We use data from 1983 and 1985 on the volume of Medicare physician services to analyze whether Medicare's Prospective Payment System (PPS), which resulted in a significant decline in hospital spending, led to a partially offsetting increase in real expenditures for physician services. We also analyze the effect of increases in assignment rates, increasing incomes of the elderly, and other factors on real expenditures during this period. Our main conclusion is that PPS has at most a small positive effect on real physician expenditures. Because people spent less time in the hospital, Medicare physician spending declined; but because of incentives to shift radiology and other services out of the hospital, some of this decline was offset. We also conclude that the sharp increase in Medicare assignment rates over this period, along with the rising incomes of the elderly during this period, contributed to the observed growth.

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