Reputation versus Supplier-induced Demand in the Market of Medical Care: an Application of Optimal Control Model

This paper employs a dynamic optimal control model which is consistent in the explanation of optimal treatment (output) decision of the supplier and how the patients translate signal of advertising-like and reputation into expectation of quality and price. The supplier's advertising-like efforts in relation to the size of the service facility signal the level of price rather than quality. Since the paper also aims to provide an alternative mechanism and measurement of the potential induced demand in medical care market equilibrium, a good quality-price-ratio may be perceived as non-exit induced demand whereas a low quality-price-ratio is seen as an exit induced demand. Whereas the paper considers quality to be a given constant (although known only by the physician and probably by old patients), the price also reflect the quality-price-ratio. Price cuts lead to a preferable while an increase in price result in a worse quality-price-ratio and decreasing reputation. An interesting focus is, therefore, on the price (fee) policy and the advertising-like expenditure of a medical care provider. Advertising-like reflects the medical care provider's investment while reputation results from the number of treated patient and the patient's experience. Reputation increases according to the service of the provider and the degree of the patient's satisfaction with the realized quality in relation to the price charged. Reputation is thus under the medical care provider's controls, but the question is whether and how the physician should invest in this kind of abstract asset. The dynamic modelling of reputation and the analysis, however, show that there are two optimal output policies of the medical care provider, both being departure from the price-corresponds-to-quality mode. One policy is the unexpected cheap service. On the others hand, the supplier might also work in an optimal way by charging too much with respect to the offered quality such that patients have every reason to halt further visits, this way reducing but not eliminating future demand. Whichever of the two departures is the case, a relatively high or a relatively low quality is signaled by reputation. * Muhammad Yunus, Chairman of the Department of Economics and Development Studies, Faculty of Economics, and Resource Economics Study Program, Graduate Studies, Hasanuddin University, Ujung Pandang, Indonesia. He held B. A. (1985) at Faculty of Economics, Hasanuddin University; M. A. (1990) and Ph.D. (1993) at School of Economics, University of the Philippines, Diliman, Q.C., Philippines. INTRODUCTION The study of health economics has traditionally focused on "special characteristics" of medical care market equilibrium (Kessel, 1958; Arrow, 1963; Pauly, 1980; Yunus, 1994). The problem is the difficulty of evaluating medical services. It is asserted that demand is physician-controlled