HMGT 435 WK 4 DISC 4

CHAPTER

73

5UNDERSTANDING COSTS

Learning Objectives

After reading this chapter, students will be able to

• calculate average and marginal costs, • articulate why increasing efficiency is important, • identify opportunity costs, and • forecast how changes in technology and prices will change costs.

Key Concepts

• Costs can be hard to measure and depend on perspective. • Incremental cost equals the change in cost resulting from a change in

output. • Average cost equals the total cost of a process divided by the total

output of a process. • Large firms have a cost advantage if there are economies of scale. • Multiproduct firms have a cost advantage if there are economies of scope. • Costs depend on outputs, technology, input prices, and efficiency. • Opportunity cost is the value of a resource in its best alternative use. • Sunk costs, which are costs you cannot change, should be ignored.

5.1 Understanding Costs

Understanding and managing costs are core managerial tasks. Whatever the mission of the organization, cost control must be a priority. An organization with costs that are too high, given the quality of its product, will be hard- pressed to succeed.

An efficient producer of a good or service has a competitive advan- tage. For example, a pharmacy that can accurately dispense a product more cheaply than its competitors has an advantage. The efficient producer can

efficient Producing the most valuable output possible, given the inputs used. (Viewed differently, an efficient organization uses the least expensive inputs possible, given the quantity and quality of output it produces.)

competitive advantage Offering products of the same quality at lower cost than rivals, offering products of higher quality at the same cost as rivals, or offering products that customers are willing to pay more for.

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Economics for Healthcare Managers74

win more contracts, enjoy higher profit margins, and more easily weather a slump. In healthcare, the bar has been raised: Increased attention to the outcomes of care challenges us to think about health, not just medical care. Healthcare organizations are being challenged to work with customers to produce health efficiently, not just to produce goods and services efficiently.

The pressure to become more efficient has grown. As the next chapter details, public and private insurers have taken steps to steer patients to pro- viders with lower costs. If your organization is a high-cost producer, it will soon need to become more efficient.

This chapter focuses on what is necessary to turn an organization into an efficient producer. The starting point is to understand costs, which requires a combination of two definitions. First, the goods or services an organization uses in producing its outputs are called inputs. Second, oppor- tunity cost equals the value of an input in its best alternative use. From this production-oriented perspective, costs equal the opportunity cost per unit of input multiplied by the volume of inputs. Reducing the cost per unit that the organization pays for inputs reduces total costs, but real savings result from reducing the volume of inputs the organization uses. To reduce input volume, managers must lead efficiency improvement efforts or outsource the production of goods and services.

5.2 Cost Perspectives

Costs are complex because they may be difficult to measure and depend on the perspective of the beholder. For example, consumers will characterize the cost of a prescription in terms of their out-of-pocket spending and ancil- lary costs, such as the value of time spent filling a prescription. Pharmacists will focus on the spending required to obtain, store, and dispense the drug. Insurers will focus on their payments to the pharmacist for the prescription and their spending on claim management. Each of these perspectives on costs is valid. Exhibit 5.1 illustrates costs from three perspectives.

In exhibit 5.1, a pharmacist acquires a drug for $10 and incurs $5 in processing, storing, and billing costs. The pharmacist should recognize that reasonable returns on her time and on her investment in the pharmacy rep- resent opportunity costs because both could be used in other ways. The con- sumer is uninterested in the pharmacist’s costs. What matters to him are his out-of-pocket costs and the $4 in travel expense he incurs when he drives to the pharmacy. When the consumer does not have insurance, as shown in exhibit 5.1, the consumer’s perspective on costs mirrors society’s perspective. Both will say that the drug costs $20, although the two calculations are different. The consumer will focus on the price he pays and his travel costs. Society will

output A good or service produced by an organization.

input A good or service used in production.

opportunity cost The value of what one cannot do as a result of making a choice.

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Chapter 5: Understanding Costs 75

ignore the price the consumer pays and focus on the underlying resource use by the pharmacist and the consumer. The payment is an accounting entry, not a real use of resources (because it equals the amount the pharmacist receives).

Exhibit 5.1 illustrates two important concepts. First, what one party views as a cost, the other views as revenue. Reducing costs sounds wonderful from the perspective of the buyer, but not from the perspective of the seller. Second, it is often convenient to use the price of a product as a proxy for the cost of producing it.

Exhibit 5.2 lists cost perspectives when the prescription is covered by insurance. Although the cost looks the same from the pharmacist’s perspective, three things change as a result of coverage. First, the additional perspective of the insurer must be considered. Second, the insurer incurs expense by processing the claim. Third, the consumer’s perspective on costs now differs from society’s.

The insurer focuses on its share of the retail price and its cost of paying the bill. Again, the insurer should factor in the opportunity cost of using its investment to provide pharmacy insurance benefits but will probably express this figure in terms of a required return on investment. From the perspec- tive of the insurer, covering the prescription adds $21 in costs. From the perspective of the consumer, insurance coverage reduces costs by $11. Note

Pharmacy Consumer Society

Wholesale price $10 $0 $10

Travel $0 $4 $4

Processing $5 $0 $5

Capital $1 $0 $1

Retail price ($16) $16 $0

Total $0 $20 $20

EXHIBIT 5.1 Prescription Costs from Three Perspectives Without Insurance

Pharmacy Consumer Insurance Society

Wholesale price $10 $0 $0 $10

Travel $0 $4 $0 $4

Processing $5 $0 $9 $14

Capital $1 $0 $1 $2

Retail price ($16) $5 $11 $0

Total $0 $9 $21 $30

EXHIBIT 5.2 Cost Perspectives with Insurance

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Economics for Healthcare Managers76

also that society’s perspective on costs differs from the perspective of any of the participants when insurance plays a role. Society adds the processing and asset costs that the insurer incurs, making the total $30.

The concept of cost cannot be fully understood without stating a cost perspective. The part of cost that matters depends on your point of view. Your revenues are someone else’s costs, and your costs are someone else’s revenues.

Most people want to focus on costs from the perspective of the orga- nization in which they work, but shifting costs to customers or suppliers seldom represents a good business strategy. Long-term business success rests on selling products that offer your customers excellent value and offer your suppliers adequate profits.

As stated earlier, the difficulty of measuring cost components also complicates the concept of costs. For example, opportunity costs are some- times hard to measure. Managers sometimes become confused when cal- culating the opportunity cost of resources that have changed in value. For example, land that your organization bought a few years ago may be more valuable if rents in the area have risen or less valuable if rents have fallen. In most cases, though, an input’s opportunity cost is simply its market price.

Linking the use of a resource to the organization’s output also poses problems. A focus on incremental costs (i.e., the cost of the additional resources you use when you increase output by a small amount) often simpli- fies this task. “How much more of a hospital’s information system does its intensive care unit use when it cares for an additional patient?” is an example of a way to reframe the relationship between resource use and output and facilitate its measurement.

Cost Reductions at Baptist Health System

Baptist Health System, a clinically integrated network of five hospi- tals in Texas, has taken part in Medicare’s knee replacement bundled payment programs since 2008. Medicare began bundled payments in the hope that its costs (the amount it pays doctors, hospitals, nursing homes, and rehabilitation centers) would go down. Baptist Health Sys- tem also sought to improve quality and reduce costs, thereby gaining a competitive advantage (Navigant 2016).

It seems that both parties got what they wanted. Average Medi- care payments per knee replacement without complications declined

bundled payment Payment of a fixed amount for an episode of care. The payment might cover just hospital care or might include the physician, hospital, and rehabilitation.

Case 5.1

(continued)

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Chapter 5: Understanding Costs 77

5.3 Vocabulary

To talk sensibly about costs, we need a clear vocabulary. At the core of that vocabulary are the concepts of average cost and incremental cost. Average cost equals the total cost of a process divided by the total output of a process. In exhibit 5.3, when total cost equals $10,500 and output equals 300, aver- age cost equals $35. Incremental cost, also called marginal cost, equals the change in a process’s total cost that is associated with a change in the pro- cess’s total output. In exhibit 5.3, total cost rises from $8,000 to $10,500 as output rises from 200 to 300, so incremental cost equals ($10,500 − $8,000) ÷ (300 − 200), or $25 per unit of output.

In exhibit 5.3, average cost is significantly larger than incremental cost. This difference is common because many processes require resources (e.g.,

average cost Total cost divided by total output.

marginal or incremental cost The cost of producing an additional unit of output.

by 21 percent between 2008 and 2015 (Navathe et al. 2017). However, Baptist Health System’s cost per case declined by 25 percent, primarily

because of reductions in implant and rehabilitation costs (Navathe et al. 2017). In addition, outcomes appeared to improve. Episodes with readmissions decreased from 6.4 percent to 5.0 percent, epi- sodes with emergency department visits decreased from 7.4 percent to 6.5 percent, and episodes with prolonged stays decreased from 22.4 percent to 7.3 percent (Navathe et al. 2017). Overall, Medicare spent less, Baptist earned a higher profit margin, and patients got better care.

Discussion Questions • This case includes two perspectives on costs. Which is correct?

• How did participating in the bundled payment change Baptist’s perspective on costs?

• Did Baptist reduce both marginal and average costs?

• Did Baptist gain a competitive advantage as a result of these changes?

• Baptist reduced implant costs by 29 percent. How could it do this?

• Baptist reduced rehabilitation costs by 27 percent. How could it do this?

• Was Baptist Health System efficient in 2007?

• Whose revenues fell as a result of the changes that Baptist made?

Case 5.1 (continued)

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Economics for Healthcare Managers78

equipment or key personnel) that do not change as output varies. For example, to open a pharmacy, a pharmacist has to rent a building. If sales fall short of expectations, the rent will not change. Rent is an example of a fixed cost, a component of total cost. In contrast, some labor costs and the cost of restock- ing the pharmacy will vary with sales. Average cost includes fixed and variable costs, but incremental cost includes only variable costs. The fact that average cost often exceeds incremental cost is important because management deci- sions often hinge on knowing how much increasing or decreasing production of a good or service will cost. Your willingness to negotiate with an insurer that offers $300 per service is likely to depend on whether you believe an additional service will cost you $440 (the average cost) or $120 (the incremental cost).

Most management decisions concern incremental changes. Should we increase hours in the pediatric clinic? Should we reduce evening pharmacy staff? Should we accept patients needing skilled nursing care? These decisions demand data on incremental costs.

In addition to being the most relevant concept for managers, incre- mental costs are easier to calculate than average cost. Average cost calculations always involve difficult questions (e.g., How much of the cost incurred by the chief financial officer should we allocate to the pediatrics department?). In contrast, incremental cost calculations involve more straightforward ques- tions and can be performed by most clinicians and frontline managers (e.g., What additional resources will we need to keep the pediatric clinic open on Wednesday evenings, and what are the opportunity costs of those resources?). To decide whether to start or stop a service, a manager needs to compare average revenue and average cost. For example, a telemedicine program that has average revenue of $84 and average cost of $98 is unprofitable. To decide whether to expand or contract a service, a manager needs to compare how revenue and costs will change. To make this comparison, information about incremental costs is essential. Usually confusion about cost arises because one person is talking about average cost and another is talking about incremental cost (or because one person is talking about costs to society and the other is talking about costs to the organization).

fixed cost A cost that does not vary when output changes.

variable cost A cost that changes when output changes.

Output Total Cost Average Cost Incremental Cost

0 $3,000

100 $5,500 $55 $25

200 $8,000 $40 $25

300 $10,500 $10,500/300 = $35 ($10,500 − $8,000)/ (300 − 200) = $25

EXHIBIT 5.3 Total, Average,

and Incremental Costs

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Chapter 5: Understanding Costs 79

5.4 Factors That Influence Costs

Producer costs depend on what is produced (the outputs), the prices of inputs, how outputs are produced (the technology), and how efficiently inputs are used. We will explore each of these factors.

5.4.1 Outputs Differences in outputs can profoundly affect costs. Firms that produce large volumes of a good or service may have lower costs than firms that produce small volumes. Large firms that have a cost advantage have economies of scale. Firms that produce several different kinds of goods or services may have lower costs than firms that produce just one. Multiproduct firms that have a cost advantage have economies of scope. Economies of scale and scope result from sharing resources.

An example of economies of scale might be a large pharmacy’s use of automated dispensing equipment. In a larger pharmacy the fixed costs of the equipment could be shared by a larger number of prescriptions, so the cost per prescription could be lower. An example of economies of scope might be a nursing home that expands to offer skilled care as well as intermediate care. Fixed costs (e.g., the cost of the director of nursing) would be shared by additional patients, so average costs for intermediate care could be lower.

Differences in the quality of outputs can affect costs as well. For an efficient firm, higher-quality products cost more. For an inefficient firm, higher-quality products may not.

What is higher quality? Economists define quality from the per- spective of consumers, not from the clinical perspective common in healthcare. In economics, a good or service is of higher quality when it is more valuable to a well-informed customer than comparable goods or services. Consumers usually find greater value in goods or services that produce better clinical outcomes, so the clinical perspective is not wrong. Economists also define quality in terms of nonclinical factors. Well-informed consumers may attribute higher quality to a product that is easier to use, a service for which the wait is shorter, an insurance plan with less confusing referral requirements, a provider who bills more accurately, or a more cordial staff.

If higher quality does not cost more, failure to provide it demon- strates inefficiency. The many opportunities available to improve quality in healthcare without increasing costs reflect how inefficient most healthcare organizations are. Once an organization has become efficient, higher qual- ity (better service, improved reliability, greater accuracy, less pain, and other enhancements) will cost more to produce.

economies of scale When larger organizations have lower average costs.

economies of scope When multiproduct organizations have lower average costs.

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Economics for Healthcare Managers80

Improving Performance in Primary Care

Lean is a performance improvement strategy that emphasizes reducing waste, with waste defined as activity that adds less value than it costs. Examples of waste include patients’ waiting time (which adds no value from their perspective), staff looking for supplies, staff who are not using all their skills, and unnecessary paperwork.

The Lean approach stresses increasing efficiency and redesigning products so that they meet customers’ goals better. Does Lean reduce costs in primary care? Does it improve customer satisfaction? Does it improve staff satisfaction? Does it improve clinical quality? California’s Palo Alto Medical Foundation for Health Care, Research and Education (which has more than 1,400 physicians and more than 5,000 other employees) systematically evaluated its systemwide Lean initiative to find out (Hung et al. 2017).

This initiative standardized the equipment, supplies, and educa- tion materials in exam rooms; set up shared work spaces for physi- cians and staff; and redesigned multiple workflows. For example, teams started daily morning huddles to review schedules, expanded the roles of medical assistants, and established metrics to track clini- cal quality, costs, patient satisfaction, staff satisfaction, and physi- cian satisfaction. Most measures of clinical quality did not change, although diabetes care improved. Costs dropped, patient satisfaction increased, staff satisfaction increased, and physician satisfaction did not change (Hung et al. 2017).

Discussion Questions • What are other examples of waste?

• How would standardizing equipment, supplies, and education materials increase efficiency?

• Why would expanding the roles of medical assistants increase efficiency?

• Cost per visit fell by 12.5 percent. How would this affect profits?

• How might huddles reduce costs? Increase quality?

• Would the changes described in this case reduce costs from a patient’s perspective?

Case 5.2

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Chapter 5: Understanding Costs 81

5.4.2 Input Costs Higher input prices mean higher costs. Shifting to a different combination of inputs will only partially offset the effects of higher input prices. However, this rule does not hold when a firm is inefficient or when a perfect, lower- priced substitute for the higher-priced input is available. An inefficient firm might be able to limit the effects of a cost increase by shifting to a more efficient production process. For example, even if the wages of pharmacy technicians increase, the cost of dispensing a prescription might not increase if the pharmacy switches to the automated system it should have been using before the wage increase. A firm also can avoid higher costs by switching to a perfect substitute. For example, if an Internet access provider tried to raise its monthly rates, firms could switch to rival Internet access providers, and costs would not go up. Unfortunately, firms are unlikely to find such a replacement in most cases.

5.4.3 Technology Advances in technology always reduce the cost of an activity, but volumes may increase enough to increase spending. Adopting a new technology would be pointless if it increased the costs of a process (unless it increased the quality of the process). For example, installing an automated laboratory system would be absurd if it increased the cost per analysis. An automated laboratory system that reduces the cost per analysis, however, does not guarantee that laboratory costs will go down. Lower costs per analysis may prompt physicians to request more analyses, and the greater volume could cancel the cost savings and might even drive up costs.

5.4.4 Efficiency Increases in efficiency always reduce the cost of an activity. Production of almost every healthcare good or service can be made more efficient. Few production processes in healthcare have been examined carefully, and most healthcare workers have little or no training in process improvement. Con- sequently, mistakes, delays, coordination failures, unwise input choices, and excess capacity are far too common. More and more, though, healthcare organizations are responding to financial and quality challenges by trying to increase efficiency (Rotter et al. 2017).

Even though greater efficiency reduces costs, not everyone is in favor of it. Greater efficiency often means that fewer workers will be needed. Workers whose jobs are in jeopardy may not want to help improve efficiency. (Commitment to a policy of no layoffs is usually one of the core terms of effi- ciency improvements.) Others have limited incentive to participate in efforts to improve efficiency. Physicians must help change clinical processes, yet many physicians have little to gain from these efforts. The gains produced by the

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Economics for Healthcare Managers82

changes will accrue to the healthcare organization, but the resulting billing reductions will be problematic for physicians and other healthcare workers not employed by the organization. A major challenge lies in devising incen- tives that will encourage workers and contractors to help improve efficiency.

5.5 Variable and Fixed Costs

Managing costs requires an understanding of opportunity costs and triggers that change costs. As stated earlier, opportunity costs usually are easy to assess. The opportunity cost of using $220 in supplies is $220. The opportu- nity cost of using an hour of legal time billed at $150 per hour is $150. Other cases demand more study. For example, the opportunity cost of a vacant wing of a hospital depends on its future use. If the wing will be reopened for acute care in response to a rising hospital census, the opportunity cost of the wing will depend on its value as an acute care unit. If the wing will be reopened because the hospital needs a skilled nursing unit, the opportunity cost of the wing will be determined by its value in that role.

Sunk costs should be ignored. A sunk cost is a cost you cannot change. A computer’s purchase price is a sunk cost, as is money spent to train employees to operate the computer. If your current needs do not require the use of a computer, you should not fret about its initial cost. The opportunity cost of the computer will depend on its value in some other use (including its resale value).

In the long run, all costs are variable. Buildings and equipment can be changed or built. The way work is done can be changed. Additional per- sonnel can be hired. The entire organization could shut down, and its assets could be sold. However, in the short run, some costs are fixed. An existing lease may not be negotiable, even if the building or equipment no longer suits your needs. Ignore fixed costs in the short run. They are sunk costs.

When fixed costs are substantial, average costs typically fall as output increases because the fixed costs are spread over a growing volume of output. As long as the average variable cost (AVC) is stable, this drop in the average fixed cost (AFC) will cause a reduction in average total costs. Average total costs equal AFC plus AVC. As exhibit 5.4 illustrates, AFC drops from $30 to $15 as output rises from 100 to 200. If variable costs rise quickly enough, average total costs may rise despite the fall in AFC. In exhibit 5.4, variable costs rise by $10,000 as output increases from 200 to 300. As a result, aver- age total cost rises to $60 even though AFC continues to fall.

Fixed and variable costs are important concepts for day-to-day manage- ment of healthcare organizations. For example, an advantage of growth is that fixed costs can be spread over a larger volume of output. The idea is that lower

sunk cost A cost that has been incurred and cannot be recouped.

average variable cost (AVC) Variable costs divided by total volume.

average fixed cost (AFC) Fixed costs divided by total volume.

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Chapter 5: Understanding Costs 83

AFC can result in lower average total costs, so profit margins can be larger. As exhibit 5.4 illustrates, growth should not result in increases in AVC large enough to offset any reduction in AFC. Otherwise, growth will be unprofitable.

Misclassifying costs can create odd incentives. For example, fixed over- head costs are often allocated on the basis of some measure of output, which can understate the profits from growth because the overhead costs allocated to a unit would increase as the unit grows. So that unit managers are not dis- couraged from expanding, allocated fixed costs should not vary with output.

EXHIBIT 5.4 Fixed and Variable Costs

Output Total Cost

Fixed Cost Average Total Cost

Average Fixed Cost

Average Variable Cost

0 $3,000 $3,000

100 $5,500 $3,000 $55 $30 $25

200 $8,000 $3,000 $40 $15 $25

300 $18,000 $3,000 $18,000/300 = $60 $3,000/300 = $10 $15,000/300 = $50

Costs of Care in the Emergency Department

A Colorado woman took her daughters to what she thought was an urgent care clinic in a shopping mall (Olinger 2015). Both were treated for respiratory problems, and the visit went well. “I thought it was a fine experience,” she commented, “until I got the bill.” She had gotten care from a free-standing emergency department, not an urgent care clinic, and her out-of-pocket obligation for the visits was nearly $5,000.

This represents an unusually high price, but care is expensive in emergency departments. Ho and colleagues (2017) found that treating respiratory infections in a hospital’s emergency department averaged $1,074, and treating respiratory infections in a free-standing emer- gency department averaged $1,351. In contrast, treating respiratory infections in an urgent care center averaged $165. (These are average prices paid, not charges.) Prices in emergency departments are typi- cally more than ten times those in urgent care clinics.

Case 5.3

(continued)

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Economics for Healthcare Managers84

These high prices explain why many health- care reform plans seek to steer patients away from using emergency departments. For example,

Oregon moved most Medicaid enrollees into coordinated care orga- nizations, with the explicit goal of reducing emergency department use (McConnell 2016). (Because they have difficulty accessing other sources of outpatient care and because they face low out-of-pocket costs, Medicaid enrollees tend to use emergency departments at high rates.) In Oregon, use of emergency departments fell by 8 percent (McConnell 2016).

About a third of emergency department visits are not emergen- cies, and there is an ongoing controversy about how much such a visit costs (Galarraga and Pines 2016). Perspective differences cause part of the controversy. Insurers and patients talk about the prices that they pay, and providers talk about how much it costs to produce such visits. Yet another perspective notes that patients who use emergency departments as usual sources of care have high rates of preventable hospitalizations. Galarraga and Pines (2016) estimate that the average payment for a visit that is not an emergency is $883 but the average payment for a preventable hospitalization is $9,515.

Discussion Questions • Why do patients who are not critically ill go to emergency

departments?

• Why are prices so high in emergency departments?

• Are production costs also high in emergency departments?

• What is an example of a fixed cost in an emergency department? A variable cost?

• If an emergency department’s volumes fell, how would its costs change?

• Should insurers try to reduce emergency department use?

• How might insurers reduce emergency department use?

Case 5.3 (continued)

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Chapter 5: Understanding Costs 85

5.6 Conclusion

Cost management has become vital because organizations that are more efficient have a competitive advantage. Increasingly, managers are challenged to reduce costs while improving clinical quality and customer service. This pressure has intensified as purchasers have realized that high costs do not guarantee high quality and that high quality may not be more expensive. Healthcare organizations are beginning to adopt cost-reducing technol- ogy, substitute low-cost production techniques for high-cost ones, purchase goods and services more conservatively, and rethink what they produce. In addition, providers and insurers are being challenged to improve the health of target populations in ways that are cost-effective—a task that is more dif- ficult than the efficient production of healthcare products.

Exercises

5.1 Why is it important to distinguish between fixed and variable costs? 5.2 Explain how a decrease in input prices or an increase in efficiency

would affect costs. 5.3 You spent $500,000 on coding training last year. Is this a sunk cost?

Should it be considered in making a decision whether to switch coding software?

5.4 You bought two acres of land for $200,000 ten years ago. Although it is zoned for commercial use, it currently holds eight small, single- family houses. A property management firm that wants to continue leasing the eight houses has offered you $400,000 for the property. A developer wants to build a 12-story apartment building on the site and has offered $600,000. What value should you assign to the property?

5.5 A clinic’s cost and visit data are as follows. Calculate its average and marginal costs. Note that you can only calculate marginal cost as visits increase from 100 to 110.

Visits Total Cost Average Cost Marginal Cost

100 $2,000

110 $2,100

5.6 A community health center has assembled the following data on cost and volume. Calculate its average and marginal costs for volumes ranging from 25 to 40. What patterns do you see?

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Economics for Healthcare Managers86

Visits Total Cost

20 $2,200

25 $2,250

30 $2,300

35 $2,350

40 $2,400

5.7 Sweetwater Nursing Home has 150 beds. Its cost and volume data are as follows. Calculate its average and marginal costs for volumes ranging from 100 to 140. What patterns do you see?

Residents Costs

80 $10,000

100 $11,000

120 $12,000

140 $13,200

5.8 A phlebotomist takes 15 minutes to complete a blood draw. The supplies for each draw cost $4, and the phlebotomist earns $20 per hour. The phlebotomy lab is designed to accommodate 20,000 draws per year. Its rent is $80,000 per year. What are the average and incremental costs of a blood draw when the volume is 20,000? 10,000? What principle does your calculation illustrate?

5.9 Use the data in exercise 5.8. How would the average and marginal costs change if the phlebotomist’s wage rose to $24 per hour? What principle does your calculation illustrate?

5.10 A new computer lets a phlebotomist complete a blood draw in 10 minutes. The supplies for each draw cost $4, and the phlebotomist earns $20 per hour. The phlebotomy lab is designed to accommodate 20,000 draws per year. Its rent is $80,000 per year. What is the marginal cost of a blood draw? What principle does your calculation illustrate?

5.11 Use the data in exercise 5.8. How would the average and marginal costs change if the rent rose to $100,000? What principle does your calculation illustrate?

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Chapter 5: Understanding Costs 87

5.12 A patient visits a clinic. She incurs $10 in travel costs and has a copayment of $20. The clinic’s total charge is $60. The clinic spends $9 to bill the insurance company for the visit and uses resources worth $51 to produce the visit. The insurance company pays the clinic $40 and spends $11 to process the claim. Describe the cost of the visit from the perspective of the patient, the clinic, the insurer, and society.

5.13 A practice uses $40 worth of a dentist’s time, $30 worth of a hygienist’s time, $10 worth of supplies, and $15 worth of a billing clerk’s time to produce a visit. The practice charges a patient $25 and charges the patient’s insurer $70. The insurer spends an additional $4 to process the claim. The patient incurs travel costs of $20. What are the costs of the visit from the perspective of society, the patient, the practice, and the insurer?

5.14 Kim and Pat underwrite insurance. Each underwrites 50 accounts per month. Each account takes four hours to underwrite. The value of their time is $40 per hour. Monthly costs for each are $1,500 for an office, $2,000 for a receptionist, and $2,400 for a secretary. Calculate the average and incremental cost per case for Kim and Pat.

5.15 If Kim and Pat from exercise 5.14 merge their operations, they would need only one receptionist, and their rent for the joint office would be $2,800 per month. All other values stay the same. Calculate the average and incremental cost per case for the merged office. Do they have economies of scale at 100 accounts per month? Should Kim and Pat merge their offices?

References

Galarraga, J. E., and J. M. Pines. 2016. “Costs of ED Episodes of Care in the United States.” American Journal of Emergency Medicine 34 (3): 357–65.

Ho, V., L. Metcalfe, C. Dark, L. Vu, E. Weber, G. Shelton Jr., and H. R. Under- wood. 2017. “Comparing Utilization and Costs of Care in Freestanding Emergency Departments, Hospital Emergency Departments, and Urgent Care Centers.” Annals of Emergency Medicine 70 (6): 846–57.

Hung, D. Y., M. I. Harrison, M. C. Martinez, and H. S. Luft. 2017. “Scaling Lean in Primary Care: Impacts on System Performance.” American Journal of Man- aged Care 23 (3): 161–68.

McConnell, K. J. 2016. “Oregon’s Medicaid Coordinated Care Organizations.” JAMA 315 (9): 869–70.

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Navathe, A. S., A. B. Troxel, J. M. Liao, N. Nan, J. Zhu, W. Zhong, and E. J. Emanuel. 2017. “Cost of Joint Replacement Using Bundled Payment Mod- els.” JAMA Internal Medicine 177 (2): 214–22.

Navigant. 2016. “Improving Quality and Reducing Cost with Bundled Pay- ments.” Published April 4. www.navigant.com/-/media/www/site/insights /healthcare/2016/baptist-health-case-study.pdf.

Olinger, D. 2015. “Confusion About Free-Standing ER Brings Colorado Mom $5,000 Bill.” Denver Post. Published October 30. www.denverpost.com/2015/10/30 /confusion-about-free-standing-er-brings-colorado-mom-5000-bill/.

Rotter, T., C. Plishka, L. Adegboyega, M. Fiander, E. Harrison, R. Flynn, J. Chan, and L. Kinsman. 2017. “Lean Management in Health Care: Effects on Patient Outcomes, Professional Practice, and Healthcare Systems.” Cochrane Database of Systematic Reviews 11: CD012831.

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