The Economic Side to Other Health Issues
Production, costs, and insurance are naturally issues that involve economics, but many other health issues have economic components, even though they may seem to be purely medical concerns. A few examples illustrate this point. The choice of a health care treatment seems purely medical to many people, but physicians and other providers increasingly believe in evaluating and comparing alternative treatments on economic grounds. It is necessary to examine the costs of alternative techniques. Physicians are also increasingly sensitive to the economic side of the patient-physician relationship. The patient’s preferences are considered valid in determining the appropriateness of a given treatment. We also must explore the economic reasons behind people’s health choices. People take care of themselves well at some times and poorly at other times. People’s desired health status can be understood as a meaningful economic choice. Even addiction to a relatively benign substance such as caffeine or a harmful substance such as methamphetamine can be understood better when analyzed as a possibly rational economic choice. Other health issues clearly have an economic aspect: What role should the government play in health? What health care investments should a developing country make? Should cigarette advertising be banned? Questions like these are not solely economic; but they have an economic side.
ECONOMIC METHODS AND EXAMPLES OF ANALYSIS
We have already provided a formal definition of health economics as “the study of the allocation of resources to and within the health economy.” From another perspective, however, health economics is what economists actually do and how they apply economics to health. Economists in practice use certain characteristic approaches to their analyses of the world.
Features of Economic Analysis
Many distinctive features of economics might be exhaustively identified, but we emphasize four: 1. Scarcity of societal resources 2. Assumption of rational decision making 3. Concept of marginal analysis 4. Use of economic models
SCARCITY OF RESOURCES
Economic analysis is based on the premise that individuals must give up some of one resource in order to get some of another. At the national level, this means that increasing shares of GDP going to health care ultimately imply decreasing shares available for other uses. The “opportunity cost” of (what we give up to get) health care may be substantial. While most people will recognize the money costs of goods and services, economists view time as the ultimate scarce resource. Individuals sell their time for wages, and many individuals will refuse overtime work even if offered more than their normal wage rate—because “it’s not worth it.” Similarly, many will pass up “free” health care because the travel and waiting time costs are too high.
RATIONAL DECISION MAKING
Economists typically approach problems of human economic behavior by assuming that the decision maker is a rational being. Rationality is effectively defined as “making choices that best further one’s own ends given one’s resource constraints.” Some behaviors may appear irrational. However, when disputes over rationality arise, economists often attempt to point out, perhaps with some delight, that so-called irrational behavior often makes sense when the incentives facing the decision maker are properly understood.
MARGINAL ANALYSIS
Mainstream economic analyses feature reasoning at the margin. To make an appropriate choice, decision makers must understand the cost as well as the benefit of the next, or marginal, unit. Marginal analysis often entails the mental experiment of trading off the incremental costs against the incremental benefits at the margin. A prime example involves the purchase of brand-name drugs. Patients’ decisions to buy brandname drugs, particularly for elective treatments, may depend critically on whether they must pay $2 or $3 per pill, or, instead, a fraction of those amounts if prescription drug insurance is available.
USE OF MODELS Finally,
economics characteristically develops models to depict its subject matter. The models may be described in words, graphs, or mathematics. This text features words and graphs. These models may be understood as metaphors for reality. We say, “This is the market for physician care,” meaning “This is like the market for physician care.” Any model can be pushed too far and must be tested against a sense of reality and ultimately against the facts. Nonetheless, they can be apt, and we can learn from them. In economic analysis, the models are often abstract. Abstract models help to make sense of the world, in economics as in everyday life. A young child asking what the solar system is like will undoubtedly be shown the familiar drawing of the Sun and planets in their orbits—an abstract model. The drawing is quickly grasped, yet no one supposes that the sky really looks like this.
Economic Problems of Health Care Delivery
The Importance Attached to Economic Problems of Health Care Delivery
The health sector receives attention from policymakers because of its widely perceived problems. The substantial resources devoted to health care are reflected in a more meaningful way through the average level of this nation’s spending for health care. Table 1-4 provides various measures of health care spending and its growth since 1960. Table 1-4 shows how national health expenditures (NHE) grew from $27 billion in 1960 to $2,486 billion in 2009. During that period, the U.S. population grew by 65 percent from 186 million to 307 million. Thus, NHE per capita rose by a multiple of 55, from $147 in 1960 to $8,086 in 2009. However, the real increase is what matters most. Prices, as measured by the broad-based consumer price index (CPI), rose 625 percent over the same period. After deflating by the CPI, we find that real expenditures per capita in 2009 were 7.6 times the 1960 level—still a hefty increase.1
Inflation
Although we have deflated the spending values using the CPI, medical care prices have grown faster historically than prices overall. Table 1-4 also shows the pattern of health care inflation since 1960. Note that hospital and physician care prices have risen much faster than the CPI—a phenomenon that is typical of other health care services and commodities as well. In 2009, the medical care price index (not shown in Table 1-4) rose by 3.2 percent even as the U.S. economy experienced deflation. Medical price inflation is a common problem for maintaining health programs, and it has spurred numerous cost-containment efforts by the government. Understanding and evaluating the effects of such measures are important tasks for the health economist
Access
For many, the rising costs significantly reduce accessibility to health care. Financial affordability influences demand for most goods and services, and there are many reasons why some people do not have health insurance. What is clear is that the number of uninsured has risen and that in 2009 and 2010 approximately 50 million people in the United States lacked insurance. Many more are considered to have inadequate insurance. The problems of cost, inflation, and uninsured people have led to numerous proposals for some form of national health insurance. Later in this book, we will examine several broad groups of plans, the national health insurance programs that exist in other countries, and the newly established Patient Protection and Affordable Care Act, passed in 2010.
Quality
Increases in the quality of care contribute to spending increases. Often, the focus is on ensuring quality through professional licensure and certification and, especially for hospitals, through quality-assurance programs. At the same time, concerns arise about access to high-quality care, and they are not limited to those without insurance or with minimal insurance. Other observers, however, express concerns that the quality of care in the United States is often excessive, especially for some “high-tech” treatments. For such treatments, the costs of resources may exceed the benefits to patients. The interplay among insurance, technology, and consumption is of major interest to economists.
The health sector receives attention from policymakers because of its widely perceived problems. The substantial resources devoted to health care are reflected in a more meaningful way through the average level of this nation’s spending for health care. Table 1-4 provides various measures of health care spending and its growth since 1960. Table 1-4 shows how national health expenditures (NHE) grew from $27 billion in 1960 to $2,486 billion in 2009. During that period, the U.S. population grew by 65 percent from 186 million to 307 million. Thus, NHE per capita rose by a multiple of 55, from $147 in 1960 to $8,086 in 2009. However, the real increase is what matters most. Prices, as measured by the broad-based consumer price index (CPI), rose 625 percent over the same period. After deflating by the CPI, we find that real expenditures per capita in 2009 were 7.6 times the 1960 level—still a hefty increase.1
Inflation
Although we have deflated the spending values using the CPI, medical care prices have grown faster historically than prices overall. Table 1-4 also shows the pattern of health care inflation since 1960. Note that hospital and physician care prices have risen much faster than the CPI—a phenomenon that is typical of other health care services and commodities as well. In 2009, the medical care price index (not shown in Table 1-4) rose by 3.2 percent even as the U.S. economy experienced deflation. Medical price inflation is a common problem for maintaining health programs, and it has spurred numerous cost-containment efforts by the government. Understanding and evaluating the effects of such measures are important tasks for the health economist
Access
For many, the rising costs significantly reduce accessibility to health care. Financial affordability influences demand for most goods and services, and there are many reasons why some people do not have health insurance. What is clear is that the number of uninsured has risen and that in 2009 and 2010 approximately 50 million people in the United States lacked insurance. Many more are considered to have inadequate insurance. The problems of cost, inflation, and uninsured people have led to numerous proposals for some form of national health insurance. Later in this book, we will examine several broad groups of plans, the national health insurance programs that exist in other countries, and the newly established Patient Protection and Affordable Care Act, passed in 2010.
Quality
Increases in the quality of care contribute to spending increases. Often, the focus is on ensuring quality through professional licensure and certification and, especially for hospitals, through quality-assurance programs. At the same time, concerns arise about access to high-quality care, and they are not limited to those without insurance or with minimal insurance. Other observers, however, express concerns that the quality of care in the United States is often excessive, especially for some “high-tech” treatments. For such treatments, the costs of resources may exceed the benefits to patients. The interplay among insurance, technology, and consumption is of major interest to economists.
Importance of Labor and Capital in the Health Economy
Importance of Labor and Capital in the Health Economy
The flip side of spending is reflected through the jobs that have been created in the health economy. As shown in Table 1-3A, 15.5 million people—11.1 percent of all employed civilians—worked at various health services sites in 2009. These numbers continued to grow despite the loss of over 5 million jobs in the U.S economy between 2007 and 2009. Hospitals dominate, employing 40.5 percent of health care workers. Other major employers include offices and clinics of physicians (10 percent), nursing care facilities (12.1 percent), and offices and clinics of dentists (5.2 percent). Table 1-3B provides information on specific health care occupations and their growth since 1970. In 2009, there were over 972,000 physicians and almost 268,000 pharmacists. The nursing sector alone consisted of over 3 million people with over three-quarters of them trained as registered nurses. The considerable growth in health care personnel is evident. In 1970, there were 334,000 physicians, or 164 physicians per 100,000 people. By 2009, the number of physicians had increased by 191 percent to 972,000 or 317 per 100,000 population. The number of registered nurses had more than tripled by 2009, with their number per 100,000 population more than doubling from 369 to 842. Reflecting the increases in spending, the health care sector serves increasingly as a source of employment. Thus, cutbacks in spending on health care, if proposed and implemented, would typically mean cutbacks in employment opportunities. In addition to labor, a substantial amount of capital has been drawn to the U.S. health care system. The number of nursing home beds increased from about 1.3 million in 1976 to about 1.7 million in 2009 (beds per capita, however, decreased slightly). The number of short-term
hospital beds (as distinguished from nursing homes) peaked in the late 1970s, at almost 1.5 million, but the total number has since leveled at approximately 950,000. There are also considerable and growing amounts of other capital—such as diagnostic equipment—per bed.
The flip side of spending is reflected through the jobs that have been created in the health economy. As shown in Table 1-3A, 15.5 million people—11.1 percent of all employed civilians—worked at various health services sites in 2009. These numbers continued to grow despite the loss of over 5 million jobs in the U.S economy between 2007 and 2009. Hospitals dominate, employing 40.5 percent of health care workers. Other major employers include offices and clinics of physicians (10 percent), nursing care facilities (12.1 percent), and offices and clinics of dentists (5.2 percent). Table 1-3B provides information on specific health care occupations and their growth since 1970. In 2009, there were over 972,000 physicians and almost 268,000 pharmacists. The nursing sector alone consisted of over 3 million people with over three-quarters of them trained as registered nurses. The considerable growth in health care personnel is evident. In 1970, there were 334,000 physicians, or 164 physicians per 100,000 people. By 2009, the number of physicians had increased by 191 percent to 972,000 or 317 per 100,000 population. The number of registered nurses had more than tripled by 2009, with their number per 100,000 population more than doubling from 369 to 842. Reflecting the increases in spending, the health care sector serves increasingly as a source of employment. Thus, cutbacks in spending on health care, if proposed and implemented, would typically mean cutbacks in employment opportunities. In addition to labor, a substantial amount of capital has been drawn to the U.S. health care system. The number of nursing home beds increased from about 1.3 million in 1976 to about 1.7 million in 2009 (beds per capita, however, decreased slightly). The number of short-term
hospital beds (as distinguished from nursing homes) peaked in the late 1970s, at almost 1.5 million, but the total number has since leveled at approximately 950,000. There are also considerable and growing amounts of other capital—such as diagnostic equipment—per bed.
Insurance and Substitutability
Insurance and Substitutability
Assume now that like most Americans the patient has insurance coverage. Begin with a policy that covers a constant proportion (e.g., 80 percent) of spending on either D or M. Out-of-pocket patient costs are $10 for each prescription (20 percent of $50) and $20 for a medical visit (20 percent of $100). Because the slope of the patient’s budget line does not change, the optimal choice remains at point E, and the patient continues to buy four units of drugs and six visits. Total drug costs will continue to be minimized with the patient paying 20 percent ($160) and the insurer paying 80 percent ($640) of the $800 total bill. However, D and M often are not treated uniformly under traditional health insurance. Consider a policy that pays 80 percent of medical costs but requires a deductible of only $5 (copayment) for each prescription. The patient’s drug price is the $5 deductible regardless of the actual price of the medication. If the patient’s out-of-pocket drug costs diminish, the numerical slope of the cost-minimizing budget line diminishes (in our example, it is now -5/20 = 0.25). The patient will have an incentive to substitute D for M at E–. Continuing with the example, let D2 increase from 4 to 5, and M2 fall from 6 to 5.75. The patient’s cost burden diminishes from $160 to $140 or: However, the total cost of care (patient plus insurer) increases from $800 to $825. We know this is true because we already determined that E is the least costly combination to provide HS1. Similarly, if prescription prices (to the insurer) increase, say to $100, the patient still pays $5 and will remain at E– with the insurer picking up the increased drug costs. Patients have no incentive to economize by making substitutions and moving toward E. The higher the prescription price, the greater is the distortion. A similar distortion toward excessive levels of M and greater total costs occurs when the patient’s coverage excludes or limits drug benefits. Here, the savings from reducing M will more than offset the additional drug spending from improved drug coverage.
Technological Change
At the turn of this twenty-first century, a new category of experimental drugs, blood vessel inhibitors,
generated extraordinary excitement in the medical community by fighting both cancer and
heart disease. Technology often is associated with major breakthroughs. More often, however, new
drugs are similar to existing drugs, but they may produce somewhat better outcomes (if only for
some patients) or reduced side effects.
With technological improvements, fewer inputs are needed to produce a given health outcome,
or outcomes that were previously unattainable are now attainable. For example, begin with
HS1 in Figure 17-3 and let HS1
* represent all combinations of inputs with a new drug that leads to the same health status as HS1. If the cost-minimizing ratio of inputs at a given price ratio remains
unchanged, so that it lies along the ray 0E (denoted (M/D)0), the innovation represents a neutral
technological change. As drawn, the new drug saves a relatively high amount of the medical input at
any given price ratio. That is, drug utilization increases relative to medical care as the patient moves
to E* and substitutes D for M. As noted in the figure, the lower ratio of M to D is reflected in the less
steeply sloped ray, (M/D)1.
New technology can increase costs for two reasons. First, it can routinely provide health levels
that were unattainable previously (e.g., HS2
* at point E**). It may require much more drug use and
possibly increased use of M, as well. When health improvements are dramatic or when drugs treat
serious conditions that were not treatable previously, cost concerns are likely to be far less troublesome
than those leading to only marginal improvements in health.
The second cost pressure comes from insurance. As we have seen, a patient with a constant
copayment will not face any price increases of the new drug. Assume that the slope of the budget
line in Figure 17-3 reflects the patient’s copayment of $5 and the patient moves from E to E*
. If the
price of the new drug is high enough, the total cost of care at E* could be substantially higher than
total costs at the original equilibrium at E.
For conventional goods, where the consumer pays the entire price out of pocket, such technological
changes will not be introduced because they will not be demanded. With insurance, the
determination and elimination of cost-inefficient technology are far more difficult. A drug-maker
may market a socially cost-inefficient drug successfully simply beca
Assume now that like most Americans the patient has insurance coverage. Begin with a policy that covers a constant proportion (e.g., 80 percent) of spending on either D or M. Out-of-pocket patient costs are $10 for each prescription (20 percent of $50) and $20 for a medical visit (20 percent of $100). Because the slope of the patient’s budget line does not change, the optimal choice remains at point E, and the patient continues to buy four units of drugs and six visits. Total drug costs will continue to be minimized with the patient paying 20 percent ($160) and the insurer paying 80 percent ($640) of the $800 total bill. However, D and M often are not treated uniformly under traditional health insurance. Consider a policy that pays 80 percent of medical costs but requires a deductible of only $5 (copayment) for each prescription. The patient’s drug price is the $5 deductible regardless of the actual price of the medication. If the patient’s out-of-pocket drug costs diminish, the numerical slope of the cost-minimizing budget line diminishes (in our example, it is now -5/20 = 0.25). The patient will have an incentive to substitute D for M at E–. Continuing with the example, let D2 increase from 4 to 5, and M2 fall from 6 to 5.75. The patient’s cost burden diminishes from $160 to $140 or: However, the total cost of care (patient plus insurer) increases from $800 to $825. We know this is true because we already determined that E is the least costly combination to provide HS1. Similarly, if prescription prices (to the insurer) increase, say to $100, the patient still pays $5 and will remain at E– with the insurer picking up the increased drug costs. Patients have no incentive to economize by making substitutions and moving toward E. The higher the prescription price, the greater is the distortion. A similar distortion toward excessive levels of M and greater total costs occurs when the patient’s coverage excludes or limits drug benefits. Here, the savings from reducing M will more than offset the additional drug spending from improved drug coverage.
Technological Change
At the turn of this twenty-first century, a new category of experimental drugs, blood vessel inhibitors,
generated extraordinary excitement in the medical community by fighting both cancer and
heart disease. Technology often is associated with major breakthroughs. More often, however, new
drugs are similar to existing drugs, but they may produce somewhat better outcomes (if only for
some patients) or reduced side effects.
With technological improvements, fewer inputs are needed to produce a given health outcome,
or outcomes that were previously unattainable are now attainable. For example, begin with
HS1 in Figure 17-3 and let HS1
* represent all combinations of inputs with a new drug that leads to the same health status as HS1. If the cost-minimizing ratio of inputs at a given price ratio remains
unchanged, so that it lies along the ray 0E (denoted (M/D)0), the innovation represents a neutral
technological change. As drawn, the new drug saves a relatively high amount of the medical input at
any given price ratio. That is, drug utilization increases relative to medical care as the patient moves
to E* and substitutes D for M. As noted in the figure, the lower ratio of M to D is reflected in the less
steeply sloped ray, (M/D)1.
New technology can increase costs for two reasons. First, it can routinely provide health levels
that were unattainable previously (e.g., HS2
* at point E**). It may require much more drug use and
possibly increased use of M, as well. When health improvements are dramatic or when drugs treat
serious conditions that were not treatable previously, cost concerns are likely to be far less troublesome
than those leading to only marginal improvements in health.
The second cost pressure comes from insurance. As we have seen, a patient with a constant
copayment will not face any price increases of the new drug. Assume that the slope of the budget
line in Figure 17-3 reflects the patient’s copayment of $5 and the patient moves from E to E*
. If the
price of the new drug is high enough, the total cost of care at E* could be substantially higher than
total costs at the original equilibrium at E.
For conventional goods, where the consumer pays the entire price out of pocket, such technological
changes will not be introduced because they will not be demanded. With insurance, the
determination and elimination of cost-inefficient technology are far more difficult. A drug-maker
may market a socially cost-inefficient drug successfully simply beca
Loading Costs and the Uninsured
Loading Costs and the Uninsured
The analysis of loading costs provides one avenue for addressing the problem of those who cannot get
insurance. Health insurance in the United States has been largely available through participation in the
labor market. Those who do not participate in the labor market, and many of those who are employed
by small businesses, self-employed, or sporadically employed have found it difficult to get insurance.
Many explanations have been proposed, but it is apparent that the per-person costs of processing
information and claims of those individuals who are outside larger organizations (either companies
or unions) are higher. This results in an increase in the firms’ marginal costs relative to the
consumer’s marginal benefits and can reduce or eliminate the range of services that may be offered.
The analysis also helps address the impacts of entry and exit in the insurance market. More
efficient processing and information handling presumably will lower the premiums that must be paid by
customers in the market. If we look again at Figure 11-1B, we recognize that improved information handling
and processing would not only lead to lower marginal costs and hence lower prices, but also would
permit firms to offer services (based on probability of occurrence) that had not previously been offered.
Consider points C or D, where the expected marginal benefit was previously just equal to (or
possibly just below) the marginal cost. An insurer who lowers costs can offer coverage for types of
events that previously were uncovered. Conversely, increased costs, due either to market forces or to
mandated coverage, would force firms to cut back coverage on events for which they could not (due
to limited consumer surplus) pass along the increased costs on to the customers.
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