Lecture Notes – Physician Services Market

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

the physician services firm vs. the marketvertical 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 firmprofitleisure (of who?)patient's healthWhat are the relationships?

important issues to be addresseddemand side or allocative efficiency supply side or technological efficiencypublic policy implications

Demand Side PerformanceOverriding issue is allocative efficiency but difficult

to measure either benefits or costs => How to assess allocative efficiency?

variations in physicians' fees between areas/physicianshow 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? Doesn’t pay to search for the best deal for small budget item.

is the market for physicians' services competitive? empirical results

Conclusions = ? Get large variation even for large budget items =>

Evidence that the market is not competitive.

Variation in Physician Fees

Procedure High LowPercent

DifferenceInitial office visits 53 31 70.97%Normal delivery 1450 775 87.10%

stress test 300 100 200.00%prostate surgery 2000 1200 66.67%

hernia repair 1030 450 128.89%

Note: all data is from the 1980s

increases in physicians' fees over timewhat should happen to fees in both short and

long-run if the market is competitive? Short-run competitive firms can make profits =>

prices and costs may vary independently. Long-run competitive firms can not make profits =>

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

Supply Side Performancethe production of physician services

how do you measure output physician visits? - advantages and disadvantages annual gross billings? - advantages and

disadvantageswhat 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?

technological efficiencyempirical 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 =>

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 => 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 (Dr’s) to maximize profit?

group practice studies Group practices produce more at lower costs => 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. => the market is non-competitive but the level of competition is increasing.

Models of Physician Pricingmonopoly pricing model (collusive joint

profit maximization model)the importance of entry barrierscheating on the cartelwhat 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?

Supplier induced demandTwo 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

Drs income falls

P and Q rise

P

Responds by inducing D

D1

P

Q

S

D

S1

S increases

QS increases

Q

S

D

D increases

D1

P and Q rise

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 => 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)

Y=Drs income, + impact; W = Drs hours of work, - impact D=Disutility 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

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 firstEmpirical 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) => find evidence of SID from differential impact of D.

Some evidence exists of SID although not large impact

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).

Public Policyconclusions 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) => reduce regulation?

Problems Medicare payment reform Others?

The Physician as Laborwhy become a doctor? (what matters when

making the decision?) the cost of becoming a doctor the benefits of becoming a doctor graphical

time

$

Graduate with BA/BS

Graduate with MD

Earnings BA/BS

Earnings MD

$0

Area A = Direct costs of MD Area B = Indirect costs of MD Area C = Benefit of MD Invest if C > A + B – not quite, also add discount rates Empirical Results – see handout on rates of return for MD education

empirical rates of return

time

$ Earnings BA/BS

Earnings MD

A

B

C

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 => 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 => test the impact of

licensing on professional fees => conclude sometimes fees increases but sometimes not.

Quality – if licensing increases quality => supports public interest. Again sometimes find quality increased, sometimes decreased =>

support for political economy theory.

labor supply of physicianswhy do physicians supply labor?

labor as a consumption good Work because it gives us utility => implications?

labor as an investment good Work because it gives us money => implications

the relationship between labor and leisure Leisure is what you do when you’re 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

what does an individual's supply of labor look like? Two effects of a wage increase

Focus on the labor/leisure tradeoff => when leisure ↑ or ↓ then labor ↓ or ↑.

substitution effect – w ↑ => consumption of leisure ↓ because leisure is now more costly (↑ opportunity cost of leisure) => substitute less time intensive types of leisure for more time intensive types => ↑ quantity supplied of labor.

income effect – w ↑ => income rises (↑ price of labor) => leisure is a normal good => consumption of leisure ↑ => ↓ quantity supplied of labor.

Both effects occur simultaneously => which is largest?

Empirical question – examine behavior as wages increase

Empirical studies of physician labor supply shows the following:

W

Hrs/Week112

Theoretical Maximum = 16x7

SL

Substitution Effect outweighs Income Effect

Income Effect outweighs Substitution Effect

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?

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 => should see more

communities with drs. Same is true of specialists. Empirical evidence supports these predictions.