Unbiased Analysis of Today's Healthcare Issues

Cutting Medicare reimbursement increases the quantity of medical care

Written By: Jason Shafrin - May• 05•08

Traditional economic theory suggests that when the price of a good falls, the amount supplied will fall as well. Most economists always assume that the supply curve is upward sloping.

But that is not always the case in medical world. Because a physician serves both as the patient’s advisor and the supplier of medical treatment, physicians can induce patients to increase the amount of medical care they wish to receive. Patients are easily convinced because of 2 market failures: asymmetric information and moral hazard.

Asymmetric information means that the physician know more about your health condition than you do. Thus, patients rely on the advice of the physician. Moral hazard occurs because patients have health insurance. Since patients do not pay for the care they receive (or pay for it at a reduced rate), they are very amenable to follow the doctors orders.

A 1998 letter from the Health Care Financing Administration (HCFA) found that it was typical that a 50% offset will occur when Medicare payments are reduced. This means that a 20% reduction in price, will lead to a 12.5% increase in quantity. Overall, this will lead to only a 10% decrease in total cost. Since 10% is 1/2 of 20%, we have a 50% offset. Physicians are increasing the quantity provided in order to make up for the income lost from lower Medicare reimbursement rates.

This is a classic example of supplier induced demand.

An article by Yip (JHE 1998) found that this was the case for coronary artery bypass graft (CABG) surgeries as well.

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  1. Lawrence Liebscher says:

    Recent documentation of this phenomenon is included in the just published article cited below. Lower reimbursement for imaging procedures in southern California as compared to northern California mirror a higher per member utilization rate in southern California.

    Utilization Trends for Advanced Imaging Procedures: Evidence From Individuals With Private Insurance Coverage in California.

    Medical Care. 46(5):460-466, May 2008.
    Mitchell, Jean M. PhD