ECO/HCM 504 – Health Care Economics

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. P P S S S1 D1 D1 D D Q Q S increases D increases QS increases Drs income falls Responds by inducing D 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 => 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. 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. $ time • 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. Earnings MD $ Earnings BA/BS time C B • 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 A

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 => 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. Hrs/Week 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 => should see more communities with drs. • Same is true of specialists. • Empirical evidence supports these predictions.