BUDGETS AS DYNAMIC GATEKEEPERS

Most large organizations allocate resources by means of fixed budgets: each subunit is normally entitled to spend a defined amount over a fi xed period, usually one year. Fixed budgets create clear incentives fo r subunits to control costs. Yet such arrangements create major incent ives for dynamic inefficiency, for example by encouraging subunits to exhaust their budgets toward the end of the fiscal year. This paper de velops a dynamic optimization model to examine the incentives fostered by budget systems. It invokes the metaphor of physicians involved in a health care delivery system to examine incentives created by decentr alized ''gatekeeping'' as a mechanism to control medical costs. The pa per also discusses some methods to reduce the incentives for dynamic i nefficiency that fixed budgets create.