Explain the Rationale for the Existence of Supplier Induced Demand in Health Care and Explore the Extent to Which Empirical Work Has Been Able to Establish Its Existence

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In the traditional market, consumers decide how much to consume and suppliers decide how much to supply and prices coordinate the decisions. For perfect competition it is assumed inter alia that there is: perfect information so that individuals are fully informed about prices, qualities etc; a lot of buyers and sellers; no single buyer or seller that has influence on the price. But health care market falls short of the perfect market paradigm as it is dogged by many phenomena that cause it to fail (Arrow 1963). One such phenomenon is supplier-induced demand (SID), whereby health care providers, usually physicians, exploit their information advantage over patients in order to induce patients to utilize more healthcare services than they would if they were accurately informed. The phenomenon of SID tends to take an important place within social debates because it has an impact on health care expenditures, health status and the allocation of income between patients and physicians (Labelle et al 1994). Therefore, it has attracted considerable attention in the health economics literature since Roemer (1961), who observed a positive correlation between the number of hospital beds available and their use leading to the observation, ‘a bed built is a bed filled’, sometimes referred to as Roemer’s Law. Although a variety of empirical tests of SID have been reported in literature, researchers disagree on the definition of and tests for SID. The validity of the results from the tests is controversial. Therefore there is no consensus on the development and implementation of public policy based on these results (Labelle et al 1994, p349). Indeed, Doessel (1995, p.58) observed that this area of research can be described as a theoretical and empirical quagmire. After defining the terms, this essay is going to explore and explain the theoretical rationale, the empirical evidence and policy implications for the existence of SID. The argument will be summed up in the conclusion.

Health Care Market and SID

A market is a shorthand expression for the process by which households’ decisions about consumption of alternative goods, firms’ decisions about what and how to produce, and workers’ decisions about how much and for whom to work are all reconciled by adjustment of prices. Health care comprises services of health care professionals, which are addressed at health promotion, prevention of illnesses and injury, monitoring of health, maintenance of health, and treatment of disease, disorders, and injuries in order to obtain cure or, failing that, optimum comfort and function (quality of life) (Worldbank website). In health care market there is: a few buyers and sellers; asymmetry of information therefore violation of consumer sovereignty; allocation of resources by physicians and not price mechanism etc. Therefore patients face a dilemma in translating their desire for good health into a demand for medical care. This requires both information and medical knowledge, which they usually do not have. There is no definitive and widely accepted definition of SID. In literature, the definitions range from positive and value free (Fuchs 1978) to normative with negative connotations (Folland et al 2001, p.204). McGuire (2000, p504) says that SID ‘exists when the physician influences a patient’s demand for care against the physician’s interpretation of the best interest of the patient’. Labelle et al (1994, p. 363) point out the need to incorporate in the definition of SID both the effectiveness of the agency relationship and the effectiveness of the induced services. This means that inducement can give rise to ‘good’ or ‘bad’ outcomes for patients depending on its clinical effectiveness, e.g. if a doctor persuades a patient to undertake more...
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