A Theory of Physician Behavior with Supplier-Induced Demand

Abstract

The care crisis of the 1960's and 1970's fueled unprecedented efforts by the Congress to control costs and, at the same time, improve access to care. As a basis for policy, the economics literature offers confusing direction, consisting of alternative theories of [9; 13], theories of market structure [12; 5; 11; 10], and theories of physician behavior and supply response [4; 1]. At the most fundamental levels of controversy, economists have not resolved the issues of demand creation, satisficing behavior, and targeted income in the modelling of the physician firm. The notion that health care markets may be dominated by the health care provider's ability to create was introduced formally in Newhouse [12]. Evans, Parish and Sully [4], Green [8] and Fuchs [6] all offer further refinement of the supplier-induced model; however, as yet no formal presentation of such a theory exists. To a large extent, an analytical framework that incorporates the physician's decision-making processes is absent and remains implicit in the empirical results found in the literature. This paper presents a theoretical framework for a supplier-induced model of physician behavior whereby we may compare and contrast its implications with those of the standard neoclassical model [1]. The acknowledged strength of the supplier-induced theory is its ability to explain empirical evidence which stands at odds with more traditional approaches. In particular, a number of studies have reported a direct association between physician density and physicians' fees [12; 7; 2]; that is, as the stock of physicians increases, the price of medi-