Supplier-induced demand: reconsidering the theories and new Australian evidence

This paper reconsiders the evidence and several of the key arguments associated with the theory of supplier-induced demand (SID). It proposes a new theory to explain how ethical behaviour is consistent with SID. The purpose of a theory of demand and one criterion for the evaluation of a theory is the provision of a plausible explanation for the observed variability in service use. We argue that Australian data are not easily explained by orthodox possible explanation. We also argue that, having revisited the theory of SID, the agency relationship between doctors and patients arises not simply because of asymmetrical information but from an asymmetrical ability and willingness to exercise judgement in the face of uncertainty. It is also argued that the incomplete demand shift that must occur following an increase in the doctor supply is readily explained by the dynamics of market adjustment when market information is incomplete and there is non-collusive professional (and ethical) behaviour by doctors. Empirical evidence of SID from six Australian data sets is presented and discussed. It is argued that these are more easily explained by SID than by conventional demand side variables. We conclude that once the uncertainty of medical decision making and the complexity of medical judgements are taken into account, SID is a more plausible theory of patient and doctor behaviour than the orthodox model of demand and supply. More importantly, SID provides a satisfactory explanation of the observed pattern and change in the demand for Australian medical services, which are not easily explained in the absence of SID.