The Market for Medical Care: Why You Don’t Know the Price; Why You Don’t Know about Quality; And What Can Be Done about It.

Policy Reports | Health

No. 296
Monday, March 12, 2007
by Devon M. Herrick and John C. Goodman

Source of the Problem: Third-Party Payment

The primary reason why doctors and hospitals do not disclose prices in advance of performing services is that they do not compete for patients based on price.  The reason: Patients rarely pay their own health care bills .   Instead, they are paid by third-party payers.  And, it turns out, when providers do not compete on price, they do not compete on quality either. 3

Because third parties - employers, insurance companies or government - pay most medical bills, patients often do not know or care what the price is. 4   As Figure I shows, the proportion of health care paid directly by consumers has been falling for decades: 5

  • In 1960, consumers paid about 47 percent of overall health care costs out of pocket. 
  • The proportion had fallen by almost half to 23 percent by 1980.
  • In 2004, consumers paid only 13 cents out of their own pockets every time they spent a dollar on health care. 

The Market for Physician Services.   On the average, every time American patients spend a dollar on physician services, they pay only 10 cents out of their own pockets.  Millions of people do not even spend that much.  Medicaid enrollees, Medicare enrollees with medigap insurance, and people who get free care from community health centers and hospital emergency rooms pay nothing at the point of service .    And in most employer-provided plans, employees make only modest copayments for primary care services. 

Since the services of physicians are a scarce and valuable resource, at a price of zero (or at a very low out-of-pocket price) the demand for these services far exceeds supply.  In other markets, supply and demand are brought into balance through prices paid by consumers.  Clearly, health care consumption is not rationed on the basis of price.  Instead, people typically pay for physicians' services with their time, just as they do in other developed countries.  According to a study in the American Journal of Managed Care , nearly half of patients must wait more than 30 minutes to see their doctor after arriving for an appointment. 6   And this is in addition to the time it takes to travel to and from the doctor's office.

“Consumers pay only a fraction of health care costs directly.”

Like money, time is valuable.  So the higher the time cost to patients, the lower the demand will be for physicians' services.  Thinking of market wages as a proxy for the opportunity cost of time (the next-best use of time), the cost of an hour of time is higher for a high-income patient than a low-income patient.  Accordingly, physicians' practices in high-income areas need shorter waiting times to ration the same amount of care as practices in low-income ones.  This suggests the longest waiting times of all will be for Medicaid patients and patients in hospital emergency rooms, where the money price is usually zero and people have a lower opportunity cost of time. 7

Medical Care out-of-Pocket Spending

“The time of physicians is rationed by requiring patients to wait for care.”

The evidence appears to bear this "rationing by waiting" out.  A recent survey found two-thirds of Medicaid patients were unable to obtain an appointment for urgent ambulatory care within a week. 8   Those who turn to hospital emergency rooms for their care find the average wait is about 222 minutes. 9

One consequence of rationing by waiting is that the time of primary care physicians is usually fully booked, unless they are starting a new practice or working in rural areas.  This means almost all the physicians' hours are spent on billable activities.  Further, there is very little incentive to compete for patients the way other professionals compete for clients.  The reason: Neither the loss of existing patients nor a gain of new patients would affect the doctor's income very much.  Loss of existing patients, for example, would tend to reduce the average waiting time for the remaining patients.  With shorter waiting times, the remaining patients would be encouraged to make more visits.  Conversely, a gain of new patients would tend to lengthen waiting times, causing some patients to reduce their number of visits.  Because time, not money, is the currency patients use to pay for care, the physician doesn't benefit (very much) from patient-pleasing improvements and is not harmed (very much) by an increase in patient irritations.

The upshot is: When doctors do not compete for patients based on price, they do not compete on quality either.  In a very real sense, they do not compete at all.

The Market for Hospital Services.  In the opinion of most analysts, America has too many empty hospital beds. 10   Over the past decade or so, there has been a drastic decrease in the average length of stay and a steady movement from inpatient to outpatient services. 11   Under normal conditions, excess supply would signal a buyer's market - with sellers lowering prices, offering discounts and holding sales to shed their excess inventory.  Hospitals, however, are not competing for patients based on price. 

“Physicians typically do not compete for patients based on price or quality.”

Since doctors (rather than patients) more often choose the hospitals their patients enter, doctors are in essence the real customers of hospitals.  But since doctors are not paying hospital prices (any more than patients are paying them), hospitals tend to compete for doctors based on the services and amenities doctors prefer.  Having a surplus of beds and underutilized equipment (such as MRI scanners) means the system can easily adjust to the doctor's schedule rather than the other way around.

The analogue to patients waiting for doctors in a primary care setting is beds and equipment waiting for doctors in an inpatient setting.  In neither case are prices allocating resources.  And since prices do not ration resources, hospitals do not compete on the basis of price any more than doctors compete on price.

Moreover, as in the market for physicians' services, when there is no price competition there is no quality competition.  In fact, as far as the patient is concerned, there is no competition at all.

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