An Economic Analysis of Litigation

I asked our twitter followers if there was anything in specific they would like me or my brother to write about and someone asked us to contemplate the question – “Does fear of litigation force doctors to overcompensate?”

The immediate thought I had was “it has to force them to overcompensate”.  Here is why:

If we consider this through a decision theoretic approach, it is easy to see why doctors are likely to overcompensate. Decision theory is similar to game theory, except, instead of considering multiple individuals making decisions against each other, we consider a single individual making decisions against “states of the world.” The possible states of the world we must consider are: x = not overcompensating and correct diagnosis, y = overcompensating and correct diagnosis, z = not overcompensating and wrong diagnosis, w = overcompensating and wrong diagnosis.

Now, consider what “states of the world” are most favorable. Obviously it is either x and y, and to the doctor the difference between them is negligible even if to the patient they are not. This leaves z and w as the two least favorable situations, and of them, w is more favorable to the doctor while z is more favorable to the patient ( z >w for the patient because lower medical bills, w>z for the doctor because “they covered all their bases” and is less likely to lead to litigation). From this we can see the rational decision for the doctor is to overcompensate because it maximizes his expected “payoff”.  (payoff being keeping his job, not getting sued etc.) The payoff is greater because the payoff of x=the payoff of y, but the payoff of w > payoff of z.

What effect does this have on society is the next question. Well for one, it increases costs to the patient. In the state of Illinois women had to buy psychiatric coverage, unlimited overnight stays in the hospital, OBGYN coverage, unlimited mammograms and a plethora of other things. The reason why they had to purchase these features is because doctors have to “cover their bases.”  This obviously increases health insurance costs. It seems absurd that a woman who is sane, or not trying to have a baby, shouldn’t be allowed to buy basic coverage. This is at least part of the reason why so many people could not afford health insurance. This of course leads to all sorts of other costs to society, such as medicare/medicaid, and libs pushing and passing the Affordable Care Act.

This is how I think of this problem, and I hope it helps everyone understand the situation more clearly.

– JW

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