Physician Overtreatment and Undertreatment with Partial Delegation

The physician induced demand literature finds that doctors tend to overtreat patients for financial gain. We analyze this phenomenon when patients are rationally skeptical of doctor's motives and can reject a proposed treatment. We find the classic physician induced demand approach understates patient's welfare loss: treatment on average is excessive but also less medically appropriate, and the latter effect may dominate. Inappropriate treatment arises from the doctor's strategic misdiagnosis to forestall rejection, but this problem can be attenuated by insurance which better aligns incentives and improves communication. We resolve an open question in the partial delegation literature by showing that a generalization of the Krishna and Morgan (2001) equilibrium is the most informative equilibrium that survives the intuitive criterion in a setting that nests both our and their model.