When Medicare reduced reimbursement rates for certain physician services by 10%, physicians increased the volume of those services, partially offsetting the revenue loss. What economic concept does this illustrate?
APrice elasticity of demand — lower prices increase demand
BSupplier-induced demand — physicians, acting as both advisor and provider, recommended more services to maintain their income
CMoral hazard — patients demanded more services at lower prices
DThe substitution effect — physicians switched to cheaper services
This is the classic evidence for supplier-induced demand (SID): when the price per service falls, physicians increase volume to compensate. In a standard market, a price cut reduces quantity supplied. In healthcare, the physician controls both the recommendation and the provision of the service, and can shift the patient's demand curve outward by recommending additional tests, follow-up visits, or procedures. The evidence for SID is strongest for procedures where physician discretion is high (elective surgery, imaging) and weakest where it is low (emergency care).
Question 2 Short Answer
A health system switches from fee-for-service to capitation for primary care physicians. What behavioral changes would economic theory predict?
Think about your answer, then reveal below.
Model answer: Capitation pays a fixed amount per enrolled patient regardless of services provided, so the physician maximizes income by enrolling many patients and providing fewer services per patient. Predicted changes include shorter visits, fewer follow-up appointments, fewer referrals to specialists (since these represent costs the physician bears under full capitation), and more emphasis on prevention (which reduces future costly care). The risk is that capitation incentivizes underservice — skimping on necessary care to save costs — and cherry-picking healthy patients who require little care while avoiding complex, expensive patients.
The shift from FFS to capitation fundamentally changes the physician's marginal incentive from 'more services = more revenue' to 'more services = more cost.' Neither extreme is ideal: FFS overserves, capitation underserves. Blended payment models (a capitated base plus FFS bonuses for preventive care and quality targets) attempt to balance these competing incentives.
Question 3 True / False
Pay-for-performance programs that tie physician bonuses to measurable quality indicators (e.g., percentage of diabetic patients with controlled HbA1c) have consistently produced large improvements in healthcare quality.
TTrue
FFalse
Answer: False
The evidence on P4P is surprisingly disappointing. Most large-scale evaluations (including the UK's Quality and Outcomes Framework and US Medicare P4P programs) show modest or no improvements in quality, partly because the measured indicators capture a small fraction of what constitutes good care, physicians may focus on measured targets at the expense of unmeasured aspects (teaching to the test), and the financial incentives are often too small relative to physician income to change behavior. P4P works best when the target behavior is clearly defined, measurable, and under the physician's control, and when the incentive is financially meaningful.