CLASS WEB PAGE

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CLASS WEB PAGE

• http//www.cbe.wsu.edu/rosenman/econ455/

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Chapter 1 Introduction Health Economics
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• Can we apply the tools of economics to study the
  health care sector?

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Outline

• The 4 basic questions of health economics.
• The production possibilities curve
• Economic models
• Positive and normative analysis
• Net Benefit calculus

The following slides summarize material in
Santerre Neun, Health Economics Theories,
Insights and Industry Studies, Dryden, 2000.
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Health Economics

• studies the supply and demand of health care
  resources and the impact of health care resources
  on a population. (Mosby Medical Encyclopedia
  1992, p. 361)

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The 4 Basic Questions

• What combination of nonmedical and medical goods
  and services should be produced in the
  macroeconomy?
• Should the federal government spend more on
  missile defense or to reduce the number of
  uninsured children?
• Should the federal government spend more on
  education or prescription drugs for the elderly?

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The 4 Basic Questions (cont.)

• What particular medical goods and services should
  be produced in the health economy?
• Should the federal government spend more on
  prescription drugs for the elderly or on home
  health care?
• Should the federal government spend more on
  research to cure cancer or on cancer screening
  programs?

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The 4 Basic Questions (cont.)

• What specific health care resources should be
  used to produce the final medical goods and
  services?
• Should more ambulatory patients be cared for by
  nurse practitioners instead of physicians?
• When is medical vs. surgical management of a
  health condition appropriate?

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The 4 Basic Questions (cont.)

• Who should receive the medical goods and
  services?
• Should all of the elderly receive prescription
  drug coverage from the federal govt, or only the
  low-income elderly?
• Should illegal immigrants receive free care in
  county clinics and hospitals?

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The Production Possibilities Curve (PPC)

• A framework for answering the 4 basic questions.
• Depicts the availability of resources and
  indicates what can be produced.

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A PPC for the Federal GovtNational Defense vs.
Health Care
Full-proofness of the U.S. against terrorist
attacks
Points outside the PPC are not achievable with
current technological know-how.
100
Points inside the PPC represent production
inefficiency
100
Health care
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A PPC for the Federal Govt (cont.)

• The federal govt must make tradeoffs.
• Spending more on health insurance ? spending less
  on defense
• Tradeoffs ? the PPC slopes downwards.
• Tradeoffs imply opportunity costs.
• The value resources would yield if they were put
  to an alternative use.
• The opportunity cost of raising health insurance
  coverage by 1 could be a 2 reduction in the
  number of armed forces trained to deal w/
  terrorist attacks.

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A PPC for the Federal Govt (cont.)

• Resources are allocated optimally if the value
  obtained from a particular expenditure (e.g.
  raising health insurance coverage by 1) is
  greater than its opportunity cost.
• Whos value? In this case, one must come up with
  a valid measure of societys value

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A PPC for the Federal Govt (cont.)

• Resources are imperfectly substitutable
• Each additional unit of production has a rising
  opportunity cost.
• e.g. Raising health insurance coverage from 10
  to 20 may reduce the full-proofness of the U.S.
  defense system from 95 to 94. But raising
  insurance coverage from 90 to 100 could reduce
  the readiness of the U.S. defense system from 10
  to 0.
• The PPC is concave.

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A PPC for the Federal Govt (cont.)National
Defense vs. Health Care
All other goods
100
Identical increases in health insurance coverage
require larger reductions in defense readiness as
more resources are devoted to insurance.
100
Health care
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A PPC for the Federal Govt (cont.)

• All points on the PPC are efficient, and the
  point which is chosen will depend on societys
  preferences.
• But is the optimal point fair??
• To the poor?
• To those who would die in a terrorist attack?

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A PPC for the Federal Govt (cont.)

• As we will see in this course, market competition
  often leads to an efficient allocation of
  resources.
• However, a society which is also concerned with
  equity can redistribute resources, often using
  taxation.
• However, taxation leads to inefficiencies.
• A tradeoff often exists between efficiency and
  equity.

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Economic Models

• Models are abstractions of reality and are used
  in economics to simplify a very complex world.
• Usually describes a hypothesized relation between
  two or more variables.
• Can be expressed in verbal, graphical, or
  mathematical form.

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Economic Models (cont.)

• Example We hypothesize that health care
  expenditures are dependent upon an individuals
  income.
• E f(Y)
• In stating this hypothesis, we assume that all
  other likely determinants of E (e.g. prices,
  tastes, preferences) stay constant.

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Economic Models (cont.)

• We can hypothesize that health care expenditures
  are linearly related to income.
• E a bY
• a expenditures if income is zero.
• b slope of the expenditure function.
• b ?E/?Y

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Economic Models (cont.)

• We can quantify the linear relation between
  income and health expenditures.
• E 1000 .1Y
• 1000 expenditures if income is zero.
• Each 1,000 increase in consumer income raises
  health care expenditures by .1(1000) 100.

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Economic Models (cont.)

• The economic models states that ceteris paribus,
  E1000 .1Y.
• We can incorporate changes in other factors into
  the model as well.
• Suppose that the population has aged, so that
  yearly medical costs rise by 500 for the typical
  household.

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Economic Models (cont.)

• We respecify the model as
• E 1500 .1 Y
• In our graphical representation of the model,
  this represents a shift up in the entire health
  care expenditure function.

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E1 1500 .1Y
E0 1000 .1Y

• We will rely on the results of multiple
  regression analysis to quantify models like this
  in this course.

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Positive and Normative Analysis

• Positive analysis makes statements or predictions
  regarding economic behavior.
• What is?
• What happened?
• Normative analysis deals with the appropriateness
  or desirability of an economic outcome or policy.
• What ought to be?
• Which is better?

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Positive and Normative Analysis (cont.)

• According to Becker and Murphy (1988), a 10
  increase in the price of cigarettes leads to a 6
  reduction in the number of cigarettes consumed.
• The government should increase the tax on
  cigarettes to prevent people from smoking.

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Positive and Normative Analysis (cont.)

• It is in our countrys best interests that the
  federal government take a more active role in the
  prevention of AIDS.
• A study by Hellinger (1991) estimates that the
  average yearly cost of treating someone with AIDS
  is 38,300, while the lifetime costs equal
  102,000.

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Positive and Normative Analysis (cont.)

• To control health care expenditures, the United
  States should adopt a national health insurance
  program similar to Canadas.
• National health care expenditures per capita in
  the U.S. equaled 4,094 in 1998.

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The Net Benefit Calculus

• Economic models assume that individuals are
  rational.
• People can rank their preferences from high to
  low, or best to worst.
• People never purposely choose to make themselves
  worse off.
• If expected benefitsgtexpected costs for a given
  choice, it is in the agents best interest to
  make that choice.

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The Net Benefit Calculus (cont.)

• NB(X) B(X) C(X)
• X choice or activity under consideration
• NB expected net benefits
• B expected benefits
• C expected costs
• B(X) Pr(X)B(X) 1?Pr(X)?0

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The Net Benefit Calculus (cont.)

• Health care providers, government agencies, and
  individual consumers use such cost-benefit
  analysis to make decisions.
• Explicitly or implicitly.

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Conclusion

• Because resources are limited, health economists
  are concerned with determining what medical
  services to produce, how they should be produced,
  and who should receive them.
• As we will see in this course, the tools of
  economics can be applied to the health care
  sector to derive valuable insights about our
  health care system.

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Industry Overview Health Economics
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Health Care Expenditures in the United States,
1960-2001
1960 1970 1980 1990 1995 1999 2001
Nominal health expenditures 26.9 73.2 247.3 699
.4 987.0 1210.7 1424.2 (billions of
dollars) Annual rate of growth --
10.6 12.9 10.9 6.7 5.2 8.4 (average annual
change from previous period shown) Nominal per
capita health 143 341 1,052 2,690 3,686 4,358 5,0
43 expenditures Health expenditures
as 5.1 7.1 8.9 12.2 13.3 13.0 13.4 percentage of
GDP
Projected Source Health Care Financing
Administration Homepage http//www.hcfa.gov/stats
/stats.htm
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The Health Care Industry is Rapidly Evolving.

• Advances in medical technology and drugs are
  dramatically improving patient care.
• But, these improvements are costly.
• Aging U.S. population.
• 65 years
• 1950 8.1
• 1970 9.8
• 2000 12.7

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The Health Care Industry is Rapidly Evolving.

• Increased cost containment efforts.
• Changes in government reimbursement of health
  care providers.
• Private insurers are exercising more control over
  patient care.
• Increased competitive pressures.
• Mergers of existing providers.
• Entry of new competitors.
• Where are the most promising business
  opportunities?

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HOSPITAL CARE

• 32 of all health care expenditures in 1999.
• But insurers moved from cost-based reimbursement
  to fixed price reimbursement in the 1980s.
• Slower revenue growth
• In order to attract patients, many hospitals
  overspent on high-tech equipment.

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HOSPITAL CARE

• Improved surgical techniques led to shorter stays
  in hospital after surgery, more outpatient
  surgery.
• Lower demand for hospital beds and operating room
  time.
• 1998 community hospital occupancy rate 62.5
• A glut of hospital beds and high-tech services
  has led to too many hospitals competing for too
  few patients.

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NYT 10/25/96
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Modern Healthcare 2/8/99
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If hospital revenues are shrinking, which sectors
of the industry are growing?
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Americas Top 100 Fastest-Growing
CompaniesFORTUNE, September 4, 2000
EPS GROWTH RATE
REVENUES (millions)
100 RANK
COMPANY
WHAT THEY DO
16 VISX 100 266.8 Holds 150
patents for laser technology, charges a
per- procedure licensing fee. 23
Advance 78 1968.4 Prescription-drug
benefit Paradigm
manager 23 Forest 105
959.9 Licenses drugs developed by
Laboratories other companies markets
them. 28 Minimed 71
252.1 Infusion pump worn like a pager for
diabetes patients to avoid injections. 30
Polymedica 48 156.9 Sells
diabetes-testing equipment to seniors
covered by Medicare. 30 Sunrise
124 280.6 Assisted Living
Homes Assisted Living 69 Biogen
60 881.1 Biotech drug
company, leader in MS drugs. 92
Impath 38 99.0 Collects and
interprets Cancer data
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PHARMACEUTICAL INDUSTRY

• U.S. prescription drug expenditures reached
  99.6b in 1999.
• Industry highly dependent on research and
  development (RD).
• 300m to bring a new drug to market.
• Aggressive marketing to physicians, hospitals,
  pharmacists, and even the patient.

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PHARMACEUTICAL INDUSTRY

• Merck
• 40.4b in sales in 2000
• 50 of sales come from Merck-Medco
  (pharmaceutical benefits management)
• 50 of human health sales come from 5 drugs
  Vioxx, Zocor, Fosamax, Cozaar/Hyzaar, and
  Singulair

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WSJ 2/10/99
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MANAGED CARE

• Systems which manage the quality and cost of
  patient care.
• Most common
• Health Maintenance Organization (HMO)
• Consumer pays a fixed annual capitation fee, for
  which HMO agrees to provide comprehensive medical
  services.
• 60 of U.S. population (66.8m) enrolled in 2000.

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MANAGED CARE

• ADVANTAGE If capitation fee gt costs, HMO keeps
  the profit.
• DISADVANTAGE HMO responsible for cost overruns.
  
• Subject to lawsuits if provides sub-optimal care.

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WSJ 2/17/98
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Integration and Disintegration
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On One Hand...
Between 1995 and 1998, over 2,800 hospitals were
involved in mergers, acquisitions, joint
ventures, long-term leases, and other
partnerships.
Source Modern Healthcare. January 11, 1999.
Deals include mergers, acquisitions, joint
operating companies, joint ventures, long term
leases, and system affiliations.
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On the Other...
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LONG-RUN KEY TO SURVIVAL

• Be an efficient provider of high-quality patient
  care.