eco question

Health Economics ECON 5860 PROF. KURT LAVETTI

Unique feature #3: Uncertainty and Information Asymmetries

 Multiple levels of uncertainty:  For each individual / patient:

 Uncertainty over onset / severity of disease

 Uncertainty about diagnosis  Uncertainty about efficacy of therapy for the

particular patient  For MDs

 Uncertainty over appropriateness of treatment  Variation across geography / within geography

 Insurers  Other medical provider organizations like hospitals

Asymmetric Information

 Differences in information:  Patients and physicians

 Physicians know a lot more about your condition, prognosis  Consumers rely on physicians to act as their agents

 Reputation may or may not be possible to accurately incorporate in evaluating physician performance  If you were to rate your doctor, what characteristics would

affect your rating? Are these the right measures?

Asymmetric Information

 Differences in information:  Patients and physicians (continued)

 From an economics perspective, what is a physician’s objective function?  Supply labor to a firm, sometimes also own the firm, maximize profits

of firm, maximize health of the patient, minimize costs and side- effects to patient

 Sometimes these goals can contradict each other  How do physicians actually make these choices?

 How can we design incentive structures to encourage physicians to make socially efficient choices?

 Can institutions help address the information asymmetry problems  e.g. Physician ethical standards, quality standards, specialty

certification boards

Asymmetric Information

 Differences in information:  Patients and Insurers

 Patients know more about their own health status than insurers do (private information)

 Insurers try to sort patients into groups of similar people, and set benefits and premiums to fit group characteristics

 Either of these features can lead to adverse selection in insurance markets, which can cause markets to collapse (no stable long-run equilibrium exists) or can cause deadweight losses in markets

Unique feature #4: Role of Insurance

 Actually many other industries rely on insurance

 Auto / Home / Life

 Insurance can improve welfare by protecting against risk

 Health care costs are particularly risky because the distribution of costs has a large upper tail

 That is, average health spending is heavily driven by the most expensive patients, much more than a normal distribution

 Insurance is typically costly to society

 Moral Hazard (post-insurance behavior shifts) can cause deadweight loss

 Adverse Selection (pre-insurance behavioral sorting) can also cause deadweight loss

Unique feature #5: Externalities and Government Involvement

 Clinical Externalities  Vaccines and Herd Immunity

 Social net benefit different than private net benefit

 Financial Externalities  Risk pooling

Unique feature #5: Externalities and Government Involvement

 Government Financing  Many systems in developed countries, government pays for 90%+ of total medical

spending

 Even in US (prior to ACA)—governments represent almost 50% of total healthcare spending

 Medicare: Government funded system addresses increased potential for adverse selection and resultant inefficiency

 Medicaid: Transfer for low-income

 Government Regulation  Physicians: Licensing

 Hospitals: Capital investment approval, Entry/Exit/Merger approval

 Suppliers: Pharmaceutical test trials before marketing to public

 Insurers: Mandatory coverage of certain treatments, pricing regulations

Unique feature #5: Externalities and Government Involvement

 Rely on government to overcome market failures  Many aspects of the Affordable Care Act are

designed to reduce deadweight loss caused by adverse selection in insurance markets

 Intergenerational Transfers:  Medicare payroll tax transfers money from working-age to

older, retired

 Part of this includes transfer from low-income workers to rich retirees

Unique feature #6: Role of Non-profits

 78% of private community hospitals are non- profit

 Many health insurers, nursing homes, other healthcare providers are also non-profit

 Economics relies heavily on assumptions of profit maximization so these institutions require a unique perspective  If they don’t maximize profits, what do they

maximize?

What is the Role of Economics in Health Care Markets?

The Role of Economics

 Gives us the tools to analyze resource allocation decisions in the market

 Defines the best (“efficient”) way to allocate scarce resources.

 Efficiency in economics  Exhaustion of gains that are mutually beneficial

 MB=MC

General Approach of Course

 Theory: Use microeconomic theory to predict behavior under a set of assumptions (health care specific)  hypotheses that can be tested empirically

 Evidence: Summarize the descriptive and analytical evidence  consistent with which theory?

 Application: In light of the evidence consider benefits / costs of different policy options.

Disciplines of economics used to analyze health care markets

 Labor: Role of insurance in labor markets

 Public: Role of government and raising money

 Industrial Organization: Hospital competition

 Contract Theory: Principal-agent problems

Iron Triangle: Key Trade-offs in Health

Cost Quality

Access

Optimal quantity of health care services

Consider very simple health care economy:  Individuals can purchase medical services, M  Purchasing more M allows people to have more

healthy days (fewer sick days) according to a function Q=f(M)

 Society values each additional healthy day at $100

 The price per unit of M is $100

QUANTITY OF MEDICAL CARE (M)

$

Total Cost of M

$ Value of Benefits from M

What is the Socially Optimal Level of Health Spending?

M* Mmax

QUANTITY OF MEDICAL CARE (M)

$

400

100

100

100

1

1

1 1

Total Cost of M

$ Value of Benefits from M

What is the Socially Optimal Level of Health Spending? Answer: M* occurs where the marginal benefit of M (ie the slope of the benefit function) equals the marginal cost of M ($100)

• M* is the optimal amount of medical care • At M*, slope of the total cost line (ie the cost

per unit) equals slope of health benefit curve (ie the marginal benefit of healthcare in dollars).

• The socially efficient quantity of M is where next dollar spent on healthcare delivers exactly one dollar of value • Notice this does not occur at Mmax where

health is maximized • Some people could become healthier by using

more healthcare, but doing so is inefficient

The Romantic Fallacy

 Medical care is not priceless, and is not of infinite value  Scarcity exists---the more we spend on medicine as a society,

the less we have left to spend on other things, like education, infrastructure, etc.

 Society ought to avoid using medicine that has small benefits relative to its cost

 Implications:  There is (often) no such thing as “medical necessity”  Efficiency means leaving some good undone  Demanding the highest quality care is not always efficient

What does ‘efficiency’ really mean?

 When we say that outcomes in perfectly competitive markets are efficient, what exactly do we mean by that?

A Closer Look at the Concept of ‘Efficiency’

 Based in welfare economics which focuses on how the world “should be”

 An efficient outcome is one in which no one can be made better-off without making someone else worse-off (Pareto optimum)

 Often not equitable  alternate welfare functions  Extreme case: One has all and one has none;

Efficient, but not equitable

A Closer Look at the Concept of ‘Efficiency’

 Pareto efficiency is achieved in a perfectly competitive market (and equity can be improved with income redistribution)

 BUT, are health care markets perfectly competitive?  Probably not! Uncertainty, Information, Externalities,

etc…

 Promoting competition may or may not improve outcomes

Evaluating Policy: Efficiency vs. Equity

 Question: should it be legal for people to sell their own kidney?

Evaluating Policy: Efficiency vs. Equity

 Question: should it be legal for people to sell their own kidney?

 Law prohibits the sale of human organs  This means we are willing to sacrifice economic

efficiency in order to achieve something that is viewed as fair or equitable

 Providing health care or health insurance to the poor  Equitable, but may also be efficient due to the

presence of externalities

Summary

 Health care is a unique and interesting market to study within economics

 Economics is relevant in the analysis of important health policy questions

 Economics studies the allocation of scarce resources (of which there are many in health care) and defines the optimal outcome  Efficiency is ‘ideal’, but has some gloomy implications for

policy

 Efficiency arises naturally in perfectly competitive markets (of which there are few in healthcare)

 Alternate objectives yield alternate measures of efficiency

 All of this, and more, to come!!

Questions?

Demand for Health and Healthcare

Elasticity measures the degree of downward-sloping  Elastic demand DE

 price sensitive: changes in price greatly affect the quantity demanded

 Inelastic demand DI  Price insensitive: changes in

price do not significantly change the quantity demanded

Price Elasticity of Demand

Elastic Demand

Inelastic Demand

|η|=1 Demand

Price

Quantity

η = %∆Q %∆P

= ∆Q ∆P

* P Q

Comparative Statics #1: Income and MC Demand • Additional income typically increases both

consumption and medical care (normal goods).

U

Medical Care (MC)

Consumption (X)

Budget ConstraintHigh Inc

U

Budget ConstraintLow Inc

Comparative Statics #2: Illness and MC Demand

• What happens to the demand curve for medical care when someone gets sick?

Price of Medical Care (PMC)

Quantity of Medical Care

DemandNot Sick

Comparative Statics #2: Illness and MC Demand

Price of Medical Care (PMC)

Quantity of Medical Care

DemandSick

DemandNot Sick DemandVery Sick

• Theory suggest that demand shifts out when illness occurs. • Elasticity of the curves generally diminishes (become more

vertical) as illness severity increases.

Comparative Statics #2: Illness and MC Demand

• Illness changes the slope of the indifference curves: MC will be more valued than X when one is sick relative to healthy

• Illness could possibly move the budget constraint inward (if one’s ability to work is affected)

• In this case there’s an income effect from the change in the budget constraint, and a substitution effect from getting sick

UWell

Medical Care (MC)

Consumption (X)

Budget ConstraintWell

Budget ConstraintSick

USick

UWell

Comparative Statics #3: Price of Medical Care

• An increase in the price of medical care is reflected by pivoting the budget constraint downward.

• The increase in the price of medical care decreases the amount of medical care demanded and increases the amount of other goods demanded

U

Medical Care (MC)

Consumption (X)

Budget ConstraintP_MC_Low

U

Budget ConstraintP_MC_High

Comparative Statics #4: MC Demand and Insurance

The effective marginal price of medical care decreases with health insurance, increasing the quantity of medical care demanded. Consider a plan with a 0% coinsurance (perfect insurance): what happens to the demand curve for insured medical care?

Price of Medical Care (PMC)

Quantity of Medical Care

DMC_No Ins.

Comparative Statics #4: MC Demand and Insurance

Price of Medical Care (PMC)

Quantity of Medical Care

DMC_No Ins.

DMC_50% Ins.

DMC_100% Ins.

The effective marginal price of medical care decreases with health insurance, increasing the quantity of medical care demanded. Consider a plan with a 0% coinsurance (perfect insurance): what happens to the demand curve for insured medical care?

Welfare Loss and Health Insurance Since individuals do not pay full price, more is consumed than socially optimal (assuming typical assumptions about markets). What is the area of the welfare loss? More on “Moral Hazard” in insurance sessions.

PMC

Medical Care

DMC_No Ins. DMC_Ins.

SupplyMC

Welfare Loss and Health Insurance

Since individuals do not pay full price, more is consumed than socially optimal (assuming typical assumptions about markets). What is the area of the welfare loss? More on “Moral Hazard” in insurance sessions.

PMC

Medical Care

DMC_No Ins. DMC_Ins.

SupplyMC

Empirical Welfare Analysis

PMC

Medical Care

DMC_No Ins. DMC_Ins.

SupplyMC

• Suppose our goal is to reduce deadweight loss from moral hazard

• What do we need to know empirically about healthcare markets in order to measure the effects of policies or insurance generosity on social welfare?

Challenge to Estimating Demand: Price vs Quality Differences

• Quality may also vary across observations (different demand for different observations)

• Ideally, η is measured along a demand curve, not between demand curves. Result: Estimate of η is biased upward (even positive)

Demand (High Quality)

Demand (Low Quality)

Price

Quantity

Perceived “Demand” curve (incorrect)

Challenge to Estimating Demand: Price Changes over Time

• Even within an observation, many other factors may also vary across time (different demand for different time periods)

• Result: Estimate of η can be biased in either direction

Demand (Time X)

Demand (Time Y)

Price

Quantity

Estimating Demand Curves from Insurance Variation

 People have insurance policies with different levels of coverage.

 The cleanest case: varying levels of proportional coinsurance: 0%, 10%, 20%, 50% etc. See if those who pay 10% use more than those who pay 50%.

 But what if people who are sicker buy the policies with lower coinsurance?

 Endogeneity of plan choice is an important threat to validity  A problem in early studies showing effects of low coinsurance

on use

Negative Bias and Insurance Selection

Demand (Sick) η = -0.2 (B)

Demand (Healthy) η = -1.2 (A)

“Perceived” Demand (incorrect) η = -3.8 (A)

Price

Quantity

• Suppose sicker patients with greater (and more inelastic) demand for medical care choose more generous insurance plans

• Because of this selection into insurance plans based on unobserved health status, the estimated elasticity will be too negative

• Will cause us to overestimate the degree to which healthy consumers respond to prices.

A B