This is a TIE-U post associated with Jonathan Kolstad’s The Economics of Health Care and Policy (Penn’s HCMG 903-001, Spring 2012). For other posts in this series, see the course intro.
The second sentence of Richard Frank’s Behavioral Economics and Health Economics  (an ungated pdf is available) provided the motivation for this post.
Consider a set of economic activities where addictions figure prominently; where consumers have limited information that they must use to make choices in the context of fear, urgency and trust in an expert; and where the services used are often credence goods (Emons, 1997 ) whose applications are frequently governed by professional norms and habit. [Bold added.]
Not knowing what a “credence good” was, I looked up Emons (1997) (ungated pdf available).
With a credence good, consumers are never sure about the extent of the good they actually need. Therefore, sellers act as experts determining the customers’ requirements. This information asymmetry between buyers and sellers obviously creates strong incentives for sellers to cheat on services.
A credence good is a term used in economics for a good whose utility impact is difficult or impossible for the consumer to ascertain. In contrast to experience goods, the utility gain or loss of credence goods is difficult to measure after consumption as well. The seller of the good knows the utility impact of the good, creating a situation of asymmetric information.
Another term for “credence good” is “post-experience good,” but that is not very helpful. An experience good is one for which “product characteristics such as quality or price are difficult to observe in advance, but these characteristics can be ascertained upon consumption.” And, for completeness, a search good is one with “product or service with features and characteristics easily evaluated before purchase.”
All other things being equal, one would expect more price competition (greater price elasticity) for a search good than an experience good and for an experience good than a credence good. Fundamentally, the less it costs to obtain information about a good the more sensitive consumers should be to price. If you know what you’re buying, you can tell if the price is worth it. If you don’t know what you’re buying, it’s easy to overpay. Buyer’s remorse would be least common with a search good.
From the title, Frank’s paper is obviously about ways in which behavioral economics can address some of the limitations of standard economic models as they are applied to health care. If you know even a little bit about behavioral economics you know that it’s concerned with marrying economics with observed psychological heuristics humans tend to use in decision making. In other words, the fully informed, perfectly rational decision maker steps aside, at least somewhat.
Well, if there is one domain in which people are clearly not always fully informed or perfectly rational it’s health care. Even in good health it’d be hard to meet anything close to that standard. In poor health, forget it. So, we often rely on heuristics. For example, we judge a doctor not based on objective quality measures but based on our gut feeling about him or her or based on what our friends say. Quoting Frank,
Consumers of health care have been shown to be good reporters of certain attributes of care and weakly aware of others. For example, patients have been shown to accurately report information on whether a physician was respectful, attentive, clear in explaining clinical issues and operated a clean and efficient office. These same patients were found to be inaccurate in reporting of the technical quality of care. That is, they were not accurate in judging whether a physician supplied appropriate evidence based treatment . It has also been shown that the dimensions of care that consumers understand and can accurately report are not highly correlated with so-called technical aspects of quality care . The implication here is that patients will commonly develop a prior about a primary care physician by relying on reports from family and friends that will be based on observations about some dimensions of medical care and perhaps not on the dimensions that most directly affect their health outcomes. […]
Note that the above is true even when quality metrics about physicians are available. People tend not to pay attention to or trust them.
Another observation from the literature, reviewed by Frank, is that more choice does not result in better decisions. The reason is that people can only process so much information. As the volume of it increases, they rely on simpler heuristics to cut down the decision space. Just as in the problem of choosing a physician, the heuristics for other choices — like health plan — are not always highly correlated with good indicators of quality.
Obviously this problem is amplified in the case of a credence good. Heuristics can’t be expected to be correlated with quality in that case. In fact, the correlation should be random. If you can’t tell much about what you’re buying in advance your heuristics may be comforting, they may be related to how our brains evolved, they may serve sensible social purposes, but they don’t help you make a good decision.
The policy implications stemming from the application of behavioral economics in analyzing health care markets are potentially profound. Two cornerstones of recent U.S. health policy are: 1) the presumption that increasing the availability of information to consumers will result in improved quality of care, and 2) that more choice of health plans and providers will inevitably make consumers better off. Examining the basic laboratory and psychological research used in behavioral economics immediately raises challenges to these policy fundamentals. [Bold added.]
More is not necessarily better, not in health care and not in health plans. The intuition that consumer information and more competition always* improve decision making and drive down costs just doesn’t seem to apply, not just for behavioral economics reasons but for others like market power considerations and the supply sensitivity of care. I wouldn’t say this is “potentially profound.” It’s just profound.
* NB: It’s possible (likely even) that more can be better in cases where there are few choices, but there is a limit. You probably want some choice, some competition, but not too much. That’s why more isn’t always better.
 Frank, Richard. “Behavioral Economics and Health Economics.” 2004, NBER Working Paper #10881.