Applied Welfare Economics Lecture 4

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Applied Welfare EconomicsLecture 4

• Hamish Low

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From Mr Evans Course

• Optimal contracts in first best
• complete risk sharing
• Second best
• incentive compatibility constraint
• trade-off between providing incentives to work
  and providing risk sharing
• second best optimal effort lower than first best
• Examples
• equal compensation principle (academics paid by
  research)
• ratchett effect good performance today affects
  standard set for tomorrow

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Outline Incentives in the Public Sector

• Definitions of Efficiency
• Incentive Contracts Health care
• contracts for Doctors
• equity
• Competition and Quasi-Markets

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Issues

• Should competition or incentives within the
  public sector be used to improve public
  performance?
• How should competition or incentives be used to
  improve public performance?
• Changing competition, contracts and (maybe)
  ownership
• which of these matters for outcomes?

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Efficiency and Equity

• Allocative efficiency
• Resources are allocated such that marginal
  benefit equals marginal cost across all goods P
  MC
• Productive efficiency
• Cost minimisation produce at bottom of average
  cost curve
• Equity
• equality of opportunity
• equality of outcome

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Achieving Efficiency
Firm incentives perfect competition
Firm incentives monopoly
p
p
MC
MC
AC
AC
P
P
MC
Dd
MR
q
q
Neither productive nor allocative efficiency
Productive and allocative efficiency
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Health Care

• Patients lack information
• about their needs
• about options
• about risks
• Acquiring information is costly. Delegate this to
  doctors who provide the information.
• Uncertainty about future health needs insurance
• Adverse selection individuals know their health
  status better than the insurance company (no
  health insurance for over 65s in the US)
• under-provision
• Moral hazard health care is free to the patient
  and a third-party pays the doctor
  
• over-provision

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Incentive Contracts Doctors

• Multiple principals (patients, insurance
  companies, govt)
• incentive contracts less sharp
• Multiple tasks
• At general level efficiency and equity
  considerations
• At specific level performance targets distort
  choices
• incentive contracts less sharp

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Incentive Contracts Doctors

• Contracts in the US
• Drs are paid according to the costs they incur by
  the insurance co.
• Allocative efficiency P MC
• No incentive to minimise costs no productive
  efficiency
• Contracts in the UK
• Primary care trusts are paid according to the
  number of patients on the Doctors books.
• No increase in payment for incurring greater
  costs (eg more time, greater use of hospital
  resources, community care).
• Productive efficiency minimise costs
• No allocative efficiency P ? MC
• Quality? Who assesses quality?

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Efficiency Properties
Allocative efficiency
Productive efficiency (encourages innovation)
Trade-off between the two types of efficiency
whereas under perfect competition there is no
trade-off.
Two types of cost high and low Cost is partly
due to luck and partly due to effort

• Fee-for-service is full insurance
• Prospective payment is full incentives

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Dynamic Efficiency Properties

• What determines the size of the prospective
  payment?
• costs actually incurred in the past?
• how often is the size of the prospective payment
  recalculated?

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Alternative Health Maintenance Organisations

• US problem of Doctors over-supplying health care
  and not minimising costs
• Doctors and insurance companies merge doctors
  bear the cost of over-supplying (correcting the
  externality)

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Equity

• Adverse selection issue lack of access to health
  care
• make insurance compulsory
• use taxation (ie forcing a pooling equilibrium
  and cross-subsidising the high-risk)
• Should health care redistribute from the rich to
  the poor?
• consumption externality? Transfers should be
  wisely spent (ie subsidise health care rather
  than giving income)
• BUT
• First best separate efficiency from equity.
  Price at marginal cost and redistribute through
  lump-sum taxes
• Second best / D-M no lump-sum taxes, maintain
  production efficiency and redistribute through
  consumer prices

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Quasi-Markets

• Inefficiency due to lack of competition
• introduce choice and lowers costs
• Providers of services are rewarded for good
  performance by receiving more contracts
• Health patients move to better Primary Trusts,
  more money
• Education more pupils (better pupils?), more
  money

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Quasi-MarketsCompetition in Health Care

• Incentives for Doctors in the UK to undersupply
  are mitigated because patients can move Primary
  Trust
• Purchaser provider split Primary Trusts decide
  which hospital should treat their patients and
  bargain over the price
• hospitals compete over patients
• But
• Cream-skimming long-term ill excluded? No
  evidence.
• Economies of scale only one local hospital
• Long-term relationships damaged (second best
  world)
• Who assesses quality? Doctors? Evidence that
  quality fell.
• Incentives / contracts matter more than
  competition

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Quasi-MarketsCompetition in Education

• Finance follows pupils schools budgets are
  determined by the number of pupils
• Information on school quality provided by league
  tables
• BUT
• Cream-skimming over-subscribed schools take only
  the best students, and this leads to better
  results
• Focus on tasks that feed into information set
  (league tables)

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Conclusions

• Incentives
• Contracts affect efficiency trade-off between
  allocative and productive efficiency
• Sharper incentives difficult in public sector
  where multiple principals and multiple tasks
• Different contracts lead to different outcomes
• Competition
• Quasi-market consumer choice leads to
  reallocation of resources
• Limited information on choice (eg. league tables)