Strategic Pricing and Competitive Procurement in the Physician Services Market

Abstract

We propose and test a model of the strategic interaction between public (e.g., Medicare) and private insurers in the physician services market. Our model nests two alternatives: 1) cost shifting, which predicts negative correlations between public and private prices and physician supply that is inelastic with respect to relative public and private prices; and 2) competitive procurement in which public and private prices are positively correlated and physician supply skews towards the more generous payer. These alternatives have contradictory implications for both public policy and structural estimation. Using a data set of private and public sector prices and public sector quantities, we find clear evidence favoring the competitive procurement model. Private sector insurers strongly mimic public sector price changes, consistent with recent findings. Moreover, providers supply Medicare beneficiaries 1%-14% fewer services for every 10% increase in private prices, ceteris paribus.