Abstract

We present a theoretical framework for investigating the effect of the Japanese government-regulated medical fee schedule, 'Shinryo-Houshu-Seido,' on the behavior of medical providers. We also discuss the optimal rule of this fee schedule for the regulator, taking into account information asymmetry between the regulator and providers. Our simple model predicts that under the current fee schedule heterogeneous providers either under-provide or over-provide medical inputs, depending on the price. Furthermore, our analytical results show that when the allocated budget is reduced to a certain level, even the second-best outcome becomes unachievable, no matter how the fee schedule is regulated. While we demonstrate that the global budget caps or the limited budget size is shown to have a clear negative effect on social welfare, we suggest that the prospect of obtaining the second-best outcome without complete information on heterogeneous providers is left to negotiation between the regulator and the budget allocator.