Health Economics Introduction

1
Health Economics - Introduction

• Understand behavior
• Providers
• Insurers
• Health care professionals
• Consumers
• Learn how to apply economic way of thinking to a
  particular industry
• Learn to think about the implications of
  government regulation of industry

2
Chapter 1 Why Health Economics?

• Is health care different? Does market failure
  warrant government intervention?
• Externalities
• Uncertainty
• Asymmetric Knowledge
• Societys responsibility for health care

3
Is health care different? Does market failure
warrant government intervention?

• Example from state medical licensing
• Economists have debated licensure of medical
  professionals
• Monopoly or asymmetric information?

4
Asymmetric Information as the basis for
government regulation of health care provision

• The doctorhas a considerably, possible
  massively, greater level of knowledgeabout the
  diagnosis and treatment of disease.
• The doctor might be able to deceive the patient
  and make money doing so. (Phelps, 2003, 5)
• Phelps, Charles E. Health Economics, 3rd Edition.
  Addison Wesley, Boston, 2003

5
Monopoly as the basis for regulation of
physicians and non-physician clinicians

• Economists see licensing (by state governments)
  as a source of cartel power among physician
  groups.
• Kessel (1958 and 1970) pointed out
• licensing requirements increase returns for
  existing practitioners at consumers expense.
• Licensure gave the AMA (American Medical
  Association) the power to approve medical
  schools. allowing organized medicine to control
  entry to the very market it served (Kessel 1958,
  283).
• Kessel, Reuben A. 1958. Price Discrimination in
  Medicine. Journal of Law and Economics 1 20-53
• Kessel, Reuben A. 1970. The A.M.A. and the Supply
  of Physicians. Law and Contemporary Problems
  35(2) 267-283

6
Economists cite economist Kenneth Arrow

• The general uncertainty about the prospects of
  medical treatment is socially handled by rigid
  entry requirements.
• These are designed to reduce the uncertainty in
  the mind of the consumer as to the quality of
  product insofar as this is possible. (Arrow
  1963, 966)
• Arrow, Kenneth J. 1963. Uncertainty and the
  Welfare Economics of Medical Care, American
  Economic Review 53(5) 941-973.

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Arrow (Continued)

• I think this explanation, which is perhaps the
  naïve one, is much more tenable than any idea of
  a monopoly seeking to increase incomes.
• No doubt restriction on entry is desirable from
  the point of view of the existing physicians, but
  the pubic pressure needed to achieve the
  restriction must come from deeper causes. (Arrow
  1963, 966)

8
Arrow (Continued)

• How well they achieve this end is another
  matter. R. Kessel points out to me that they
  merely guarantee training, not continued good
  performance as medical technology changes.
  (Arrow 1963, 966)

9
Arrow (Continued)

• Both the licensing laws and the standards of
  medical-school training have limited the
  possibilities of alternative qualities of medical
  care . . . that might appeal to different
  tastes and incomes. (Arrow 1963, 953).
• restrictions on entry to the field have
  constituted a direct and unsubtle restriction on
  the supply of medical care. (Arrow 1963, 955)

10
Arrow (Continued)

• The licensing laws . . . exclude all others from
  engaging in any one of the activities known as
  medical practice. As a result, costly physician
  time may be employed at specific tasks for which
  only a small fraction of their training is
  needed, and which could be performed by others
  less well trained and therefore less expensive.
  (Arrow 1963, 957)

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Arrow (Continued)

• the present all-or-nothing approach could be
  criticized as being insufficient with regard to
  complicated specialist treatment, as well as
  excessive with regard to minor medical skills.
  (Arrow 1963, 967)

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Phelps on Licensure

• Asymmetric information consumer unable to judge
  quality
• Difficult to trade in service when it does not
  work (vs. car)
• Mistakes harder to correct than with goods
• Most people dont know much about medical care
  (vs. auto repair)
• Market failure implies role for government

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Against State Licensure

• Government does not assure quality
• Licensure means it is legal for all doctors to
  perform brain surgery
• State boards rarely discipline physicians (revoke
  or suspend license)
• Consumers are protected by
• Private specialty board certification
• Need for reputation (repeat customers and
  referrals)
• Hospital and Health Maintenance Organization
  (HMO) oversight (check records of physicians)
• Malpractice insurance must be purchased

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Chapter 1 - Health as a Durable Good

• Health as a durable good
• Think of yourself as having a stock of health
  that you are trying to keep in good shape (like
  painting a home)
• The demand for medical services is a derived
  demand.
• That means people dont want medical services
  (enjoy your last root canal?), but they want
  health.
• The demand for medical services (healthcare) is
  derived from the underlying demand for health.

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Utility Function U U(X,H)

• U Utility (satisfaction from consumption of
  goods and services) in a specific period of time
  for a particular consumer
• Economics Consumers act so as to maximize their
  utility
• H health during that period of time (how
  healthy were you?)
• NOTE this is not the consumption of health care
  goods and services, but the consumption of health
• X other consumption goods and services
• So, you consume health and other goods and
  services every day/week/year

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U U(X,H)

• Utility is a function of the amount of X you have
  (the amount of goods and services consumed) (each
  line drawn below is for a particular level of H
  H is held constant along each line)

The positive slope illustrates that U increases
as you get more X. The shape of the line
(concave to the horizontal axis) shows that
Utility increases at a decreasing rate as you get
more X (diminishing returns to the consumption
of additional units of X)
U (HH2)
Utility
U (HH1)
Utility increases with more Health H2 gt H1
X
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U U(X,H)

• Utility is a function of the amount of H you have
  (the amount of goods and services consumed) (each
  line drawn below is for a particular level of X
  X is held constant along each line)

The positive slope illustrates that U increases
as you get more H. The shape of the line
(concave to the horizontal axis) shows that
Utility increases at a decreasing rate as you get
more H (diminishing returns to the consumption
of additional units of H)
U (XX2)
Utility
U (XX1)
Utility increases with more X X2 gt X1
H
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• Consider points A and B Which one has more goods
  and services (X)?
• Which one has better (more) health (H)?
• Would you rather be at point A or B?
• This person would be indifferent to a trade of H2
  H1 for X2 X1

U (XX2)
Utility
A
B
U (XX1)
U1
Utility increases with more X X2 gt X1
H
H1
H2
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Definition Indifference Curves show a consumers
willingness to trade one good for another.

• If you are indifferent, that means you dont
  have a preference if you are indifferent
  between two baskets of goods (two combinations of
  goods), it means the Utility associated with the
  two baskets is equal you dont care which one
  you get.

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Indifference Curves Choosing between health and
all other goods.

• Would you trade health for other consumption
  goods and services?
• Marginal vs total distinction (not an all or
  nothing decision)
• Why dont you get a checkup every 3 months?
• Why doesnt the city station a paramedic on every
  street corner?
• Do you engage in behaviors that reduce your
  health? (eat foods high in fat and sugars? Play
  professional football?)

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Indifference Curves show the consumers
willingness to trade health for other goods

• How much health would you give up to have more
  of other goods?

A
H (units of health)
This person would trade H2 H1 units Of health
for X2 X1 dollars of other goods and
services Why is U steep north of A?
H2
B
H1
U
X (other goods/services, measured in dollars)
X2
X1
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Production Function H g(m, D)

• H is the annual consumption of health
• m is medical care
• D is disease

Common Cold
Broken Arm
H
Allergies
m
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Investment in Health An Intertemporal Decision
Health in Period 2
Fun in Period 1 (unconstrained behavior sun
exposure, smoking, junk food, risky sports)
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Consumers pick Lifestyle

• H g(XB, XG, m)
• XB includes bad goods/services (bad for your
  health)
• Age-specific death rates are lower in Utah. Is
  that good?

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In what areas can economists contribute to the
health policy discussion?

• Licensure and scope-of-practice laws
• Regulation of pharmaceutical industry profits
• Price controls (through Medicare/Medicaid)
• Decisions about investment in hospitals and
  equipment (e.g., certificate of need programs)
• Insurance market insights (moral hazard, adverse
  selection) (impact of subsidies)
• Universal coverage (government provision vs.
  procurement)

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Chapter 1 End-of-Chapter Questions

• Problem 6