Question

Question 5 (5 marks)

1. Describe what is meant by supplier-induced demand? (use asupply and demand diagram to help you explain your answer)

2. Why would economists be concerned about the presence of supply-induced demand?

Answer 1

economics, supplier induced demand (SID) may occur when asymmetry of information exists between supplier and consumer. The supplier can use superior information to encourage an individual to demand a greater quantity of the good or service they supply than the Pareto efficient level, should asymmetric information not exist. The result of this is a welfare loss... On the other hand, One of the defining characteristics of the healthcare market is the large knowledge gap between the doctor (the agent) and the patient (the principal). Due to this asymmetry of knowledge and the high cost and difficulty of obtaining full knowledge, patients rely on doctors for advice on the proper amount and type of services needed to maximize their health. Doctors, on the other hand, want to maximize their own utility function. This utility function is dependent on their value of leisure-time, income, and the patient’s well being . The possibility for SID to exist is rooted in the presence of the asymmetric knowledge and the fact that physicians can be motivated by financial incentives in order to maximize their utility. Though, these two characteristics of the healthcare system gives rise to the possibility of SID, they do not guarantee its existence.

SID occurs when physicians use their superior knowledge to increase demand of medical services for patients beyond that is recommended or appropriate as deemed by the fully-informed patient. In this special case, supply and demand become interdependent, and the quantity demanded increases or the type of services provided changes. One of the first problems in identifying SID lies within the theory itself. When supply shifts and induces a subsequent shift in demand, it is uncertain how the price of the medical services will change. In reality, we don’t observe these shifts in the supply and demand curves. All that is observed in the healthcare market are the changes in the price and changes in the quantity of services ( Figure 1 shows a possible scenario where price decreases and quantity increases). Even though in theory, price can decrease, the real concern is the inflation of price due to SID. This inflation of price can lead to inefficiency and waste. If the effect of SID is large, then a possible scenario is an increasing percentage of GDP will be spent on medical services with no subsequent change in health outcome or even a deterioration of health due to overutilization.

SID can only be measured indirectly because it is impossible to know the care patients choose to utilize when they have the same knowledge and information as a physician. In general, studies measure “marginal” SID by examining the effect of practice and environmental changes on utilization patterns. The results from these studies vary depending on the type of treatment and the measure for SID. Even when studies show the presence of SID, there is no robust or reliable evidence on the likely magnitude of the effect. Most studies show a larger magnitude for surgical procedures and very low magnitude for services rendered by primary care physicians. In general, the absolute value of the effect of SID on utilization is small compared with other variables that influence utilization such as health status.

correlation between physician-population ratio and doctor-initiated visits also run into criticisms. One of them is that the health status variable always shows a stronger correlation with physician-initiated visits compared with the physician-population ratio variable in these studies . In fact, most studies on healthcare utilization show that health status is the most determinant of demand. Another problem is that doctor-initiated visits is not an “adequate proxy” for medically unnecessary induced visits . The differentiation between physician-initiated and patient-initiated visits is also questionable since these surveys usually ask patients to define the type of visits. Opponents of these studies also argue that SID can occur with inducement of physician visits, but it is most likely that physicians induce demand by ordering more tests during the visit. Therefore, doctor-initiated visits do not capture all the facets of SID. Other studies in the area also have shown that physicians do not induce demand for physician visits or that these visits cannot actually be proven to be inappropriate.