Quality incentives in a regulated market with imperfect information and switching costs: capitation in general practice

We model a system akin to the British National Health Service (NHS), in which general practictioners (GPs) are paid by capitation from general taxation. GPs are horizontally and vertically differentiated and compete for patients via their imperfect observed quality. We show that for any given capitation fee quality is lower and the incentive effects of the fee on quality are smaller when there is imperfect information. There are diminishing welfare gains from improving patient information but increasing welfare gains from reducing switching costs. GPs do not act efficiently to improve patient information via advertising or to reduce the costs of switching.