In a typical market, an increase in the consumers’ willingness to pay will increase price and increase quantity (see graph). On the other hand, a decrease in willingness to pay will decrease price and decrease quantity.
This axiom of economics does not hold in the health care market; at least not according to a 1998 HCFA White paper to Richard Foster. The paper found that when Medicare decides to reduce its fees, the quantity of medical services supplied by physicians actually increases. In fact, a Medicare price decrease led to increased medical service volume and intensity by 31% (significant at the 5% level). A Medicare price increase also increased volume and intensity but the results were not statistically significant.
Other papers have found similar results:
- Yip (1994) found that after Medicare reduced the price for coronary artery bypass graftings (CABGs) in New York and Washington, there was a large and statistically significant increase in the volume and intensity of CABGs.
- Christensen (1992) looked at the state of Colorado in the 1970s. He found that a one half of a Medicare price decrease was offset by increased volume of medical services and one third of the price decrease was offset by increased intensity of medical services.
- Nguyen and Derrick (1997) estimated a behavioral response which was statistically significant only among physicians whose practices received a Medicare price reduction. The magnitude of the response was 40% for these firms.
Why is this occurring?
- First, patients often do not know what type of care they require so they physicians can suggest treatments which may be unnecessary.
- Since patients bear little cost of these procedures, their price sensitivity is low relative to the total cost of a procedure. It is also possible that when Medicare prices decrease, the amount of the coinsurance paid by patients needed to cover a procedure goes down; this demand change may have some influence on the increase in quantity.
- Uncertainties in the practice of medicine allow for a variety of practice styles, so even peer review or a physician’s behavior may not be appropriate.