Question

Consider that a physician’s profit/income is given by: Profit/Income = mQ0 + mI where m is the assumed profit rate, Q0 is the amount of patient care with no inducement and I is the amount of inducement. The physician gets disutility from inducement (that is, even though he gets income from it which he likes, the action of inducing patients reduces his utility). Suppose that the initial profit rate is $1 (i.e. m=1). Then suppose that increased competition lowers the profit rate from m=1 to m=0.5.

a. Suppose there is no income effect, but a substitution effect (i.e. physicians are pure profit maximizers). Demonstrate graphically what happens to equilibrium inducement under this scenario and explain in words.

b. Suppose now that there is both an income and substitution effect, and that the income effect outweighs the substitution effect. Demonstrate graphically and explain in words what happens to equilibrium inducement under this scenario.

Answer 1