Predicted results of doctor reduction program

Problem II (parts a and b are 8 points each and c and d are 7 points each)

Read the following New York Times (8/25/97) article and then answer the questions that follow.

1,000 Hospitals Will Be Paid To Reduce Supply of Doctors, New York Times, 8/25/97, Warren Leary

The Government has agreed to the nationwide expansion of a program that offers financial incentives to hospitals that train fewer doctors, officials said today.
The budget legislation recently signed by President Clinton included a little-noticed provision on paying hospitals temporarily for not filling positions in their residency-training programs. The financial incentives were approved for New York State hospitals in February. The plan, which seeks to alleviate a growing glut of doctors, extends the payments to the more than 1,000 teaching hospitals across the country.
Chris Jennings, a senior White House health aide, said today that both Democrats and Republicans had agreed to extend the incentive program because it was a way to save billions of dollars.
"Unlike most aspects of the free-enterprise system," Mr. Jennings said, "an oversupply of doctors does not lead to more competition and less cost. When you get more physicians, you get more medical testing and other costs that drive up the price of health care."
The Health Care Financing Administration, which oversees Medicare and Medicaid, accepted a proposal from the Greater New York Hospital Association for the Government to pay New York hospitals about $400 million in exchange for reducing the number of doctors they train by 20 to 25 percent over the next six years.
Hospital executives from elsewhere in the country, facing the same training problems, protested the demonstration program, saying it was unfair for New York alone to benefit. The protests, and opposition to the New York program by some members of Congress, led to an effort to expand provisions of the plan and write them into the legislation, Congressional spokesman said.
The Government spends $7 billion a year to train doctors, with much of that money coming through Medicare. Medicare provides an average subsidy of $100,000 a year for each resident to hospitals to train medical school graduates, who provide much of the primary care at hospitals for a fraction of that amount.
Although several national studies have predicted a growing glut in the number of doctors, particularly in anesthesiology and surgery, many hospitals have been reluctant to cut their residency programs because they do not want to lose the subsidy.
Under the voluntary New York program, 41 teaching hospitals agreed to a gradual reduction in training money over six years as they trimmed their residency programs, using the payments to hire lower-cost health workers or other measures to cut costs or services.
The expanded program offers similar provisions to hospitals in other states, spread over five years instead of six.
Some conservatives protested that the Government should not be using its money to adjust a labor force, likening the effort to a subsidy program that pays farmers not to plant. Mr. Jennings and others point out that current law provides incentives to train medical students and doctors who are not needed, so reversing this trend is not revolutionary.
Representative Bill Archer of Texas, the chairman of the Ways and Means Committee, and his Republican colleague Bill Thomas of California, its health subcommittee chairman, were initial critics of the New York program but supported the national program, said a committee spokesman, Ari Fleischer.
"We think it will be a very innovative and highly successful approach to a growing problem," Mr. Fleischer said. "If we can reduce the glut through this program, it will benefit the country."

a. Explain how you expect that this new policy (offering financial incentives to hospitals that train fewer doctors) will affect the (labor) market for doctors. Use demand and supply analysis to explain how equilibrium price (salaries) and quantity will be affected.

b. Paragraph 9 states that hospitals have now an incentive to hire more lower-cost health workers. Use the concepts of cost minimization and isoquants to explain how a hospital would respond to the new policy in the choice between residents and lower-cost health workers.
c. Paragraph 9 also reports that hospitals will take measures to "cut costs or services". Explain why this will occur. Consider the market for hospital services. How do you expect this market will be affected, discussing in particular the effect on the price and the quantity.

d. Explain how the changes mentioned above will affect the equilibrium in the (labor) market for lower-cost health workers.