Medicaid/Medicare Supply of Medical Services

Decrease price…increase supply?

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?

  1. First, patients often do not know what type of care they require so they physicians can suggest treatments which may be unnecessary.
  2. 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.
  3. 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.