Is Medical Care Different? Old Questions, New Answers

Abstract. This paper examines whether changes in medical markets may be making them more like other markets. The emergence of HMOs and other managed care systems appears to have increased the consumer's potential ability to make better comparative judgments about the price and quality of medical care, and also seems to have made medical care more like other goods. However, the evidence that medical care is a "reputation good" suggests that it is, in this respect, different from other goods. Finally, the social concerns about medical care use necessarily make medical care different.

In answering this rhetorical question a decade ago (Pauly 1978), I tried to distinguish between three kinds of medical care "situations": those for which economic analysis works reasonably well; those for which analysis does not work well; and those for which, under a new competitive framework, analysis might work. Parallel with the question of whether positive economic analysis might explain behavior was the normative question of whether "competition" in some inchoate form might also be feasible and be able to achieve a fair degree of economic efficiency in the various types of medical markets.

My view is that we now have a much clearer understanding of the applicability of economic analysis to different kinds of medical markets, especially to markets for the "potentially competitive" type of service. In contrast to my earlier view, I think both institutional change and the development of new methods of analysis have gone a long way toward filling in the gaps in our ability to apply analysis to medical markets. There is still a good deal left to be learned, but I believe that much of the question of the form and feasibility of competition has been answered. The critical normative question of whether competition can or does produce an efficient outcome also has answers that are surer than they used to be, although there is still considerable room for answering the question posed above with "maybe."

Types of services

In my previous work, my main point of departure was to distinguish these three types of medical services and consider the possibilities for positive and normative analysis of each. Those types were characterized by the frequency of their purchase, the knowledge the typical consumer had about the value of the service in general, and the appropriateness of the service for the consumer's particular problem. The intrinsic characteristic that separated the three types was how much the consumer knew relative to what the seller/provider knew or could know. "Testing" or trying out some medical services (e.g., a hernia repair) was fairly costly. I was beginning to describe what Mark Satterthwaite and I (1981) later called "reputation goods" (or, as I described them ten years ago, goods whose quality is judged by the experience of the consumer's friends). The point we made then was that there are three types of medical services: those that the consumer consumes frequently enough to be able to judge quality and know price (e.g., pediatric office visits for preschoolers); those that the consumer buys infrequently but the provider furnishes commonly, for which a reputation in principle can develop (perfect reputation goods); and those that are rare for everyone and for which, even in the best of circumstances, reputations or track records will be hard to determine (imperfect reputation goods). Indeed, the market for medical care is almost as much a market for information as it is a market for specific services.

I stand by my earlier conjecture that as much as one-fourth of medical care spending occurs in markets when purchases are consumer-initiated and repetitive and when experience is tolerably good. What I think is new is our understanding of what affects the remaining three-fourths of the spending. Here I will comment on four different influences: the development and testing of a theory of reputation as a constraint on or a substitute for demand creation by physicians; developments in the market for health maintenance organizations (HMOs) and other forms of managed care and the attendant reputation effects; the emergence of a market in information on quality and outcomes; and peculiarities in insurance markets.

Reputation, demand creation, and the market for medical care

Once me consumer has initiated a process of formal medical care and begins to obtain information from providers, there will be an opportunity for providers to alter the content of mat advice so as to offset the demand for future services. This phenomenon probably characterizes other kinds of repair services and professional services as well; indeed, it is present to some degree in the advertising or selling efforts which accompany most products. In this sense, if medical care differs from other goods, it is in the relative importance of seller-provided information compared to information gleaned from observing ("searching") the product or experience with the product.

Further development of the theory of reputation goods has indicated that such markets work somewhat differently than the homogeneous good, full...