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 => 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? Doesn’t 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 =>
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 => 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

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 => 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?

9. 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.

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. Q S D S D P P Q S1
S increases
Responds by inducing D D1
D increases D1
QS increases
Drs income falls
P and Q rise
P and Q rise

13. Disutility of discretion model
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

14. Empirical Evidence on SID
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) => 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) => 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
time $
Earnings BA/BS $0
Graduate with BA/BS
Graduate with MD

18. empirical rates of return
time $
Earnings BA/BS
Earnings MD C B A
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

19. the cost and benefits of specialization empirical rates of return
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.

20. labor supply of physicians
why 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

21. 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:

22. Income Effect outweighs Substitution EffectSL
Income Effect outweighs Substitution Effect W
Hrs/Week
Theoretical Maximum = 16x7
Substitution Effect outweighs Income Effect
112

23. Physician Location Decisions
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 => should see more communities with drs.
Same is true of specialists.
Empirical evidence supports these predictions.