith no

inducement.

m is the rate ofprofit per patient

care unit

Q0 is the number

of patient care

units without

inducement.

mQo +mI

mQo


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Inducement

Income

The optimal level

of inducement is

found at thetangency between

the income line

and indifference

curve.

This physician

induces QI* non-

medicallynecessary care.

mQo +mI

U

QI*

mQo


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Inducement

Income

If the profit rate

per patient falls,

the income line islower and flatter.

Now the optimal

level ofinducement is

higher.

m1Qo +m1I

U1

QI1*

m2Qo +m2I

U2

QI2*


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C. Do Physicians Respond to Financial Incentives?

Nassiri and Rochaix, (2006)

when physicians are paid per service provided, they

provide more services than when they are given a fixed

total payment (capitation)

Studies also suggest that physicians respond to income

pressures on their practice by striving to increase their

incomes (Iversen, 2004; Gruber and Owings, 1996;

Quast, Sappington, and Shenkman, 2008; Rizzo and

Zeckhauser, 2003, 2007).


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II. Supplier-Induced Demand (SID)

On becoming ill, consumers hire health care professionals.

In medicine, we identify the physician as the agent, and

the patient as the principal.

The policy concern is that out of self-interest physicians

may violate their roles as agents.


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Physicians provide care, but also sell it.- competition lowers the per-patient profit rate

- increased inducement

An increase in physicians would cause an increase in thesupply of services, but also an increase in demand for

services (induced demand).


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Health economists have modeled supplier-induced

demand for at least two reasons:

- to understand the motivations of physicians, how

their incentives affect their practice

- models are needed to understand the data we

observe


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A. Supply and Demand Model

Even without SID, the market predicts that an increase in

supply of physicians will increase the quantity of services.

- supply shifts right higher quantity, lower price

If demand increases such that the price of service rises,

then SID is identified (Reinhardt Fee test).

But, maybe physicians respond to competition byincreasing their quality. (dont need SID to explain higher

quantity)


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B. Target Income Hypothesis (TIH)

This argues that physicians have desired incomes that they

strive to achieve or to restore whenever actual income falls

below the targets.

This target income model is a special case of the

benchmark model, though a relatively extreme one.

This model has received criticism because- income is the main focus of the physician

- but not income beyond the target


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Inducement

Income

If the profit per patient falls, so does the physicians

income.

m1Qo +m1I

U1

I1

m2Qo +m2I

U2

I2

1

2

The TIH says

this physician

will try to

increase their

income.


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Inducement

Income

The physician can increase income by increasing

inducement.

m1Qo +m1I

U1

I1

m2Qo +m2I

U2

I2 I2

1

2

2'

The dashedline is parallel

to the original

income line,

and thentangent to the

new level of

utility.


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Inducement

Income

This shows the change in inducement from removing

income from the physician.

m1Qo +m1I

U1

I1

m2Qo +m2I

U2

I2 I2

1

2

2'

The incomeeffect is the

distance I1 to

I2.


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If instead of having a target income a physician is a profitmaximizer, then a reduction in the profit rate results in an

income effect equal to zero.

- profit-maximizer gains utility only from

more net income

- values inducement only if it brings in more

income


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C. McGuire-Pauly synthesis:

the size of the income effect is critical tounderstanding SID behavior

A lower profit rate (m) will have two effects on

inducement:- substitution effect: when inducement is less

profitable, providers will substitute away from it

- income effect: decreased income will makeinducement more attractive


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D. The Parallel Between Inducement and Marketing

Stano (1987)argued that an influx of new competition (which reduces

the physicians profit rate) may lead physicians to induce

more, or less, depending on the cost structure of the

firms production and its advertising.

If the physicians SID is analogous to advertising/

inducement, then inducement would usually decline in an

increasingly competitive market.


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E. What Do the Data Say?

Two criticisms were raised about much of the earlier

SID work.

- many of those studies could not distinguish

between the SID model and the conventional supplyand demand model.

- many estimates of the SID effect proved to be

statistically flawed


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McGuire (2000)showed that the implications of availability on fees in

when physicians operate in monopolistically competitive

markets are not so clear.

Feldman and Sloan (1988)

show that if physicians can adjust their quality in

response to increased competition, then higher fees could

result even when there is no inducement.


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Rizzo and Blumenthal (1996)

use surveys of physicians to compare their desired

incomes to their actual current incomes.

Physicians with greater gaps were found to demand

greater price increases.

Rizzo and Zeckhauser (2003)

find the physicians whose current incomes fall below

their reference incomes are observed to show greater

income growth than the average of other physicians in

subsequent periods.


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III. Small Area Variations (SAV)

Are physicians themselves always well informed?

Medical and surgical use rates can vary even in a small

geographical area.


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A. How to Measure

The Coefficient of Variation (CV) relates the standard

deviation of observed medical use rates to the mean of

the same measure.- then divide by the mean (adjusts for size of the

rate being studied)

0.00 to 0.10 is low variation

0.10 to 0.20 is moderate variation0.20 and up is high variation


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Extremal Ratio ratio of the largest rate observed acrossthe small areas to the smallest rate observed


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Variations by Medical Procedure Type


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B. Causes of the Variation

Much of the SAV work focuses on- contribution of socioeconomic characteristics of

the population

- role of the availability of supplies of hospital and

physician services

The studies together reached two conclusions:

1) Supply variables are important and demand

characteristics play a somewhat lesser role though bothare statistically and materially significant.

2) much variation is still left unexplained


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C. The Physician Practice Style Hypothesis

Practice style probably varies among physicians due to

an incomplete diffusion of information on medical

technologies.

Wennberg (1984)

argued that much of the observed variation is closely

related to the degree of physician uncertainty with

respect to diagnosis and treatment.


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Epstein and Nicholson (2005)

find that a physicians residency has relatively little

influence on his practice style.

Stronger influences are his peers with the hospital where

he practices as well as his peers in the other hospitals in

his region.


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Studies show that information programs directed atphysicians can alter their behaviors and thus presumably

their practice styles.

One study found that an informational programsignificantly affected the tonsillectomy rates in 13 New

England areas.


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Wennberg and Fowler (1977)

found that morbidity and many socioeconomic

variables were not sufficient in explaining the

variations in a region.

Concluded that variations in use rates probably are due

largely to practice style differences across the small

areas.


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Phelps and Parente (1990)

found that standard demand and supply variables

typically account for between 40 and 75 percent of thevariation in their study of 134 separate diagnostic

categories.

Escarce (1993)found that 43 percent of the variation in cataract surgery

rates for the Medicare population is explained by

socioeconomic variables.


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D. Social Cost of InappropriateUtilization

The most important issue in the SAV literature is the

proposition that substantial variation in utilization rates

is an indication of inappropriate care.

Phelps and Parente find that the welfare loss due to

variations from true practice in the nation total $33

billion.


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Inefficiency from Misinformation about Benefits

MB,

MC

Rate ofUtilization of

Intervention X

MC

True MBMB as perceived byDoctor 1

MB as perceived by

Doctor 2

R*R1 R2

social loss


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IV. Other Issues

A. Physician Pricing and Price Discrimination

Physicians in private practice have some degree of

monopoly power (monopolistic competitors)

Arbitrage of physician services isnt possible.

Price discrimination is therefore possible.By segmenting their market and charging

different prices to different patients for the same

services, physicians can increase revenue.


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B. Paying for Outcomes:

fee-for-service vs fee-for-outcome

Fee-for-outcome is rare in the developed world but fairly

common among traditional healers (ex: in Africa).

Fee-for-outcome is difficult because of the uncertainty in

treating heath issues.

Outcome based contracts are more successful when both

the patient and the physician work together.


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Key Points

Our benchmark model depicts the physician as someone

who values positively net income, and leisure, anddislikes inducing patient demand.

The model shows that for the supplier induced demand

(SID) hypothesis to be supported, the physicians incomeeffect must be positive and substantial.

Small area variations can be understood as a result of

uneven diffusion of medical information to these same

physicians.


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Discussion Questions:

What forces limit a providers ability and willingness toengage in SID?

In the profit-maximizing model of SIC, what are the

costs to the physician of inducement?

Assuming that SID is prevalent and substantial, what

are the implications for policy?

health economics- lecture ch15

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