Living Economics

Over the years, the Dartmouth Atlas Project has consistently shown a positive association between the supply of staffed hospital beds per 1,000 residents and the hospitalization rate for medical (non-surgical) conditions among Medicare patients. More than half of the variation in discharge rates is associated with bed capacity. The use of hospitals for the treatment of people with medical conditions is particularly intense during the last few months of life, and the variation among regions is striking. On average, patients living in the lowest rate regions spent about six days in hospitals, while those in the highest rate region spent twenty days. The amount of physician services also follow the same pattern: On average, regions with twice as many cardiologists per 100,000 residents will have twice as many available office visit hours. In particular, physician visit rates among people who are in their last six months of life vary substantially. In the highest-rate region, these people had an average of more than 55 visits during their last six months; in the lowest-rate regions the average was about 14 visits (Wennberg).

On the surface, there is nothing unusual about this correlation between capacity and utilization. In the real world, actual quantity supplied must always be equal to actual quantity demanded. Whatever is produced must end up somewhere. But not always at the expected price. The general law of supply and demand says that when the expected quantity supplied exceeds the expected quantity demanded at a certain price, the price will fall to clear out the excess supply. What is unusual about hospital services is that the quantity demanded always matches the quantity supplied at the predetermined prices (Medicare reimbursement rates). Not only that price may not fall, it may increase instead because greater marginal cost of increased supply must be covered. This anomaly is known as Roemer's Law which says that a built (hospital) bed is a filled bed (Roemer).

Two reasons explain such supply-induced demand. One, in contrast to effective care¹ and preference-sensitive care², where clinicians have strong opinions on the need for specific interventions, medical theories and medical evidence play little role in governing the frequency of use of supply-sensitive services. For patients at a given stage in the progression of chronic illness, medical textbooks contain no evidence-based clinical guidelines for scheduling patients for return visits, when to hospitalize or admit to intensive care, when to refer to a medical specialist, and, for most conditions, when to order a diagnostic or imaging test (Wennberg). Second, Medicare payments are often based on treatment rather than on outcome with only a loose overall budget constraint. If there is surplus capacity, more treatment will be ordered to fill available capacity.

Unlike medical services where the budget is from funds pooled through some insurance schemes, there is no guaranteed demand on ordinary goods because consumers spend their own money upon each purchase. If sellers oversupply a good or service, they just have to absorb the loss by lowering their target price.