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Health econ
Wednesday, January 09, 2013
11:08 AM

What is health economics?
Studies the supply & demand of health care resources & the impact of health care resources on
a population
...
anything else?
Quality problem:
Bedside manner vs smart/"good" doctor
Nice or professional
Impolite, world-class doctor= a problem
Bad ratings, but great at doing the job
So… who is qualified to rate quality?
Access
Most people have access & confuse this with quality
Access problem: get more people to have care
Obamacare= increase in access
46 million people uninsured is a number thrown out a lot, but not necessarily
accurate
Affordability
Just cuz it's cheap doesn't mean it's accessible
Affordability problem: cost is high no matter what, take resources from one
expenditure & allocate to health care
Medicare= elderly & disabled, all federal, 1965
Medicaid= poor, state & federal (known as Medical in CA)
In rich states, half is paid by state half is federal
In poor states, more is paid by federal & less by state
Why do we care
Health care state now
Health care expenditures as % of GDP
1929=3
...
9
%'s of healthcare costs- use of US health funds
31% of spending on hospital care
20% on physician & clinic
10% on prescription drugs & supplies
Health employs approx
...
1 hard terms
Capitation
Dr's get paid per head in the computer, not by how many people he actually sees
Don't see primary physician for 3 yrs, but he is still be paid by insurance
Cost shifting
Price discrimination
When someone without insurance goes to ER, it raises prices for everyone else
Like a tax everyone pays to help that person get coverage
Indemnity insurance
Very basic insurance
You have an economic loss, you get it paid for by insurance
CHs 2&3
Is economics relevant to the health care market?
What does economics do
Studies human behavior
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Studies human behavior
Very systematic
Mathematical
graphs
Is a way of thinking
Primarily with how scarce resources are allocated among alternative uses to satisfy
unlimited wants
Opportunity costs
Crucial for economists
Important even in the healthcare world
Economic methodology
Critical assumptions
Rational choice & self interest
People only care about themselves
Only work towards maximizing their main goal, their self-interests
This is not perfect
People aren't always acting in self-interests
Mistakes
Info is huge since we don't always know what others are trying to
maximize
Use models/theory building
Models are giving economists something they can test
Economic optimization
Neoclassical (Traditional) Framework
Assume rational decision makers
Optimizing behavior
Health econ gets tricky
Doctor influences behavior also
Dr's idea of what will optimize health may not be individual's
Predictable results
Marginal decision making
The benefit is still positive but is decreasing
Eventually could become negative
Healthcare- visiting the dr
...

Costs rise exponentially
Marginal costs therefore rise as well, since it is exponential
The difference between benefit & cost is greatest where the slopes are equal
Where marginal cost is greater than marginal benefit, inefficiencies exists
We want to be where there is the greatest difference between MC & MB,
instead we exist a lot on where MB is zero
Insurance lowers the "perceive" cost of care for each additional unit
It essentially subsidizes a portion of the price of medical care
It lowers the exponentiality of the total cost, causing a shallower slope for
marginal cost
Law of demand
Price lowers, quantity demanded increases
Demand shifters
Tastes & preferences
Expectations
Price of substitute or compliment, related goods
Important to remember- price of good itself moves up & down demand
curve, price of related goods actually shifts demand curve
Income
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Income
Normal goods & inferior goods
Population
Number of buyers/number of people in market
Law of supply
Price lowers, quantity supplied lowers
Change in quantity supplied vs change in supply
Move along curve (change in price of that good) vs shift entire curve
News articles
Flu shots shortage
Demand curve shifts out
At the initial price, quantity demanded is greater than quantity supplied
Equaling a shortage
But then, eventually it works itself out & the price rises to the new equilibrium
Oil prices increasing=oil more scarce=latex glove price increases
Shifts supply to the left, quantity supplied is less for a high price
CS, PS, TS
Consumer surplus= difference between what you are willing to pay to what you actually
pay (WTP-P)
You feel great cuz you ended up buying the good for less than you were willing to
pay for it or intended to pay for it
Individual CS is the distance of the line created between the price on the demand
curve minus the price actually paid, according to a specific quantity
For a population, it is the area of the triangle created by price & the demand curve
Producer surplus= difference between the price & the cost to produce (PS= P-cost)
Individual PS is the distance of the line created between the price and the supply
curve, according to a specific quantity
For a population, it is the area of the triangle between the supply curve and price
Total surplus= consumer surplus added to producer surplus (TS=CS+PS)
Price ceilings & price floors
Ceiling is binding & keeps prices from climbing above a certain level
Ceiling is always below equilibrium price if is binding, or if it has an effect
Results in a shortage since quantity supplied is much less than quantity demanded
e
...
rent control (can't charge over a certain price for rent)
Floor is binding if it is above the equilibrium price
Keeps prices high
Results in a surplus since quantity supplied is much more than quantity demanded
e
...
minimum wage
Elasticity
Synonyms= responsiveness, sensitivity
Price elasticity of Demand
Price elasticity of demand= %delta Quantity D/%delta Price=
|Qd2-Qd1/(Qd1+Qd2)/2/P2-P1/(p1+p2/2)| = e
...
3
This means that after the long equation & you get
...
3%
Or…
If price increases by 10%, than quantity demanded decreases by 3%
If equation produces a number below 1, than the good is inelastic since
price has a very small effect on the quantity demanded
If equation produces a number above 1, than the good is elastic since
price has a relatively larger effect on the quantity demanded
Price elasticity of Supply
Cross-price elasticity of Demand
Income elasticity of Demand
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Income elasticity of Demand
Taxes
Taxes on seller
Messes with the supply curve
$ amount increases, but we aren't so sure what amount of quantity increases
or decreases
Buyers pay the new price where the demand curve intersects where the taxsupply curve
Price buyers pay - tax= Price buyers pay
Taxes act as a supply shifter
Buyers pay more & sellers aren't getting as much money
Taxes shrink the market
Taxes on buyers (e
...
sales tax)
Messes with the demand curve
Shifts quantity demanded down, & the demand curve to the left
Where the new demand curve intersects with the supply curve, that's what
the supplier/seller gets
What the buyer actually pays is where the new Quantity demanded taxed intersects
the original demand curve
Tax wedge in the market with consumer surplus & producer surplus
CS is area of triangle created by price buyers actually pay to the demand curve
PS is area of triangle created by price sellers pay to the supply curve
Subsidy
Subsidy on sellers
Lowering price for supply raises quantity supplied
Subsidy on buyers
Lowering price for buyer raises quantity supplied
The price for a buyer is on the opposite end of the subsidy wedge from the price for the
seller, lying on the demand curve and the supply curve, respectively
Externalities
People in mkt don't consider people outside the mkt
Making self-interested decisions has positive & negative externalities
e
...
education=positive, smoking=negative
Negative externalities
Within the market, supply=Private cost & demand= private value
External cost raises prvt cost curve creating the social cost curve
Social cost=ext
...
Cost
To get from the market quantity to the social quantity, a tax wedge is placed
The tax must be exactly equal to the external cost
Positive externalities
Benefit to society
External benefit rises prvt value curve (demand curve)
Social value= external benefit + prvt value
To get from the market quantity to the social quantity, a subsidy wedge is
placed
Subsidy must be exactly equal to the external benefit
Review of types of goods
Rival in consumption (one person's use of good diminish others' use) & Excludable (can
prevent someone from using good)
Private goods (food, cars)
Rival consumption & excludable
Common resources (fish in the ocean, oil pools)
Rival consumption, but not excludable
Negative externality issues
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Negative externality issues
Public goods (national defense, sunshine, fireworks)
Not rival in consumption, not excludable
Usually benefitting others with little benefit to supplier
Positive externalities
Other goods (books & newspapers, cable TV)
Not rival in consumption, excludable
The competitive model (the ideal)
The ideal
Uses resources efficiently
End up at the efficient quantity
The invisible hand
Characteristics of the competitive model
1lots of buyers & sellers
2standardized product- selling identical good
3no barriers to entry or exit/mobile resources
4perfect info
Graphing perfect competition model
Representative firm (one of lots of sellers, selling the same thing as everyone else)
Demand curve is perfectly flat, totally elastic
Decision rule= Marginal revenue = marginal cost
Where the marginal cost intersects the demand curve, set quantity
there
Profit equals zero there (economic profit, which means you can't do
better anywhere else, so it's good)
Strong assumptions had to be made
...
They may be appropriate for some goods in
the health care market
...

There USUALLY are not a lot of providers selling identical good
e
...

Hospital in small town= monopoly
Long term care hospital
Oligopolies
Few firms competing with each other- rivalry among firms just not lots of
firms
Competition exists, but because of low number of firms, decisions affect all
the firms
e
...
X-ray machines, MRI machines, health insurance companies
Monopolistic competition
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Monopolistic competition
Markets with lots of firms selling slightly different goods
Entry restrictions--> limit number of providers
e
...
physicians, dentists, hygienists, nursing homes & hospitals
Certificate of need must be granted & shown before such a business can open
Make hospitals/nursing homes show need in an area before they are allowed
to open
Moratorium laws nursing homes & hospitals that are already open
Can't expand/add another bed
Information costs
Link on sakai- Genetic adverse selection: evidence from long-term care insurance…
Imperfect competition in general
Downward sloping demand curve for firm
Don't have to sell at the market price
Firms aren't price takers, they are price searchers
Supply side imperfections
Factors on the supply side of the market that allow providers to enjoy monopoly returns
1toofew firms
2non-standard product
Graphing monopoly
Set Q by setting MR=MC
CS= follow price to quantity & demand curve, then up the demand curve
Approximation of PS= follow price to quantity & down to supply curve
Natural monopolies
Shape of cost curves
Fixed cost curves are huge
Marginal cost is tiny
Avg
...
will always fall after
Set quantity at MC=MR, go up to demand curve to set price
Set Q1 at Avg
...
g
...
5
Outline
Grossman- demand for medical care is "derived demand" for good health
I don't want medical care, I want what the medical care produces or does
Created in 2 different approaches
Medical care is one of several factors that can be used to improve health status for
individuals or populations
What actually goes into creating health
What contributes to good health
Lots of inputs are combined to produce a final product called a medical care
Demand for medical care, leading to a medical care system
Demand for health
America spent $2
...
g
...
g
...

2All of the other inputs besides money that changes health status
Shifts the whole curve
Measures of health status & other inputs
What are good measures of health?
Y-axis measures
Life expectancy (at birth)
Infant mortality rate
X-axis measures
Health care spending
Per capita spending
Gapminder to find out all these statistics
Has to be quantifiable
Lots of countries have to have it
Nothing measures quality of life
Measures of other inputs
What about other factors
Income & education
Environmental & lifestyle factors
Genetics
Socioeconomics
Public health & nutrition
Pgs 149-154
Research in 1980 suggested that we were already spending so much on health care
that we were at the flat part of the curve
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that we were at the flat part of the curve
The best way to improve health may be to increase other inputs
Demand for medical care
In terms of controlling costs the major focus w/policy has been to slow the supply-side of
the market
But it may be that we can have an impact on the demand side
We just need to understand the demand for healthcare
Medical care will be a result from all the other things we discussed
Medical care as an investment good
One of the things that is different about med care is that is can be viewed as an
investment good
There is a consumption component while increasing human capital
Examples of investment goods
College education, exercise,
It is not like other goods
Most goods, if you buy it… that means there is less to buy of everything else… but it isn't
necessarily like that with medical care
Why?
What influences good health? Drawing demand for medical care
If price is 0, then it will be at the clinical std
...
: price is one of the factors
What are the major influences of demand
Patient factors
Health status
Demographic characteristics
Economic standing
Physician factors
Provider of medical care
Advisor to medical care
Make sure you read about these in the book (up to the Rand study)
Rational Addiction Model
Becker & Murphy (1988) developed a model for why a rational person would choose to
consume an addictive good or service
Why discuss this now?
Challenges our moral concepts regarding behavior
Includes econ theory
There are similarities & contrast with the model of health demand so this is a good
place to include it
Becker & murphy argue that addictive behavior MUST provide SOME PLEASURE or people
would NOT pursue it
A necessary condition for this model:
Past consumption increases the Marginal Utility of current consumption
One is learning to enjoy the product more & more
What one consumed in the past, helps current or future consumption be
higher
A characteristic of many addictions is that they are harmful
The capital good/consumption capital has harmful effects similar to a reduction in health
status in the Grossman Model
e
...
Cigarettes are an investment in the wrong direction, reduce healthy days,
reduce income cuz more sick days
Becker & Murphy consider this part of "The Full Price" of the addictive good
A good is potentially addictive to the consumer if a certain pattern appears over time
When effects of present consumption of the good increase future MU MORE than
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When effects of present consumption of the good increase future MU MORE than
they increase future FULL PRICE
This patter is called "Adjacent Complementarity"
e
...
choose to smoke if
...
g
...
2 & 0
...
It
may actually make it worse
Ch 6
Market for Health Insurance
One of the primary arguments for health reform in the US was the 50
...
7% in 2009]
Types of insurance
Current/long-running policy debate in the US is over which type of health insurance
society should offer
1 indemnity
Providers reimbursement for some medical expenditures or direct payments to
those unable to work due to accident or injury
Sicker people pay higher premiums
Higher expected cost has higher premiums
2 social insurance
An insurance plan supported by tax revenues & available to everyone regardless of
age, health status, & ability to pay
Higher taxes wealthy & really everyone to pay for everyone to have health
insurance coverage
Examples from Medicare Parts A,B,C
Part A- funded by payroll tax, more like social insurance, those with
Review of assignment
Scarcity of shortage
Shortage- quantity demanded is Q demanded > Q supplied
Scarcity- unlimited wants, but limited resources--> decision-making & opp costs
Statistics review
Random variable- X
xi= the different values the random variable can take on
pi = the probability associated with xi
Expected value of X= E(x)= Σ xipi= population mean= µ
E
...
1
X1= 2
X2= 3
X3=4
P1=
...
5
P3=
...
25
E(x)= 2(
...
5)+(4(
...
V
...
g 5 people, times they went to the ER
2, 4, 6, 8, 10
Find mean (xbar)
Xbar= 6
Sample variance(s2)= (2-6)squared+(4-6)squared+(6-6)squared+(8-6)
squared+(10-6)squared/5-1
=16+4+0+4+16/4
=10 visits squared
Sample variance doesn't really mean anything, we can calculate it but
the units are weird
Sample std dev
...
16 visits
Population variance
Σ
= Σ (xi-E(x))2 pi
Population std dev
σ=
New Section 1 Page 12

σ=
=

Σ

e
...

From above where E(x)=3
=
(0
...
5
σ=
= 0
...
5)+

(0
...
g
...
01 & would cost $50,000 to
treat
Goal: calculate E(costs) var(costs) std dev(costs)
x=cost due to stroke
x= either stroke or no stroke, $50,000 or $0
p= 0
...
01=0
...
99
E(x)= µ= xbar= average health cost= 50,000(
...
99)= $500
On average, individual be paying $500
But individual will never pay that since either you have a stroke or not
You don't pay the average from the whole population
Var(x)= = Σ(x-xbar)squared pi= (50,000-500)squared(0
...
99)
= 20250000+247500=24,750,000
Var(x)= 24,750,000 dollars squared
Std dev(x)= σ= square root of 24,750,000=$4,974
...
cares about:
Expected value of AVG claim
Variability of AVG claim
AVG claim lowers health care costs because it decreases the variability
Lots of variability is bad
What we know from Statistics
Variability decreases proportionally with # of people enrolled in
plan/group/pool
Variability means variance
Var(E(x))=var(xbar)= /n= var(x)/n
Std dev(E(x))= std dev(xbar)= σ/n
E(xbar)= E(x)=µ
So avg value of x for the group will be the same as the avg for
individuals
e
...

Same example of as above
X1=$50,000
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X1=$50,000
X2=$0
P1=
...
99
But now insurance company has 10,000 n=10,000
E(x)= $500, for the individual
Insurance cares about
Variability of the group/pool
Var(xbar)= var(x)/n= 24,750,000/10,000=2,475 dollars
squared
Std dev(xbar)=
= $49
...
's group/pool of paying customers will have claims
in between $450 and $550
95% of insurance co
...
g
...
50
68% of people in group/pool have claims between $2
...
50
Terms & concept
Premium:
A periodic payment to purchase an insurance policy
How do insurance companies determine the premium?
E(xbar)= E(x)
Community & experience rating
In the US insurance companies community rate & experience rate insurance plans
What does that mean
Community rate:
The premium will be based on health use of everyone in group
Everyone in group pays same premium
Experience rate:
The premium is based on health use of the group vary by age, sex, smoker
status, etc
Today in the US typically in group plans
The premium is community rated so everyone pays the same premium but
the premium is different than other groups
It is also experience rated so the premium a group pays depends on the
group's behaviors & past claims
More reading on community & experience ratings on Sakai
An actuarially fair premium:
Exactly what you'd think an insurance company is paying out
Expected value of claims= E(xbar)= E(x)
In all reality, premiums are higher than claims
Loading factor
Difference between premium & claim- what insurance company charges to stay
functioning
= (actual premium - actuarially fair/ actuarially fair) x 100
Does not equal profit
Health insurance & risk aversion
This section looks at how an individual's preference for risk determines if health insurance
is a worthwhile purchase
A person that is risk-averse prefers a certain outcome to a gamble that has an expected
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A person that is risk-averse prefers a certain outcome to a gamble that has an expected
outcome of the same value
A person that is risk-loving prefers a gamble to a certain outcome
Risk-neutral person is indifferent- same average outcome so impartial to gamble or the
money for certain
The larger the amount of money, average people become more risk-averse
e
...

X1= 50 with P1= 0
...
5
E(income)= E(x)= 0
...
5(150)= 100
Compare the happiness of 100 for sure with the happiness of uncertain 50 with
probability of 0
...
5
Income increases--> utility(happiness) increases
However, marginal utility decreases
So happier, but extra dollar doesn't make you that much more happy
Expected utility from the gamble
E[u(x)]= 0
...
5 u(150)= 0
...
5(200)= 150
Note: these U values were from a table
Compare this to U[e(x)]= u[100]=170 Note: from table
The utility of the expected value of x or u[e(x)] is larger than the expected utility
from the gamble or e[u(x)]
Therefore we know that this individual is risk averse
This is easy to see on a graph also
U[e(x)] is higher than the line, the middle of which is E[u(x)]
Expected losses
= Net income - E(x)
Risk premium
Amount over & above expected loss willing to pay to avoid consequences of loss
Will to a lot to avoid the gamble- super risk-averse
Basic idea of Adverse Selection
Patients & physicians are an example where there are differences in info
Asymmetric info
There are lots of info problems in the health care market
Not the only market
e
...
Real estate, craiglist, mechanics
Akerlof won the Nobel prize for introducing the idea of asymmetric info with an analysis of
the used car market
We are going to work thru an example w/used cars & then apply it to the health market
Tell us about adverse selection
Unraveling of the insurance market
Discrete distribution is in a flat straight line- uniform distribution
Normal distribution is continuous
Sellers & owners
Assumptions
The owner of the car know the car's quality level
The buyers of the car only know the distribution of quality
Distribution of quality= the average quality & spread of quality (std
...
&
variance)
Where the asymmetric info comes in
Reserve value is price of car x quality
Buyers' value= price buyer is willing to pay x E(quality)
Moral Hazard
Arises in a variety of settings, not just health econ
It arises when the act of obtaining insurance of some sort changes people's behavior
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It arises when the act of obtaining insurance of some sort changes people's behavior
(1) It can occur because of a failure to take preventive measures
(2) Also occurs because once a loss occurs, the losses become larger when insured
Prices for the individual are lower with insurance
Graph
Consumer pays Qins x Pins
Ins company pays Qins x (Pnoins -Pins) this is the same as delta insurance
Delta society= delta consumers + delta insurance
Price elasticity of demand
There is a difference between all care and outpatient care
In general, health care is inelastic
Even if the price goes up, people still go to the doctor
Going to the hospital (inpatient) is less elastic than going to a primary physician
(outpatient)
Welfare loss
Looking at welfare loss due to insurance for the entire US population under 65 years of
age
Using calculation comparing 95% plan to the free plan
Rand Study
They gave people different co-pays
25%, free, 95%
But there was a MDE (maximum dollar expenditure)
Couldn't pay more than that
This produced a bunch of different insurance coverage
They found out that the hospital is more inelastic
Outpatient care will always be consumed regardless of the price
Inpatient (general physicians) will be consumed according to the price
Graphs
To show what welfare loss looks like when you move from 95% coinsurance plan to
free plan
No insurance, pay 100% price (Y-intercept)
At 95% to the demand curve, triangle created is the consumer surplus
At free plan, the whole triangle is the consumer surplus
Delta CS is positive, & consumers are better off moving to the free plan
What about insurance- health expenditures?
Rectangle created by the P100% & P95% to the Q95% is the expenditures with
the 95% plan
Rectangle created by the P100% & P0% to Q0% is the expenditure with the
free plan
Insurance company is worse off= delta expenditures is positive & :
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