Association for Public Policy Analysis & Management

Since at least Kenneth Arrow’s pioneering paper on the subject, economists have recognized two peculiar features of healthcare markets compared to other market goods and services:  the altruism of healthcare providers towards their patients, and the reliance of patients on their physicians for information and guidance.  Less well recognized is the inherent tension between these two aspects of healthcare provision.  To provide insight on the importance of this issue, we note that there for some procedures, increasing Medicare prices will increases use, while for other procedures, increasing Medicare prices will reduce use.  This pattern is difficult to explain when relying on either agency problems or altruism alone.  What is needed is a unifying framework that considers how altruism and agency problems interact to drive healthcare markets.

This paper develops a model of joint physician and patient decision making.  We study how altruism and agency problems compete, and we derive the positive and normative implications for healthcare markets.  From a positive standpoint, we show that exogenous price changes may increase or decrease quantity supplied.  When higher prices lower quantity, we say dynamics are primarily “patient-driven,” and when the opposite is true, we say they are primarily “physician driven.”  Specifically, pricing is more likely to be patient-driven when patients are poorer and when healthcare provision is less profitable.  Physician altruism is more likely to win out when the value of behaving altruistically is higher and the cost is lower. From a normative standpoint, consumer welfare is maximized when behavior is patient-driven.  Thus, we expect less inefficiency, from the consumer’s perspective, when consumers are poorer, patient cost-sharing is higher, input prices are lower, and profitability is lower.

We empirically test our model’s conjectures in the Medicare setting.  Utilizing variation in Medicare reimbursements rates, we estimate the own- and cross-price elasticities for each Healthcare Common Procedure Coding System (HCPCS) procedure, and we examine how patient demographics, patient cost-sharing, physician profitability vary across HCPCS of differing elasticities.  Our empirical identification relies on changes in Medicare payments within HCPCS over time.  To ensure exogeneity, we use two policy shocks as instruments: in 1997, the Center for Medicare and Medicaid Services (CMS) consolidated the 210 geographic payment regions to 89 distinct regions, and in 1999, CMS changed its reimbursement calculations for physician practice expenses from a charge-based to a resource-based calculations.  These policy shocks led to differential price changes across procedures and county groupings within a state.

Our paper offers several new insights to the existing literature.  We show how physician self-interest coexists with altruism, and how the interaction of these incentives affects care utilization across patient and procedure types.  Significant policy issues are at stake since price is often viewed as an important lever for influencing behavior.  Specifically, our analysis suggests that changes in physician reimbursement rates may not always have the intended effects: higher physician reimbursements can curb utilization in specific market segments while the opposite effect will obtain in other segments.