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CHAPTER

1

1WHY HEALTH ECONOMICS? Learning Objectives

After reading this chapter, students will be able to

• describe the value of economics for managers, • identify major challenges for healthcare managers, • find current information about healthcare outcomes, and • distinguish between positive and normative economics.

Key Concepts

• Economics helps managers focus on key issues. • Economics helps managers understand goal-oriented decision making. • Economics helps managers understand strategic decision making. • Economics gives managers a framework for understanding costs. • Economics gives managers a framework for understanding market

demand. • Economics gives managers a framework for assessing profitability. • Healthcare managers must deal effectively with risk and uncertainty. • Healthcare managers must contend with the management problems

that insurance presents. • Information asymmetries create a number of problems for healthcare

managers. • Not-for-profit organizations create unique problems for managers. • Rapid change in the healthcare system forces managers to lead their

organizations into unfamiliar territory on a routine basis.

1.1 Why Health Economics?

Why should working healthcare managers study economics? This simple ques- tion is really two questions. Why is economics valuable for managers? What spe- cial challenges do healthcare managers face? These questions motivate this book.

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Economics for Healthcare Managers2

Why is economics valuable for managers? There are six reasons. We will briefly touch on each of them to highlight the themes we will develop in later chapters.

1. Economics helps managers focus on key issues. Economics helps managers wade through the deluge of information they confront and identify the data they need.

2. Economics outlines strategies for realizing goals given the available resources. One of the primary tasks of economics is to explore carefully the implications of rational decision making.

3. Economics gives managers ground rules for strategic decision making. When rivals are not only competing against them but watching what they do, managers must be prepared to think strategically (i.e., be prepared to use the insights of game theory).

4. Economics gives managers a framework for making sense of costs. Managers need to understand costs because good decisions are unlikely without this understanding.

5. Economics gives managers a framework for thinking about value. The benefits of the goods and services successful organizations provide to customers exceed the costs of producing those goods and services. Good management decisions require an understanding of how customers perceive value.

6. Most important, economics sensitizes managers to fundamental ideas that affect the operations of every organization. Effective management begins with the recognition that consumers are sensitive to price differences, that organizations compete to advance the interests of their stakeholders, and that success comes from providing value to customers.

1.2 Economics as a Map for Decision Making

Economics provides a map for decision making. Maps do two things. They highlight key features and suppress unimportant features. To drive from Des Moines, Iowa, to Dallas, Texas, you need to know how the major highways connect. You do not want to know the name and location of each street in each town you pass through. Of course, what is important and what is unim- portant depend on the task at hand. If you want to drive from West 116th Street and Ridgeview Road in Olathe, Kansas, to the Truman homestead in Independence, Missouri, a map that describes only the interstate highway system will be of limited value to you. You need to know which map is the right tool for your situation.

Using a map takes knowledge and skill. You need to know what informa- tion you need, or you may choose the wrong map and be swamped in extraneous

Cost The value of a resource in its next best use

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Chapter 1 : Why Health Economics? 3

data or lost without key facts. Having the right map is no guarantee that you can use it, however. You need to practice to be able to use a map quickly and effectively. In the same sense, economics is a map for decision making.

Like a map, economics highlights some issues and suppresses others. For example, economics tells managers to focus on marginal or incremental costs, which makes understanding and managing costs much simpler, but economics has little to say about the belief systems that motivate consumer behavior. If you are seeking to make therapeutic regimens easier to adhere to by making them more consistent with consumers’ belief systems, economics is not a helpful map. If, on the other hand, you want to decide whether set- ting up an urgent care clinic is financially feasible, economics helps you focus on how your project will change revenues and costs.

Economics also gives managers a framework for understanding ratio- nal decision making. Rational decision making means making choices that further one’s goals given the resources available. Whether those goals include maximizing profits, securing the health of the indigent, or other objectives, the framework is much the same. It entails looking at benefits and costs to

Marginal/ incremental Involving a small change from the current situation

Marginal or incremental cost The cost of producing an additional unit of output

Rational decision making Choosing the course of action that gives you the best outcomes, given the constraints you face

An Upset Customer

I ran into one of my neighbors last night. He was really upset with us. He had a routine echocardio-

gram at his cardiologist’s office and was shocked to learn that it cost $1,600. Six months ago he paid $400 for the same test in the same office. He called the doctor’s office and asked why the fee went up so much. The office staff told him that the practice had been acquired by our hospital system, so there was now a facility fee plus the higher rate that our system had negotiated with his insurer. That did not make him happier. Nor did it increase our revenue for long. The next time he went to an independent imaging center and got the test done for $300. He has a high-deductible insurance plan, so he had to pay the entire higher fee. He is also thinking of finding a new cardiologist.

Discussion questions: • Do negotiated fees really vary as much as this case suggests?

• Are hospitals buying increasing numbers of medical practices?

• Do prices typically go up when a hospital buys a practice?

• What is a high-deductible insurance plan?

• Are high-deductible plans becoming more common?

• Is buying medical practices a profitable strategy for hospitals?

• If you were this customer, how would you react?

Case 1.1

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Economics for Healthcare Managers4

realize the largest net benefit. (We will explore this question further in sec- tion 1.5.)

Managers must understand costs and be able to explain costs to others. Confusion about costs is common, so confusion in decision making is also common. Confusion about benefits is even more widespread than confu- sion about costs. As a result, management decisions in healthcare often leave much to be desired.

Economists typically speak about economics at a theoretical level, using “perfectly competitive markets” (which are, for the most part, mythi- cal social structures) as a model, which makes application of economics dif- ficult for managers competing in real-world markets. Yet, economics offers concrete guidance about pricing, contracting, and other quandaries that managers face. Economics also offers a framework for evaluating the strategic choices managers must make. Many healthcare organizations have rivals, so good decisions must take into account what the competition is doing. Will being the first to enter a market give your organization an advantage, or will it give your rivals a low-cost way of seeing what works and what does not? Will buying primary care practices bring you increased market share or buyer’s remorse? Knowing economics will not make these choices easy, but it can give managers a plan for sorting through the issues.

1.3 Special Challenges for Healthcare Managers

What special challenges do healthcare managers face? Healthcare managers face five issues more often than other managers do:

1. The central roles of risk and uncertainty 2. The complexities created by insurance 3. The perils produced by information asymmetries 4. The problems posed by not-for-profit organizations 5. The rapid and confusing course of technical and institutional change

Let’s look at each of these challenges in more depth.

1.3.1 Risk and Uncertainty Risk and uncertainty are defining features of healthcare markets and health- care organizations. Both the incidence of illness and the effectiveness of medical care should be described in terms of probabilities. For example, the right therapy, provided the right way, usually carries some risk of failure. A proportion of patients will experience harmful side effects, and a proportion of patients will not benefit. As a result, management of costs and quality

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Chapter 1 : Why Health Economics? 5

presents difficult challenges. Has a provider produced bad outcomes because he was unlucky and had to treat an extremely sick panel of patients, or because he encountered a panel of patients for whom standard therapies were ineffective? Did his colleagues let him down? Or was he incompetent, sloppy, or lazy? The reason is not always evident.

1.3.2 Insurance Because risk and uncertainty are inherent in healthcare, most consumers have medical insurance. As a result, healthcare organizations have to contend with the management problems insurance presents. First, insurance creates confu- sion about who the customer is. Customers use the products, but insurance plans often pay most of the bill. Moreover, most people with private medi- cal insurance receive coverage through their employer (in large part because the tax system makes this arrangement advantageous). Although economists generally agree that employees ultimately pay for insurance via wage reduc- tions, most employees do not know the costs of their insurance alternatives (and unless they are changing jobs, they have limited interest in finding out). As a result of the employer plan default, employees remain unaware of the true costs of care and are not eager to balance cost and value. If insurance is footing the bill, most patients choose the best, most expensive treatment—a choice they might not make if they were paying the full cost of care.

In addition, insurance makes even simple transactions complex. Most transactions involve at least three parties (the patient, the insurer, and the provider), and many involve more. To add to the confusion, most providers deal with a wide array of insurance plans and face blizzards of disparate claim forms and payment systems. Increasing numbers of insurance plans have negotiated individual payment systems and rates, so many healthcare provid- ers look wistfully at industries that simply bill customers to obtain revenues. The complexity of insurance transactions also increases opportunity for error and fraud. In fact, both are fairly common.

Despite this bewildering array of insurance plans, many providers still rely on a select few plans for their revenue (a circumstance most managers seek to avoid). For example, most hospitals receive at least a third of their revenue from Medicare. As a result, changes in Medicare regulations or pay- ment methods can profoundly alter a healthcare organization’s prospects. Overnight, changes to reimbursement terms may transform a market that is profitable for everyone to one in which only the strongest, best-led, best- positioned organizations can survive.

1.3.3 Information Asymmetries Information asymmetries are common in healthcare markets and create a number of problems. When an information asymmetry exists, the party with more information has an opportunity to take advantage of the party with

Information asymmetry When one party in a transaction has less information than another

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Economics for Healthcare Managers6

less information. Recognizing a disadvantage, the party with less informa- tion may become skeptical of the other party’s motivation and decline a recommendation that would have been beneficial. For example, physicians and other healthcare providers usually understand patients’ medical options better than patients do. Unaware of their choices, patients may accept rec- ommendations for therapies that are not cost-effective or, recognizing their vulnerability to physicians’ self-serving advice, may resist recommendations made in their best interests.

From a manager’s perspective, asymmetric information means that providers have a great deal of autonomy in recommending therapies. Because providers’ recommendations largely define the operations of insurance plans, hospitals, and group practices, managers need to ensure that providers do not have incentives to use their superior information to their advantage. Conversely, in certain situations, patients have the upper hand and are likely to forecast their healthcare use more accurately than insurers. Patients know whether they want to start a family, whether they seek medical attention whenever they feel ill, or whether they have symptoms that indicate a poten- tial condition. As a result, health plans are vulnerable to adverse selection.

1.3.4 Not-for-Profit Organizations Most not-for-profit organizations have worthy goals that their managers take seriously, but these organizations can create problems for healthcare manag- ers as well. For example, not-for-profit organizations usually have multiple stakeholders. Multiple stakeholders mean multiple goals, so organizations become much harder to manage, and managers’ performance becomes harder to assess. The potential for managers to put their own needs before their stakeholders’ needs exists in all organizations but is more difficult to detect in not-for-profit organizations because they do not have a simple bot- tom line. In addition, not-for-profit organizations may be harder to run well. They operate amid a web of regulations designed to prevent them from being used as tax avoidance schemes. These regulations make setting up incentive- based compensation systems for managers, employees, and contractors (the most important of whom are physicians) more difficult. Further, when a project is not successful, not-for-profit organizations have greater difficulty putting the resources invested in the failed idea to other uses. For example, the trustees of a not-for-profit organization may have to get approval from a court to sell or repurpose its assets. Because of these special circumstances, managers of not-for-profit organizations can always claim that substandard performance reflects their more complex environment.

1.3.5 Technological and Institutional Change This fifth challenge makes the others pale in comparison. The healthcare system is in a state of flux. Virtually every part of the healthcare sector is reinventing itself,

Adverse selection High-risk consumers’ willingness to pay more for insurance than low-risk consumers (Organizations that have difficulty distinguishing high-risk from low- risk consumers are unlikely to be profitable.)

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Chapter 1 : Why Health Economics? 7

Questions About Tax Exemptions

Pittsburgh mayor Luke Ravenstahl announced on March 20, 2013, that he was going to challenge

the nonprofit status of the University of Pittsburgh Medical Center. The mayor’s legal review concluded that the medical center provides too little charity care, has diversified overseas, and structures its opera- tions to serve wealthy customers. The review also noted that the CEO had a $5.9 million salary; that the CEO’s headquarters included a chef, a chauffeur, and a dining room; that more than 20 employees are paid more than $1 million; that the medical center owned a corporate jet; and that the medical center had profits of nearly $1 billion during the last several years. Most observers believe that the mayor is seeking a negotiated settlement that will result in payments in lieu of taxes (Hamill 2013).

Hospitals began as refuges for the poor, with clearly charitable missions. But the increasing use of hospitals by paying customers, the resulting expansion of the hospital sector, and higher tax rates neces- sitated clear standards for tax exemption. In 1956 the Internal Revenue Service published a statement requiring that a tax-exempt hospital “be operated to the extent of its financial ability for those not able to pay for the services rendered.” In addition, a tax-exempt hospital could not “refuse to accept patients in need of hospital care who cannot pay for such services,” nor was it dispensing charity if it operated “with the expectation of full payment” and incurred bad debt as a result of non- payment (US Internal Revenue Service 1956).

Thirteen years later, following the introduction of Medicare and Medicaid, the Internal Revenue Service substituted a broader “com- munity benefit” standard, which expanded the definition of activities eligible for tax exemption. After lying dormant for a number of years, the issue resurfaced in the 1980s when local groups began complain- ing about hospitals’ tax exemptions. In the 1990s, the conversion of not-for-profit hospitals to for-profit status seemed to have little effect on taxes (other than increases in local tax revenues), and concern spread. A study by the US Government Accountability Office found that the volume of charity care provided by not-for-profit hospitals was only marginally greater than the volume of charity care provided by for- profit hospitals (Walker 2005).

Case 1.2

(continued)

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Economics for Healthcare Managers8

and no one seems to know where the healthcare system is headed. Leadership is difficult to provide if you don’t know where you are going. Because change pres- ents a pervasive test for healthcare managers, we will examine it in greater detail.

1.4 Turmoil in the Healthcare System

Why is the healthcare system of the United States in such turmoil? One expla- nation is common to the entire developed world: rapid technical change. The pace of medical research and development is breathtaking, and the public’s desire for better therapies is manifest. These demands challenge healthcare managers to regularly lead their organizations into unmapped territory. To make matters worse, changes in technology or changes in insurance can quickly affect healthcare markets. In healthcare, as in every other sector of the economy, new technologies can create winners and losers. For example, between 2000 and 2007 Medicare payments to ambulatory surgery centers more than doubled. Medicare changed its policy, and growth slowed down (MedPac 2013). What appears profitable today may not be profitable tomor- row if technology, competition, rates, or regulations change significantly.

The issue is not settled. Clearly, though, los- ing tax-exempt status can have a major impact on a hospital’s finances. This issue is a major concern

for any not-for-profit manager. Most economists are skeptical of a subsidy without a clear link to the desired outcome. At a minimum, the manager must be able to explain what taxpayers receive in return.

The Affordable Care Act (ACA) requires tax-exempt hospitals to conduct community needs assessments and address the needs that are found. Most tax-exempt hospitals were required to do so by the end of 2013. In addition, the ACA is intended to reduce the number of uninsured, hence the amount of charity care that hospitals must provide.

Discussion questions: • What do hospitals have to do to qualify for tax-exempt status?

• How much charity care do hospitals provide on average?

• How much is tax-exempt status worth to hospitals?

• Should the University of Pittsburgh Medical Center be required to pay Pittsburgh taxes?

Case 1.2 (continued)

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Chapter 1 : Why Health Economics? 9

The ACA seems to have resulted in a wave of innovations by provid- ers, insurers, employers, and governments. (See Chapter 6 for more detail.) Which of these innovations will succeed is not clear. In addition, some health- care organizations will thrive in the new environment, and some will fail. The passage of the ACA appears to have been transformative, but its repeal might not undo the changes it led to.

1.4.1 The Pressure to Reduce Costs The economics of high healthcare costs are far simpler than the politics of high healthcare costs. To reduce costs, managers must reallocate resources from low-productivity uses to high-productivity uses, increase productivity wherever feasible, and reduce prices paid to suppliers and sectors that have excess supply. They also must recognize that cost cutting is politically diffi- cult. Reallocating resources and increasing productivity will cost some people their jobs. Reducing prices will lower some people’s incomes. These steps are difficult for any government to take, and many of those who will be affected (physicians, nurses, and hospital employees) are politically well organized.

Why Is the Pressure to Reduce Healthcare Costs So Strong?

The United States spends far more on healthcare than other wealthy industrial countries do but, according to health indicators, fares worse than most of them. Spending per person is nearly double the spending per person in Germany, Canada, and France (see Exhibit 1.1). Differ- ences this large should be reflected in the outcomes of care.

Country 2000 2011

Canada $2,519 $4,522

France $2,544 $4,118

Germany $2,677 $4,495

Japan $1,969 $3,213

United Kingdom $1,827 $3,405

United States $4,791 $8,508

Source: Data from OECD (2013b). Note: Spending figures have been converted into US dollars.

EXHIBIT 1.1 Healthcare Spending per Person

Case 1.3

(continued)

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Economics for Healthcare Managers10

1.4.2 The Fragmentation of Healthcare Payments The fragmentation of healthcare bills compounds the political problem. Most Americans see only a part of the cost of healthcare. A typical American pays his or her share of healthcare costs through a mixture of direct payments for care; payroll deductions for insurance premiums; lower wages; higher prices for goods and services; and federal, state, and local taxes. Because so much of the payment system is hidden, most Americans cannot track healthcare costs. The exceptions, notably employers who write checks for the entire cost of insurance policies and the trustees of the Medicare system, understand

As you can see in Exhibit 1.2, of the six countries listed, the United States has the shortest life expectancy at birth. In an analysis of potentially

avoidable deaths, Nolte and McKee (2012) noted that the United States had a higher rate of potentially avoidable deaths and slower rates of improvement than France, Germany, or the United Kingdom. Greater spending should not produce these results.

Country Males Females

Canadaa 78.7 years 83.3 years

France 78.7 years 85.7 years

Germany 78.4 years 83.2 years

Japan 79.4 years 85.9 years

United Kingdom 79.1 years 83.1 years

United States 76.3 years 81.1 years

Source: Data from OECD (2013b). a Canadian data are for 2009.

Discussion questions: • Why is spending so much more than other countries on healthcare

a problem?

• What can Americans not buy because of high spending on healthcare?

• What factors other than healthcare affect population health?

• Does this evidence suggest that the American healthcare system is not efficient?

EXHIBIT 1.2 Life

Expectancy at Birth, 2011

Case 1.3 (continued)

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Chapter 1 : Why Health Economics? 11

the need to reduce costs. Given that so few Americans recognize how much their healthcare system costs, the complex system of public regulations and subsidies will change slowly, at best.

1.5 What Does Economics Study?

What does economics study? Economics analyzes the allocation of scarce resources. Although this answer appears straightforward, several defini- tions are needed to make this sentence understandable. Resources include anything useful in consumption or production. From the perspective of a manager, resources include the flow of services from supplies or equipment the organization owns and the flow of services from employees, buildings, or other entities the organization hires. A resource is scarce if it has alterna- tive uses, which might include another use within the organization or use by another person or organization. Most issues that managers deal with involve scarce resources, so economics is potentially useful for nearly all of them.

Economics focuses on rational behavior—that is, it focuses on indi- viduals’ efforts to best realize their goals, given their resources. Because time and energy spent in collecting and analyzing information are scarce resources (i.e., the time and energy have other uses), complete rationality is irrational. Everyone uses shortcuts and rules to make certain choices, and doing so is rational, even though better decisions are theoretically possible.

Much of economics is positive. Positive economics uses objective analysis and evidence to answer questions about individuals, organizations, and societies. Positive economics might describe the state of healthcare, for example, in terms of hospital occupancy rates over a certain period. Positive economics also proposes hypotheses and assesses how consistent the evidence is with them. For example, one might examine whether the evidence sup- ports the conjecture that reductions in direct consumer payments for medical care (measured as a share of spending) have been a major contributing factor in the rapid growth of healthcare spending per person. Although values do not directly enter the realm of positive economics, they do shape the ques- tions economists ask (or do not ask) and how they interpret the evidence.

Normative economics often addresses public policy issues, but not always. The manager of a healthcare organization who can identify addi- tional services or additional features that customers are willing to pay for is demonstrating normative economics. Likewise, the manager who can identify features or services that customers do not value is also demonstrating norma- tive economics.

Normative economics takes two forms. In one, citizens use the tools of economics to answer public policy questions. Usually these questions

Scarce resources Anything useful in consumption or production that has alternative uses

Positive economics Using objective analysis and evidence to answer questions about individuals, organizations, and societies

Normative economics Using values to identify the best options

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Economics for Healthcare Managers12

Why Does the United States Spend More on Medical Care Than Other Wealthy Countries Do?

Compared to that of other wealthy countries (those that are mem- bers of the Organisation for Economic Co-operation and Development [OECD]), healthcare spending in the United States is very high. In 2011 spending per person in the United States was $8,508. This figure was more than 50 percent higher than spending in Norway and Switzer- land, which had the second and third highest spending per person (OECD 2013b). Average incomes are actually higher in Norway and Switzerland than in the United States, so income levels don’t explain the difference.

The population of the United States is actually one of the youngest in the OECD (OECD 2013a). In addition, alcohol and tobacco use are lower than in most other wealthy countries. Obesity rates, however, are the highest in the OECD, but obesity doesn’t lead to high rates of service use. Residents of the United States generally use fewer ser- vices than residents of other OECD countries.

For the most part, Americans use fewer medical services than other OECD residents but pay substantially higher prices. For example, compared to patients in other wealthy countries, American patients average 61 percent fewer physician visits and 24 percent fewer hos- pital stays (OECD 2013b). But prices are much higher in the United States. For example, at $1,634 the Medicare payment to a physician for hip replacement is 70 percent higher than the average amount paid by public programs in Australia, Canada, France, Germany, or the United Kingdom. The average private insurance payment is $3,996, which is more than double the Medicare payment and the average private insurance payment in Australia, France, or the United Kingdom (Laugesen and Glied 2011). Because private hospital and physician prices are higher in the United States, the total payments for a major procedure are much higher. In 2012, for example, average hospital and physician payments for a hip replacement were $40,364 in the United States versus $9,574 in Switzerland, $10,927 in France, $11,187 in the Netherlands, and $27,810 in Australia (International Federation of Health Plans 2013).

Americans also spend far more on hospital care, even though they are less likely to be admitted and usually have a shorter stay if they

(continued)

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Chapter 1 : Why Health Economics? 13

involve ethical and value judgments (which economics cannot supply) as well as factual judgments (which economics can support or refute). A question like “Should the Medicare program provide coverage for prescription drugs?” involves balancing benefits and harms. Economic analysis can help assess the facts that underlie the benefits and harms but cannot provide an answer. The second form of normative economics is the basis for this book’s content. This form tells us how to analyze what we should do, given the circumstances that we face. In this part of normative analysis, market transactions indicate value. For example, we may believe that a drug is overpriced, but we must treat that price as a part of the environment and react appropriately if no one will sell it for less. Most managers find themselves in such an environment.

To best realize our goals within the constraints we face, we can use the explicit guidance economics gives us:

1. First, identify plausible alternatives. Breakthroughs usually occur when someone realizes there is an alternative to the way things have always been done.

2. Second, consider modifying the standard choice (e.g., charging a slightly higher price or using a little more of a nurse practitioner’s time).

3. Next, pick the best choice by determining the level at which its marginal benefit equals its marginal cost. (We will explain these terms shortly.)

4. Finally, examine whether the total benefits of this activity exceed the total cost.

Skilled managers routinely perform this sort of analysis. For example, a profit-seeking organization might conclude that a clinic’s profits would be as large as possible if it hired three physicians and two nurse practitioners, but that the clinic’s profits would still be unacceptably low if it did. Profits would fall even further if it increased or decreased the number of physicians and nurse practitioners, so the profit-seeking organization would choose to close the clinic.

are admitted. Some of the difference can be attributed to prices, but higher levels of staffing and equipment in American hospitals are also factors. Sorting out how much of the difference in the cost per hospi- talization is attributable to price differences and how much is attrib- utable to higher levels of staffing and equipment is an example of positive economics. Sorting out whether higher levels of staffing and equipment are worth the extra cost takes us into the realm of norma- tive economics.

(continued)

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Economics for Healthcare Managers14

Let’s back up and define some terms to make this discussion clearer. Cost, as noted previously, is the value of a resource in its next best use. For example, the cost of a plot of land for a medical office would be the most another user would pay for it, not what it sold for 20 years ago. The next best use of that land might be for housing, for a park, for a store, or for some other use. Usually the next best use of a resource is someone else’s use of it, so a resource’s cost is the price we must pay for it. If 30 Lipitor tablets are worth $80 to another consumer, that will be our cost for it. Benefit is the value we place on a desired outcome. We describe this value in terms of our willingness to trade one desired outcome for another. Often, but not always, our willingness to pay money for an outcome is a convenient measure of value. A marginal or an incremental amount is the increased cost we incur from using more of a resource or the increased benefit we realize from a greater outcome. So, if a 16-ounce soda costs 89 cents and a 24-ounce soda costs 99 cents, the incremental cost of the larger size is (99 − 89) ÷ (24 − 16), or 1.25 cents per ounce. A rational consumer might conclude that

1. the incremental benefit of the larger soda exceeds its incremental cost and buy the larger size;

2. the incremental cost of the larger soda exceeds its incremental benefit and buy the smaller size; or

3. the total benefit of both sizes was less than their total cost and buy neither.

Remember, however, that rational decisions are defined by the goals that underpin them. A consumer with a train to catch might buy an expensive small soda at the station to save time.

1.6 Conclusion

Why should healthcare managers study economics? To be better managers. Economics offers a framework that can simplify and improve management decisions. This framework is valuable to all managers. It is especially valuable to clinicians who assume leadership roles in healthcare organizations.

Managers are routinely overwhelmed with information, yet lack the key facts that they need to make good decisions. Economics offers a map that makes focusing on essential information easier.

Exercises

1.1 Why is the idea that value depends on consumers’ preferences radical?

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Chapter 1 : Why Health Economics? 15

1.2 Mechanics usually have better information about how to fix automobiles than their customers do. What problems does this advantage create? Do mechanics or their customers do anything to limit these problems?

1.3 A mandatory health insurance plan costs $4,000. One worker earns $24,500 in employment income and $500 in investment income. Another worker earns $48,000 in employment income and $2,000 in investment income. A third worker earns $68,000 in employment income and $7,000 in investment income. A premium-based system would cost each worker $4,000. A wage tax–based system would cost each worker 8.5 percent of wages. An income tax–based system would cost each worker 8 percent of income. For each worker, calculate the cost of the insurance as a share of total income.

Worker 1 Worker 2 Worker 3

E = Employment income $24,500 $48,000 $68,000

I = Investment income $500 $2,000 $7,000

P = Premium cost of insurance $4,000 $4,000 $4,000

Premium as a percentage of income = P/(E + I)

W = Wage tax cost of insurance = 0.085 × E

Wage tax cost as a percentage of income = W/(E + I)

T = Income tax cost of insurance = 0.080 × (E + I)

Income tax cost as a percentage of income = T/(E + I)

1.4 Which of the payment systems in Exercise 1.3 would impose the larger burden on those with incomes under $25,000: a plan financed via premiums, via the income tax, or via a payroll tax?

1.5 Which of the plans in Exercise 1.3 would be fairer? 1.6 Which of the preceding questions can you answer using positive

economics? For which of the preceding questions must you use normative economics?

1.7 The following table shows data for Australia, Canada, and the United States. a. How did female life expectancy at birth change between 2000

and 2010? b. How did expenditure per person change between 2000 and

2010?

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Economics for Healthcare Managers16

c. What conclusions do you draw from these data? d. If you were the “manager” of the healthcare system in the United

States, what would be a sensible response to data like these?

Life Expectancy (years) Expenditure per Person

2000 2010 2000 2010

Australia 82.0 84.0 $2,861 $3,800

Canada 81.7 83.3a $3,190 $3,965

United States 79.3 81.1 $6,067 $8,508

Source: Data from OECD (2013b). Notes: Life expectancy is female life expectancy at birth. Expenditure per person has been translated into US dollars and adjusted for inflation. a Data from 2009.

References

Hamill, S. D. 2013. “UPMC, Pittsburgh Stake Positions for Court Fight on Non- profit Status.” Pittsburgh Post-Gazette, March 22.

International Federation of Health Plans. 2013. 2012 Comparative Price Report. Accessed July 2, 2014. www.ifhp.com.

Laugesen, M. J., and S. A. Glied. 2011. “Higher Fees Paid to US Physicians Drive Higher Spending for Physician Services Compared to Other Countries.” Health Affairs 30 (9): 1647–56.

Medicare Payment Advisory Commission (MedPAC). 2013. A Data Book: Health Care Spending and the Medicare Program. Published June. www.medpac. gov/documents/Jun13DataBookEntireReport.pdf.

Nolte, E., and C. M. McKee. 2012. “In Amenable Mortality—Deaths Avoidable Through Health Care—Progress in the US Lags That of Three European Countries.” Health Affairs 31 (9): 2114–22.

Organisation for Economic Co-operation and Development (OECD). 2013a. OECD Factbook 2013: Economic, Environmental and Social Statistics. Published Janu- ary 9. www.oecd-ilibrary.org/content/book/factbook-2013-en.

———. 2013b. “OECD Health Data 2013.” Accessed April 23, 2014. www.oecd. org/health/health-systems/oecdhealthdata.htm.

US Internal Revenue Service. 1956. Revenue Ruling 56-185. Accessed July 2, 2014. www.irs.gov/pub/irs-tege/rr56-185.pdf.

Walker, D. M. 2005. Nonprofit, For-Profit, and Government Hospitals: Uncompen- sated Care and Other Community Benefits. Washington, DC: US Government Accountability Office.

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CHAPTER

17

2AN OVERVIEW OF THE US HEALTHCARE SYSTEM

Learning Objectives

After reading this chapter, students will be able to

• apply marginal analysis to a simple economic problem, • articulate the input and output views of healthcare products, • find current national and international information about healthcare, • compare the US healthcare system to those in other countries, and • identify major trends in healthcare.

Key Concepts

• Healthcare products are inputs into health. • Healthcare products are also outputs of the healthcare sector. • The usefulness of healthcare products varies widely. • Marginal analysis helps managers focus on the right questions. • Life expectancies have increased sharply in the United States in recent

years. • Other wealthy countries have seen larger health gains with smaller cost

increases. • The healthcare sector may change radically in response to technology

and policy changes.

2.1 Input and Output Views of Healthcare

This chapter describes the healthcare system of the United States from an economic point of view and introduces tools of economic analysis. It looks at the healthcare system from two perspectives. The first perspective, called the input view, emphasizes healthcare’s contribution to the public’s well-being. The second perspective, called the output view, emphasizes the goods and services the healthcare sector produces. In the language of economics, an

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