Has the Erosion of the Medical Marketplace Stopped?

by Joseph P. Newhouse

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This Note updates tests of the validity of three models of medical price inflation: a standard model, in which changes in demand press against inelastic supply; a dynamic version of the standard model, in which high levels of insurance induce high rates of product innovation and development; and a model of increasing inefficiency because of weak consumer incentives to search out efficient suppliers. Earlier statistical support for the third model has weakened, which provides some evidence that the regulatory and competitive initiatives of the last decade are having their intended effects. But time series measures of medical prices, which the statistical evidence relies upon, have important methodological problems, so other types of evidence are useful. Trends in expenditure in other countries and at health maintenance organizations suggest that the most important explanation of medical price inflation is the dynamic version of the standard model, although the other models have some validity as well.

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