The Nature of Supply

• Suppliers include hospitals, which provide health care directly, and medical equipment and pharmaceutical companies, which provide inputs to the healthcare production process– The supply side of the market is heavily

dependent on theories of how firms behave—this concept is often called the theory of the firm

• Analysis of supply in economics is often dominated by theories of the firm that are based on an assumption that their overriding aim is to maximize profits

The Nature of Supply

• This can be viewed in two ways:– Such theories can be reasonable descriptions

of the aims of some firms and can therefore be used in a positive economics sense to generate predictions about the ways that firms and markets operate. • All firms must earn a normal rate of return or

profit if they are going to be able to remain in business in the long run

• The aim of most pharmaceutical companies and many insurance companies is to generate profits, and profit maximization may be a reasonable goal for them

The Nature of Supply

– Theories based on profit maximization have a second use -- they provide a useful set of performance benchmarks against which firms’ actual performance can be compared

– Even though profit maximization models are important, we will stress that for much of the healthcare industry other theories are more appropriate

Factors that Affect Supply • We may also generate a list of supply shifters• The following are exogenous determinants of supply;

in other words, factors that are held constant underlying the supply curve– Technological change. As technology improves for

producing a healthcare product, the goods become cheaper to produce

– Input prices. If the wages of physicians were to rise, this increase in an input cost would result in suppliers’ willingness to offer as much for sale at the original price

Factors that Affect Supply

– Prices of production-related goods. The price of a good related in production, such as a rise in the price of radiology services, also would be relevant

– Size of the industry. As more firms enter the market, the supply of the product will be greater

– Weather. For a number of products, Acts of God such as weather will tend to affect production

The Market for Physicians and Nurses

• Two differing points of view have characterized American attitudes toward medical professionals in the United States– The high monetary and psychological costs of

the lengthy training period, long hours, and great responsibility that being a practicing physicians entails concludes that the economic returns to practicing medicine are not excessive

– Physicians and other healthcare providers have been able to extract “economic rents” (meaning excess distribution) by charging fees that are higher than those which prevail in a reasonably competitive market

The Market for Physicians and Nurses

– Economists use supply and demand to analyze the markets for doctors and nurses

• This analysis is applied to understanding why shortages and surpluses may exist

Physician Shortage?– A medical degree can be thought of as a stock of

human capital that yields a stream of returns over time

– However, because people are attracted to fields with higher returns, persistent differentials in internal rates of return (meaning the profitability of the investment in education or training) provide indirect evidence of market imperfections

– In the 1950s and 1960s, physicians were found to receive higher internal rates of return on their training compared with the other professions

• Therefore, economists and health planners concurred that there was a shortage of physicians

Physician Shortage?

• Economic Analysis of Physician Supply– Economists define a shortage as a situation in

which quantity supplied is less than quantity demanded at a given market price• Shortages are not easy to measure in a

profession where a high proportion of the members are self-employed.

• Earnings differences may simply reflect “compensating differentials” for differences in length and cost of training

Barriers to Entry • One reason for the higher returns to medical training is

that it is a result of barriers to entry to practicing medicine

• The limited number of places in United States medical schools and the licensing requirements, coupled with immigration policy, greatly restricted the entry of foreign-trained physicians, which could explain the higher than equilibrium returns to medical training

• If demand remains constant, imposing restrictions on the number of physicians will increase the price of their services, even if the reason for the restriction is quality control

Policy Responses to a Shortage

• Public policy in the 1960s had the goal of relieving the doctor shortage– The Immigration Act of 1965 made it easier for

internationally trained physicians to practice medicine in the United States

– The Health Professions Education Act of 1965 increased federal assistance to medical schools, but required them to increase enrollments in order to qualify

– These measures led to an approximate doubling in the size of physician training programs and a significant increase in the number of physicians between 1965 and 1980

Policy Responses to a Shortage

• By 1970, returns to physicians training, adjusted for hours worked, had become approximately equal to the returns to lawyers and dentists, but were still higher than the returns to other professions requiring graduate degrees

• By 1991, internal rates of return to physicians were comparable to, and, in the case of primary care physicians, lower than the returns to training to business or law  

Choice of Specialization • Very few physicians in the United States today have

only the basic MD degree– Primary care physicians usually complete

residencies in fields such as internal medicine or geriatrics

• The proportion of graduates of United States medical schools undertaking residencies in internal medicine declined by over 30 percent between 1986 and 1994

• Between 1996 and 2001 the proportion of physicians in the practice of primary care was stabilized and remained roughly constant

Public Policy to Change Incentives

• The United States government has a policy of

forgiving a limited number of student loans for

physicians who agree to practice medicine in

underserved geographical areas under the

National Health Service Corps

• Changes in the fee structure of Medicare to favor

primary care physicians can also be viewed as a

public policy designed to alter the supply of

physicians in different specialties

Private Insurance Market Incentives

• The enhanced use of primary care physicians in managed care organizations increases the opportunity for primary care physicians

• Increased market penetration by managed care insurers during the period 1985 to 1993 was found to be associated with a narrowing of the difference between earnings of primary care physicians and specialists, such as radiologists, anesthesiologists, and pathologists

• Metropolitan areas with greater managed care organization penetration experienced slower rates of growth in specialists and in total number of physicians, but no change in the rate of growth in general practitioners, during the period of 1987 to 1997

Projections about the Supply and Demand of Physicians: Economic and

Health Planning Viewpoints• By the late 1970s, it was widely believed that there

had been a policy overshoot and an oversupply of physicians would soon develop

• The Council on Graduate Medical Education concluded that, by the year 2000, the overall physician to population ratio would be high– It also predicted that the specialists would be 60

percent higher than needed• Predictions about the future supply of physicians vary

– Some see a shortage looming ahead, but this view is not universally accepted

The Market for Nurses

• The main employer of registered nurses has traditionally been the hospital, even though by the end of the 1990s the proportion of nurses employed in hospitals had fallen to about 60 percent

• The supply of nurses depends on the decisions of individuals to undertake training and to work in the nursing profession once training is completed

• Public policy is just as important in determining the training opportunities for nurses as it is for physicians

• The relative rate of return to this occupation compared to other occupations that require comparable training undoubtedly affects the supply

Is There a Nursing Shortage?

• The American Hospital Association complained of a nursing shortage in the 1950s and 1960s and supported these claims by noting the high vacancy rates in registered nurse positions and the substitution of less highly trained licensed practical nurses for RNs– Congress responded by passing the Nurse Training Act (NTA)

in 1964, which began a tradition of government subsidization of nurses’ training

• Between 1971 and the present, there appears to have been a number of periods of adjustment in which high vacancy rates were followed by policy to expand nurses’ training, followed by reductions in shortages– Because the training period is so much shorter, responses to

imbalances in supply and demand are more rapid than in the case of physician training

Cyclical Shortages and Responses

• Nurses’ decisions about whether to enter the labor force and how many hours to work are very cyclical – Vacancy rates in nursing are typically much

lower in periods of economic recession • A recession in the early 1980s increased the

labor force participation of trained nurses and reduced the vacancy rate to a record low of fewer than 5 percent

Cyclical Shortages and Responses

• By the end of the 1980s, the vacancy rate exceeded 12 percent– A decline in the participation rate of nurses when the

economy improved, an increase in the demand for hospital nurses, and a decline in entrants into nurses’ training in the early 1980s, all contributed to the reemergence of a shortage

• This led to the passage of the Nurse Shortage Reduction Act of 1988, which provided additional subsidies for nurses’ training and the Nurse Relief Act of 1989, which relaxed restrictions on the immigration of foreign-trained nurses

• The result was a rapid increase in the supply of nurses

• Since the 1990’s vacancy rates have been rising again in many parts of the nation

Wages

• From the 1940s to the early 1960s, nurses’ wages declined relative to other female professionals despite high vacancy rates

• The situation changed with the institution of Medicare in 1965– Hospital nurses salaries increased relative to

their nonhospital colleagues, and they achieved parity with earnings in other female dominated occupations requiring the same level of education 

• Price controls in the 1970s restrained nurses’ wages, but they rose again as soon as the controls were removed in 1974

Wages• Wage levels were maintained throughout the 1980s • Nurses’ real wages increased between 1983 and 1993,

followed by a temporary decline from 1993 to 1997 – The increase in the supply of nurses resulting from

the Nurse Shortage Reduction Act of 1988 was probably a factor because vacancy rates also declined during the same period

– Cost-containment policies of managed care insurers have frequently been alleged to result in hospitals skimping on nursing care

• Since 1998, the wages of hospital nurses have increased both absolutely and relative to wages for other women with comparable education levels

The Monopsonistic Market for Nurses

• A monopsonist is a monopoly buyer of nurses, or employer – If there is only one hospital in the region, it

has potential monopsony power over its nursing supply

• For monopsony to affect market outcomes, the supply curve of workers must be upward sloping, which means that in order to attract more workers, the employer has to raise wages

The Perfectly Competitive Market • The characteristics of perfect competition are as

follows:– many sellers possessing tiny market shares– a homogeneous product– no barriers to entry– perfect consumer information– there is substantial actual competition because

there are many substitute firms offering identical products

– the potential for competition also exists because nothing prevents new firms from entering the industry

– the individual firm has no market power

Is a Perfectly Competitive Market Relevant in Health Care?

• When applied to healthcare industries, many of the assumptions of microeconomic analysis and characteristics of perfect competition often do not fit well

• Several examples highlight this point:

– the nonprofit status of medical firms means that healthcare providers may not pursue maximum economic profits

– licensure creates a barrier to entry and decreases potential competition

– consumers typically lack perfect information about prices and technical aspects of medical services, which may lead to physicians practicing opportunistically

Supply and Demand

• Perfect competition is based on a model where a large number of consumers and producers maximize their own personal utilities and profits, respectively – The massive number of participants in the market

leads to everyone being a price taker because no individual has influence over the market

– To maximize utility, each consumer consumes goods or services to the point that marginal private benefit (MPB) equals price

– The profit-maximizing firm will produce up to the point where marginal private cost (MPC) equals price

– The market clearing process occurs when the MPC equals the MPB, with price being the coordinating device (MPB=P=MPC)

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