CAS EC 387 Introduction to Health Economics

L9: Physicians

Department of Economics

Spring 2020

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Outline

Market structure

Physician agency

Supplier-induced demand (SID)

Small area variations (SAV)

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Choice of Medicine as a Career I

Substantial increase in MDs: 350, 000 (mid 70s), 1, 000, 000 (2006),
920, 000 (2017)

80% involved in direct care (remainder in training, teaching, research)

Physician/patient ratio increased from 134 to 242 per 100, 000 last 30
years

Geographic variation 432 in MA 185 in MS

Over 50% of MDs are specialists

Financial and non-…nancial incentives (extrinsic v. intrinsic

motivation)

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Choice of Medicine as a Career II
Concepts of present value and internal rate of return (on investments
in medical education)

For each individual m and each career alternative j, there is a stream

of anticipated future earnings ym,j and non-pecuniary attributes of the
occupation Aj

Non-pecuniary attributes: occupation’s prestige, intellectual content,

types of people one interacts with, ‡exibility of work schedule, risk of
injury, and job-related stress

Values of ym,j vary not only by j but also by m

Individuals di¤er in utility that they attach to earnings and

non-pecuniary attributes of job

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Choice of Medicine as a Career III

Physician utility:
Um = U (ym,j , Aj )
Here ym,j and Aj are substitutes

Higher level of anticipated earnings compensate an individual for

accepting work in an occupation with a lower Aj

Median income in 2012: $31, 017 (all US workers), $220, 942

(primary care), $396, 233 (specialists)

Reasonable or not?

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Market Structure I

Substantial barriers to entry

Is licensure necessary?

Limits on substitutability between MDs and NPs, physician extenders,

and nurses (monotechnic view)

Liability shifted from individual MDs to institutions (hospitals and

HMOs)

Relatively little research has focused on competition

Reasonable to characterize most markets for physician services as

monopolistically competitive

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Market Structure II

Physicians are not perfect substitutes (location, specialty, quality,

imperfect information)

Aggregate vs individual demand and supply - varying elasticities

Price setting and price competition

Data scarce

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Practice Form

Motives for joining group practice

economies of scale and economies of scope

referals
income ‡uctuation and revenue/expense sharing
bargaining power over payers
less costly insurance

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Physician FFS Reimbursement I

More than a third of MD/clinical services purchased by government

(60% of which is Medicare) – substantial, but still less than hospital
services

Since 1992, Medicare pays according to RBRVS used rather than

UCR rates

Most HMOs use RBRVS

Private sector responsible for 65% of MD revenues, 75% of which

coming from insurance

RBRVS assigns procedures performed by a physician or other medical

provider a relative value which is adjusted by geographic region

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Physician FFS Reimbursement II
This value is then multiplied by a …xed conversion factor, which
changes annually, to determine the amount of payment

RBRVS prices based on three separate factors: physician work (54%),

practice expense (41%), and malpractice expense (5%)

Criticisms
unlike EBM, pay is based on e¤ort rather than e¤ect/outcome ! to
overuse of complicated procedures
specialists reimbursed more than PCPs ! incentives to specialize !
leading to a lack of PCPs
the Specialty Society Relative Value Scale Update Committee (RUC) is
largely privately run
RUC holds meetings closed to the public and uninvited observers

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Marginal Revenues and Marginal Cost

MR to MD MC to patient + MC to patient 0
MD paid FFS, MD paid FFS,
+
patient pays OOP patient pays 0

MD salaried, MD salaried,
0
patient pays OOP patient pays 0

MD capitated, MD capitated,
patient pays OOP patient pays 0

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Supply-Induced Demand I

SID occurs when the physician in‡uences a patient’s demand for

health care against the physician’s interpretation of the patient’s best
interest

Imperfect agency- distinguish between useful agency and demand

inducement

Idea stems from increase in physician supply and rapid increases in

physician fees during 60s and 70s

Now large and partly controversial literature

Evidence that physicians respond to …nancial incentives

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Supply-Induced Demand II

Demand follows supply – the Reinhardt fee test

Utilization and demand: possible to in‡uence utilization but not

demand (rationing in HMOs)

“Other things equal, physicians would rather tell the truth, but they
would be willing to surrender some accuracy for some amount of
money income.” Pauly “Doctors and Their Workshops: Economic Models of Physician Behavior”, (1980)

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Supply-Induced Demand III

You know, for me, it really is the right thing for me to do the CAT
scan. If I don’t do the CAT scan, you’ll probably lodge a complaint
about me. If I do the CAT scan you’re be really happy with me. In
addition, I’m almost certain that you daughter is …ne, but there’s a
maybe a 1 in million chance that she isn’t; that maybe there is a
hidden fracture and I’m missing it. And if that’s the case, the CAT
scan will save my butt. On the other hand, if I do the CAT scan and
your daughter gets cancer twenty years from now, no one will blame
me. In addition, I’m spending a lot of time talk to you that I would
be doing other things. If I got the CAT scan, I could do it in a
second and it would be done with, it would be easy. And …nally, the
really strange thing is, I’ll get paid more if I do the CAT scan. . . So
everything about this was pushing me to do the CAT scan.” Dr Jerome
Ho¤man

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Supply-Induced Demand IV

Target income

Physician’s utility depends on positively on income and negatively on

inducement

Inducement is viewed as costly investment in demand expanding

activity – optimal inducement will depend on relative cost of
manipulating demand

Similar to advertising

A model of physician behavior

Suppose that U (Y , I ) is the physician’s utility function

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Supply-Induced Demand V
Y is net revenue and I total inducement I = Ni, where N is the
number of patients and i is the amount of inducement per patient

Budget constraint

At the optimum, the MU of increased income is equal to the psychic

MC of inducement

Suppose m goes down due to increased competition – this causes the

marginal utility of income to increase and this makes inducement
more attractive (income e¤ect)

Also, there is another e¤ect at work – if m falls, the return to

inducement falls and inducement is relatively less attractive
(substitution e¤ect)

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Supply-Induced Demand VI

Hence, two counteracting e¤ects – depends on substitution e¤ects

and income e¤ects

However, income e¤ect must be large to outweigh the substitution

e¤ect (depends on the utility function)

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Data on SID I

Early papers concerned with availability e¤ects – will exogenous

supply increase lead to higher demand?

Studies ‡awed – with unobservable variables (cross sectional data,

border crossing, imperfectly speci…ed supply functions)

Rossiter and Wilensky: physician-initiated visits should respond to

increasing supply (weak result)

Yip (1998) looked at surgeons in NY – strong evidence of income

e¤ects and increased volumes (SID present)

Hay and Leahy (1982) – physicians do not receive less treatment than
non-physicians (no support for SID)

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Data on SID II

Mixed evidence from Medicare studies and from Norway (falling

demand and incomes did not lead to service increase)

Dranove and Whener found support for SID where it shouldn’t occur

In sum, some evidence for SID but extremely di¢ cult to know its
extent

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Small Area Variations I

SAV studies typically focus on the rate at which standard populations

receive speci…c treatments (hospitals)

Use of technology is di¤erent - (patient condition, appropriateness of

treatment, preferences for treatment)

Early examples: tonsillectomies in England varied tenfold (1938),

Wennberg study of surgical procedures in VT hospitals (70s)

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Small Area Variations II

Commonly used measure of SAV is coe¢ cient of variation (CV) =

Variance/Mean

SAV predicted to be larger if little consensus regarding treatment

value and e¢ cacy

“Style” partly explains adoption of particular practice –

leader/follower argument (Dr Prozac)

Di¢ cult to disentangle SAV e¤ects from SID e¤ects

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Data on SAV I
Experiment: new information and/or monitoring may a¤ect rates
(tonsillectomy, hysterectomy)

Compare CV among homogenous populations – controlling for

socioeconomic factors may indicate practice style di¤erences
(Wennberg)

Socioeconomic variables explain some, but not all variation, nor does
insurance coverage

Regression framework:
utilization = βX + ε
where error may capture practice style

Problems with all approaches – but usual estimate is 40% 75% of

variation can be explained
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Data on SAV II

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Practice Variations I

Commonly cited reasons for practice variations/faulty decisions

Defensive medicine (controversial - Baicker et al 2007 …nd little
connection between malpractice liability costs and provider treatment
of Medicare patients)

Financial incentives (e.g. Gruber, Kim, Mayzlin, 1999; Gruber and

Owings, 1996), and especially by feefor - service reimbursement
models that can incentivize providers to increase the number of
services rendered (McClellan, 2011)

Knowledge spillovers/peer e¤ects

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Practice Variations II

Varying degrees of competence and experience - Doyle et al. (2010)

…nd that providers from the better medical school systematically
conduct fewer tests and have lower costs, even though both groups
have similar patient outcomes

Patient preferences (Cutler et al. (2013) conclude that patient

demand is a relatively unimportant determinant of regional variations-
main driver is provider beliefs about appropriate treatment that are
often unsupported by clinical evidence

Currie et al
One of the most controversial issues in medicine is whether providers
should be evaluated in terms of their adherence to simple metrics

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Practice Variations III

Such metrics increasingly popular as a way to improve the quality of

health care

In addition, it is thought that better metrics could help to control

costs

Providers argue that treatment should be tailored to the needs of

individual patients - cannot be captured through adherence to simple
rules

Dartmouth medical atlas project show that in high spending regions

of the country, patients receive consistently more treatment

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Practice Variations IV

Sutherland, Fischer, and Skinner (2009) found that “discretionary

decisions by providers seem to account for most of the regional
variation in spending,” and that outcomes were not better in high
spending areas of the country

The implication is that costs could be reduced without sacri…cing

outcomes

Chandra et al decompose provider practice style into two dimensions,

whether providers are more or less aggressive in their use of invasive
treatments and whether there are di¤erences in the extent to which
providers tailor their treatment decisions to the characteristics of
individual patients

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Practice Variations V

Shows substantial variation across providers in the extent to which

observable patient characteristics a¤ect choice of procedure

Some providers are much less likely to use invasive procedures on the
oldest and sickest patients, while others appear to pay little attention
to these factors

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Practice Variations VI

Providers who treat everyone aggressively have the best outcomes

In contrast, following prevailing norms in teaching hospitals where

providers are less likely to perform invasive procedures on the “least
appropriate” patients, reduce costs but achieve poorer health
outcomes for these patients

Most aggressive and responsive providers are young, male, and

graduated from top-20 medical schools

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Social Cost of SAV

Concern: is SAV an indication of inappropriate use of care?

E¢ cient use is when MB = MC (Under-utilization vs.

over-utilization)

Suppose the true bene…t is given by B (X ), where X is medical input

Both under-utilization (X1 ) and over-utilization (X2 ) result in welfare

loss

Consider B1 (X ) and B2 (X ) – what is the loss to society?

Phelps estimates that the welfare cost from the variation in coronary
bypass only is $750 million

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Physician Behavior and Anomalies (Hough) I

MDs percieved as rational decision makers

Heuristics

How can an MD diagnose a problem after spending only a short time

with the patient?

Why do many MDs take a long time to adopt a new procedure, drug,
or treatment protocol that has demonstrated e¢ cacy? Why no hand
wash?

Why do clinical decisions depend on how options are framed?

Why do they practice defensive medicine even in states with reform?

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Physician Behavior and Anomalies (Hough) II

Why does physician adherence to clinical guidelines decline when

…nancial incentives are removed?

Why do MDs practice di¤erently in di¤erent communities, even

though the communities are similar?

Why do medical errors - many of which seem to be easily avoided -

still exist?

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Summary I

Uncertainty may cause SID (through asymmetric information) and

SAV (incomplete information)

SID is very hard to measure – however, many observers seem

convinced it exists at least to some degree (welfare loss)

The existence of SAV is well-documented and may have di¤erent

causes - raises question of inappropriate use of care and ensuing
welfare loss

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