eco question

Health Economics ECON 5860 PROF. KURT LAVETTI

Recap:

 In general, society faces a tradeoff between cost, access, and quality in choosing how to provide medical care

 Economically “efficient” choice of healthcare spending equates marginal benefit and marginal cost

 Because resources are scarce, efficient choice of medical spending is lower than the level that would maximize health

 But what does “efficient” really mean?

 Economic theory tells us that in competitive market, any equilibrium is Pareto Efficient (which means no person can be made better off without harming someone else)

 Should we use this concept of Pareto efficiency as a framework for determining optimal health spending?

 This is a subjective choice, and may depend on values, ethics, social justice, political science, etc that extend beyond the scope of the field of economics

 Example: Laws prohibiting sale of kidneys choose to prioritize ethics over economic efficiency

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 Demand • Greater income typically increases quantity

demanded of medical care and other goods (normal goods)

U

Quantity of Medical Care

Quantity of Other Goods

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. • Demand for medical care also becomes more inelastic as the

severity of illness increases

Comparative Statics #2: Illness and Demand for Medical Care

• Illness can change preferences (the slope of indifference curves): Medical care will be more valued than other goods when one is sick

• Illness *may* also shift the budget constraint down if illness reduces ability to work • In this case there’s an income effect caused by the change in the budget constraint,

and a substitution effect caused by the change in preferences getting sick

UWell

Medical Care (MC)

Other Goods (X)

Budget ConstraintWell

Budget ConstraintSick

USick

UWell

• Where is the income effect?

• Where is the substitution effect?

Comparative Statics #3: Price of Medical Care

• An increase in the price of medical care pivots the budget constraint downward

• Decreases the quantity of medical care demanded and increases the quantity of other goods demanded

U

Medical Care (MC)

Other Goods (X)

Budget ConstraintP_MC_Low

U

Budget ConstraintP_MC_High

Comparative Statics #4: MC Demand and Insurance

• Suppose this graph depicts demand for medical care • What happens to the demand function if this individual gets free health

insurance that pays for all of their 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_100% Ins.

With perfect insurance (100% of costs are paid by insurer), consumer chooses quantity of medical care that maximizes health status, regardless of price

M* Mmax

QUANTITY OF MEDICAL CARE (M)

$

400

100

100

100

1

1

1 1

Total Cost of M

$ Value of Benefits from M

Flashback: Efficient Health Spending

M* occurs where the marginal benefit equals the marginal cost

M* Mmax

QUANTITY OF MEDICAL CARE (M)

$

400

100

100

100

1

1

1 1

Total Cost of M

$ Value of Benefits from M

Question: With perfect insurance, what level of M will a consumer choose?

Comparative Statics #4: MC Demand and Insurance

Price of Medical Care (PMC)

Quantity of Medical Care

DMC_No Ins.

DMC_100% Ins.

What does the demand function look like if the consumer pays 50% of total costs, and the insurer pays the other 50%?

Mmax

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.

What does the demand function look like if the consumer pays 50% of total costs, and the insurer pays the other 50%? • 50% insurance demand function is half way between the uninsured

demand function and the 100% insurance demand function

Mmax

Comparative Statics #4: MC Demand and Insurance

Price of Medical Care (PMC)

Quantity of Medical Care

DMC_No Ins.

Alternative way of describing this exact same effect: • Could instead keep the same demand curve, and view insurance as

reducing the price faced by consumer • Eg: 100% insurance means consumer pays 0% of market price

• Both approaches give the same answer (with linear demand)

M100% Ins

Market Price (P*)

M*

50%xP*

M50% Ins 0%xP*

• Insurance leads consumers to choose M above socially efficient level, Minsured >M* • Intuition: since consumer does not pay full price, they over-consume relative to socially

efficient level • This is similar to a negative externality • Over-consuming increases cost of insurance for everyone, but when there are many

consumers in the insurance plan each individual’s consumption choices have (approximately) no effect on their own insurance price

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

Total spending on MC without insurance

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

Total willingness to pay for M*

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

Total consumer surplus at M*

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

Total spending on MC with insurance

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

Spending on MC paid by insurer

Spending on MC paid by consumer

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

Increase in spending on MC caused by insurance

- =

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

Additional willingness to pay to increase quantity from M* to M50% Ins

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare? Is the marginal benefit to consumers from providing those additional units

Is the marginal cost to society of providing (M50% Ins - M*) additional units of medical care

Marginal cost exceeds marginal benefit, creating deadweight loss

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What is the effect of this over-consumption on social welfare?

• Deadweight loss (DWL) from moral hazard (over- consumption of medical care caused by insurance)

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What happens to the size of the DWL from moral hazard if insurance pays for 100% of medical spending?

PMC

Quantity

DMC_No Ins.

Supply

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

M* M50% Ins

• What happens to the size of the DWL from moral hazard if insurance pays for 100% of medical spending?

• Answer: DWL increases to this larger triangle • Lesson: more generous insurance leads to greater deadweight loss

from moral hazard

• The aggregate supply function for all consumers is likely upward sloping

• Aggregate DWL if everyone has 50% insurance looks like this:

PMC

Medical Care

DMC_No Ins.

SupplyMC

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

PMC

Medical Care

DMC_No Ins.

SupplyMC

Health Insurance and Social Welfare

50%xP*

Market Price (P*)

• Suppose our goal is to reduce DWL 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

Estimating the Elasticity of Demand  Randomized experiments:

Definition: a study that assigns treatments randomly to different groups of study participants

Includes: A control group (no treatment) Placebo group

Helps generate experimental groups that are statistically similar to each other

Two Randomized Experiments

 RAND Health Insurance Experiment (HIE), 1974

 Oregon Medicaid Experiment, 2008

RAND HIE

 Randomly assigned 2,000 families from six US cities to different insurance coverage plans  Copayments groups:

Free, 25%, 50%, and 95%  Tracked utilization of health care (Q) in each

copayment plan (P)  Copayment acts as the marginal cost that

each family faces when buying care

Oregon Medicaid Experiment

 Compared two groups of low-income adults  Medicaid lottery winners vs. lottery losers

 Lottery winners got to apply for public health insurance through Medicaid  So they faced lower out-of-pocket prices

for care  Lottery losers could not get Medicaid (but

might have purchased outside insurance)

Results?

 Health care demand curves are downward sloping Price changes affect demand for

health care The law of demand works!

Different measures of care

 Outpatient Care  Definition: any medical care that does not involve an

overnight hospital stay  E.g. runny noses, twisted ankles, minor broken bones

 Inpatient Care  Def: medical care requiring overnight stays

 E.g. More serious surgeries or conditions that require overnight recovery or monitoring

 ER Care  Def: care involving the emergency room

 E.g. heart attacks, strokes

Outpatient care

 RAND HIE  As patient cost-sharing (P) increases, number of episodes (Q) of

outpatient care decreases

 Holds for both acute and chronic conditions

Source: Keeler et al. (1988)

Outpatient care

 Oregon Medicaid Study  Lottery winners have more outpatient visits than lottery losers

Both the RAND HIE and the Oregon Medicaid Study find downward- sloping demand for outpatient care.

Inpatient care

 RAND HIE  Oregon Medicaid Study

No significant difference in usage rates between lottery winners and lottery losers

Demand is still downward-sloping but less elastic than demand for outpatient care

(Source: Keeler, 1988)

Emergency Room Care  RAND HIE

 Oregon Medicaid Study

 Gaining Medicaid insurance increased probability of going to ER by 20% (7 pp increase relative to mean of 35%)

 (Note: textbook discussion is outdated)

Even for emergency room care – likely the most urgent kind – those on the highest copayment plan in the RAND HIE were less likely to buy care!

(Source: Newhouse, 1993)

Pediatric care

 Pediatric care  Def: care for infants or children usually paid for by a parent or

guardian

 Data from RAND HIE:

Mental Health & Dental Care RAND HIE Results

Prescription drugs

 Data from RAND HIE

Quasi-Random Non-Experimental Evidence  U.S. Medicare

 Citizens are eligible for health insurance through Medicare when they turn 65 but not before

 If demand for health care is downward-sloping, we expect a jump in health care usage at age 65

 This is known as a discontinuity study  There is a discontinuity in health insurance at age 65

Card et al. (2009)

 Increase in Medicare insurance coverage on exactly the 65th birthday

Card et al. (2009)

 Increase in coverage leads people to use the emergency room more right after their 65th birthday

Card et al. (2009)

 Card et al. have two main findings:  Unplanned emergency department admissions follow a linear

trend around the age of 65  Other hospital admissions jump up at the age of 65

 There is a discontinuity in medical usage at the same point of discontinuity in Medicare coverage!

 This is further evidence that demand for health care is sensitive to price

 Statistics Lesson: the assumption behind this analysis is that the error term in the regression is on average the same when someone is 64.999 years as it is when they are 65.001 years

Comparing demand curves

 How can we determine which type of demand is more price sensitive?

Source: Keeler et al. (1988)

Arc Elasticity

 Need a measure to compare the relative price sensitivity of different goods  So the measure needs to be unitless (how else would we

compare ER visits to sticks of gum?)

 Arc Elasticity:

Example:

 Let’s go back to the RAND results on outpatient care

 Using only the two data points in the red boxes, what is the arc elasticity of demand for outpatient care?

Health care has inelastic demand

Does price for care affect health?  Mortality rates

 RAND HIE: no difference between treatment groups

 Looking specifically at high-risk study participants (with chronic conditions), those in the free care plan were 10% less likely to die than those on cost-sharing plans!

 Oregon Medicaid: no significant difference between lottery winners and losers

 Caveats: Both studies only examine short-run effects (1-3 years after the experiment)