Ramsey pricing and supply-side incentives in physician markets

In this paper, I develop a theory of optimal prices using a relative value scale where there are fixed costs of medical practice. I consider a regulator constrained to set prices in excess of marginal cost, in markets where physicians can create demand at the margin. Under these conditions, basing prices on physician costs alone is shown to be suboptimal. Instead, prices should anticipate the behavior of physicians by setting profit margins highest for services least susceptible to demand creation. This is equivalent to a form of Ramsey pricing, used in this case to minimize the deadweight loss of oversupply.