Benefits

1
Benefits
2
True Costs (not World Com costs)
3
Value creation and efficiency

• When a unit is produced for x and sold to
  someone who values it at y, value is created as
  long as y gt x. y-x is the value that is created
  in dollars.
• Economists say what markets are supposed to do
  is create as much value as possible. Markets
  that attain this standard are called efficient.
• Value creation applies to the production of a
  good as well as its sale to consumers. Lowering
  costs without harming quality creates value.
  Improving quality when the benefit to consumers
  exceeds the cost to producers creates value.

4
Intermezzo for Competitive Market Demonstration

5
When Markets Achieve Efficiency

• Those buying the product or service pay the full
  price and receive all the benefits (of the
  product).
• All costs accrue to those making the product, and
  the seller receives the full selling price.
• There are enough buyers/sellers to ensure
  competition.
• Sellers compete against each other for sales, as
  do buyers. They dont collude.
• (cont)

6
When Markets Achieve Efficiency part 2

• Product characteristics/quality can be accurately
  and easily assessed.
• Buyers are free to sample sellers price/quality
  and can travel inexpensively from one seller to
  another.
• Sellers are free to produce as much as they wish,
  and to choose their selling price freely buyers
  are free to buy as much as they wish.
• Sellers can enter/exit the market at will.

7
Intermezzo to Illustrate Supply/Demand Analysis

• The Market Responds in to Changes in Conditions
  in a Way that Tries to Maintain Efficiency

8
When Markets Approach Efficiency part 3

• Almost every assumption listed is violated in
  health care markets!!!
• Government involvement can limit price, entry,
  and exit
• Few sellers of hospital services in many markets,
  large HMOs can also mean few buyers
• Information problems mean quality/patient risk
  often hard to assess its difficult to sample
  sellers
• Externalities and insurance (moral hazard) mean
  benefits/costs accrue to others besides those
  buying or selling health care

9

• I THINK WE SHOULD
• PANIC!!!!!!!!

10
Insurance

• Insurance creates value by spreading risk. The
  value created is estimated by all those messy
  diagrams.
• Competition brings premiums toward expected
  payouts, plus administrative expenses
• With perfectly fair premium and no
  administrative overhead, risk-averse consumers
  would tend to fully insure so their wealth
  would be identical if sick or healthy
• Two primary market imperfections in insurance
  markets moral hazard and adverse selection

11
Moral Hazard

• Agent not acting in the best interest of the
  principal.
• In terms of insurance, it means that insured
  consumers will request services for which the
  benefit is less than the total cost, as long as
  the benefit exceeds the cost out of pocket
• Coinsurance is one way to reduce moral hazard,
  but it increases consumer risk
• Deductiblesdo they reduce moral hazard?

12
Adverse Selection

• Adverse selection is when disproportionately
  risky consumers are disproportionately likely to
  purchase insurance.
• Stems from asymmetric informationthe consumer
  knows more about his risk than the insurer does.
• Reduces the size of the marketless insurance
  purchased overall from adverse selection as it
  tends to drive up prices
• Experience rating reduces adverse selection

13
Other Market ImperfectionsInformation Problems

• Poor information about physician/hospital
  price/quality effectively reduces competition and
  prevents consumers from choosing an appropriate
  provider
• Poor information about the appropriateness of a
  procedure, even ex post, permits inducement
• Poor information about appropriateness of a
  procedure probably also gives rise to enormous
  variation in practice style across physicians and
  across areas. The latter is called Small Area
  Variation but in my own research I have found
  the former is far more significant.

14
Other Market Imperfections--Externalities

• Externalities arent discussed in the assigned
  chapters but are relevant to HC markets
• Externalities occur when the full cost of
  treatment isnt incurred by the provider or when
  the full benefit of treatment isnt received by
  the purchaser.
• Most obvious externality is that, by getting
  well, a consumer does not continue to expose
  others to contagious diseases.

15
OK, SO WE HAVE PROBLEMS

• What are we going to do about them?