INSTRUCTORS MANUAL for Health Economics and Policy 8th Edition by Henderson James. ISBN 978035713296 by welldoneassistant

Table of Contents Instructor Manual ................................................................................................................................. 1 Table of Contents ...................................................................................................................................... 1 Purpose and Perspective of the Chapter ................................................................................................... 2 Cengage Supplements ............................................................................................................................... 2 Chapter Objectives .................................................................................................................................... 2 Complete List of Chapter Activities and Assessments ............................................................... 2 Key Terms .................................................................................................................................................. 3 What's New in This Chapter ...................................................................................................................... 6 Chapter 1: U.S. Medical Care: An Uncertain Future .................................................................................. 6 Chapter Outline ......................................................................................................................................... 6 Teaching Suggestions ................................................................................................................................ 8 Additional Questions for Discussion and Evaluation ................................................................................. 9 Multiple Choice ....................................................................................................................... 9 Structured Discussion: ......................................................................................................... 11

Purpose and Perspective of the Chapter This chapter introduces the student to the economic way of thinking as it relates to the study of the U.S. medical care system. It gives an overview of the Patient Protection and Affordable Care Act (ACA) and discusses why—more than 10 years after it was passed—it has solved some critical issues but has still left many unanswered questions. The chapter then offers a brief summary of the emergence of the modern medical care system, recent changes of medical care delivery and payment structures, and the basics of system design and economic modeling. It ends with a discussion of the current framework for implementing ACA; the bill’s history, both before and after passage; and how America is succeeding on some of the major accomplishments of ACA while dealing with some unintended consequences. The chapter also lays the foundation for the focus and continuity throughout the book and introduces and defines 10 guiding principles.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Understand the nature of the health care crisis in America. 2. Identify the important historical developments affecting health care delivery and finance in the U.S. system. 3. Identify and explain the major reasons for the high and rising cost of medical care. 4. Understand how the third-party payment mechanism and managed care affect health care delivery. 5. Understand the Patient Protection and Affordable Care Act and its importance to the U.S. health care system. 6. Understand the impact of the current health care reforms. 7. Recognize the relevance of economics in studying health care issues. 8. Understand the aspects of medical care that contribute to its uniqueness as a commodity.

Complete List of Chapter Activities and Assessments Chapter Objective 1-1 Describe the history of health system reform in the

Activity/Assessment Additional Discussion Questions #3, 4, and 6 Activity: Knowledge Check 1 Activity

Source (i.e., PPT slide) Instructor’s Manual PPT slide 9

Duration 5–10 mins 5–10 mins

Chapter Objective United States.

1-2 Explain the current health care framework.

Activity/Assessment Activity: Knowledge Check 2 Answer Activity: Self-Assessment

Additional Discussion Questions #1 and 2 Activity: Knowledge Check 2 Activity Activity: Knowledge Check 2 Answer Knowledge Check 3 Activity Knowledge Check 3 Answer Activity: Self-Assessment 1-3 Evaluate Additional Discussion the progress Questions #5, 7, 8, and 9 made toward Activity: Game: Role Play system Activity transformation. Activity: Polling Activity Activity: Self-Assessment 1-4 Summarize Additional Discussion changes made Question #10 since the Activity: Self-Assessment passage of the Affordable Care Act (ACA).

Source (i.e., PPT slide) PPT slide 10

Duration

PPT slide 25

10–15 mins

Instructor’s Manual PPT Slide 11

5–10 mins

PPT slide 12

5 mins

PPT slide 16

5–10 mins

PPT slide 17

5 mins

PPT slide 25 Instructor’s Manual PPT Slide 22

10–15 mins 5–10 mins

PPT Slide 24 PPT slide 25 Instructor’s Manual PPT slide 25

5–10 mins 10–15 mins 5–10 mins

5 mins

5–10 mins

5–20 mins

10–15 mins

Key Terms Public option: A public health insurance plan comparable to Medicaid, designed to compete with private insurance. Uncertainty: A state in which multiple outcomes are possible but the likelihood of any one outcome is not known. Premium: A periodic payment required to purchase an insurance policy. Group insurance: A plan whereby an entire group receives insurance under a single policy. The insurance is actually issued to the plan holder, usually an employer or association. Medicare: Health insurance for the elderly provided under an amendment to the Social Security Act.

Medicaid: Health insurance for the poor financed jointly by federal and state governments. Flexner Report: A 1910 report published as part of a critical review of medical education in the United States. The response of the medical establishment led to significant changes in the accreditation procedures of medical schools and an improvement in the quality of medical care. Collective bargaining: The negotiation process whereby representatives of employers and employees agree upon the terms of a labor contract, including wages and benefits. Cost shifting: The practice of charging higher prices to one group of patients, usually those with health insurance, in order to provide free care to the uninsured or discounted care to those served by Medicare and Medicaid. Certificate of need (CON): Regulations that attempt to avoid the costly duplication of services in the hospital industry. Providers are required to secure a certificate of need before undertaking a major expansion of facilities or services. Employee Retirement Income Security Act (ERISA): Federal legislation passed in 1974 that sets minimum standards on employee benefit plans, such as pensions, health insurance, and disability. The statute protects the interests of employees in matters concerning eligibility for benefits. The law also protects employers from certain state regulations. For example, states are not allowed to regulate self-insured plans and cannot mandate that employers provide health insurance to their employees. Entitlement programs: Government assistance programs where eligibility is determined by a specified criteria, such as age, health status, and level of income. These programs include Social Security, Medicare, Medicaid, Temporary Assistance for Needy Families (TANF), and many others. Prospective payment: Payment determined prior to the provision of services. A feature of many managed care organizations that base payment on capitation. Capitation: A payment method providing a fixed, per capita payment to providers for a specified medical benefits package. Providers are required to treat a well-defined population for a fixed sum of money, paid in advance, without regard to the number or nature of the services provided to each person. Diagnosis-related group: A patient classification scheme based on certain demographic, diagnostic, and therapeutic characteristics developed by Medicare and used to compensate hospitals. Relative-value scale: An index that assigns weights to various medical services used to determine the relative fees assigned to them. Retrospective payment: Payment determined after delivery of the good or service. Traditional fee-for-service medicine determines payment retrospectively.

Prospective payment: Payment determined prior to the provision of services. A feature of many managed care organizations that base payment on capitation. Managed care: A delivery system that originally integrated the financing and provision of medical care in one organization. Today, the term encompasses different arrangements designed to coordinate services and control costs. Indemnity insurance: Insurance based on the principle that someone suffering an economic loss receives a payment approximately equal to the size of the loss. Horizontal integration: The merger of two or more firms that produce the same good or service. Vertical integration: Expansion to secure elements of the supply chain to ensure availability of resources to produce a product or service. Examples might include the acquisition of a primary care clinic by a hospital. Portability: The ability to easily transfer insurance coverage from one plan to another as a covered employee changes jobs. Moral hazard: Insurance coverage increases both the likelihood of making a claim and the actual size of the claim. Insurance reduces the net out-of-pocket price of medical services and thus increases the quantity demanded. Alternative payment models: Payments based on criteria other than fee-for-service, including capitation, bundled payment, and pay for performance. Bundled payment: Single payment for all services and procedures associated with an episode of care. One of the commonly suggested alternatives to fee-for service payment. Accountable care organization (ACO): An integrated care network of physicians, clinics, hospitals, and other health care providers who coordinate to provide comprehensive medical care to a well-defined population of patients. Triple aim: An approach to optimizing health system performance designed along three dimensions: enhancing the patient experience, improving population health, and reducing per capita spending. Integrator: An entity responsible for consolidating the resources required to achieve the Triple Aim. Guaranteed issue: A requirement that insurers must issue a policy to anyone who applies for one with no consideration of health status. Guaranteed renewability: A feature of an insurance policy that requires the insurer to guarantee renewal of the policy as long as premiums are paid, regardless of any changes in the health status of the policy holder.

Insurance exchange: A digital marketplace available in every state where individuals can shop for health insurance and receive government subsidies making it more affordable. Game: Bending the rules of the game in order to manipulate the outcome. Adverse selection: A situation where different parties in a transaction have access to different information that may be relevant to the exchange, placing one at a distinct disadvantage in the trade. Economic rent: The amount earned by a factor of production in excess of its opportunity cost. Typically, the supply of the factor is fixed. Natural monopoly: A firm becomes a natural monopoly based on its ability to provide a good or service at a lower cost than anyone else and satisfy consumer demand completely. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: There are several new additions to this chapter. Chief among them are an in-depth discussion of ACA, including the recognition that unless something better is introduced, ACA will remain the bedrock upon which all medical delivery systems, payment structures, and health care system design will be based. This chapter provides not only a background of what ACA is, but also a history of the 2010 legislation; key elements of ACA; its major accomplishments and its unintended consequences; and challenges and changes to the system since passage, including the abolishment of “the individual mandate” at the federal level.

Chapter 1: U.S. Medical Care: An Uncertain Future This chapter introduces the student to the economic way of thinking as it relates to the study of the U.S. medical care system. After a brief summary of the historical development of medical care delivery and finance, the chapter addresses the basics of economic modeling and analysis. It also discusses the similarities and differences between medical care and other economic goods and services. Ten guiding principles are introduced and defined: as a set of unifying themes, they provide focus and continuity throughout the book.

Chapter Outline I.

Historical developments in the delivery of medical care and payments: Three important factors served to make the modern medical care delivery system are the germ theory of disease, expanded use of medical technology, and increased urbanization. a. Private health insurance, introduced in the 1930s, later transformed medical care financing: the federal government became a major

purchaser of health care services and involved in medical care spending. Alternative payment and delivery systems—prospective payment, capitation, the use of diagnosis-related groups, and a relative-value scale—were introduced to limit the growth in health care expenses (PPT Slide 4). b. Implementation of the ACA encourages the consolidation of services within the framework with horizontal integration (stand-alone facilities into multihospital systems) and vertical integration (specialty care, hospital care, rehabilitation, home care, and hospice in one clinical system). Medical delivery care has now shifted its focus from individual health to population health (PPT Slide 6). c. Experts in 2013 (Cutler and Sahni; Ryu et al.) attribute that the decline in medical spending growth resulted from the recession, decreased private insurance coverage, and lack of technology and decreased provider efficiency. The changes in the payment structure from the 1990s to 2010s are the shift from the out-of-pocket to third-party payment, from retrospective to prospective payment, and from private to public insurance (PPT Slide 7). d. The accountable care organization (ACO) recommends the use of fully integrated delivery system for improving health care quality and reducing spending at the same time. The conceptual approach to health care delivery provides three dimensions of the triple aim or the iron triangle: experience of care, population health, and per capita health (PPT Slide 8). II. The current framework, and why the success—or failure—of ACA is important to the United States (PPT Slides 13–15). a. History of the 2010 legislation: Barack Obama handled health care reform in a way different from Bill Clinton that he let Congress do the heavy lifting. Following the death of Edward Kennedy of Massachusetts, a Republican was elected to fill the vacant Senate seat (no longer filibuster proof) and Congress never intended the Senate version to be the final legislation (so the legislation was with problems). b. The key provisions of the ACA are as follows: Additional regulation of the private health insurance market: benefits package for certification, guaranteed issue, guaranteed renewability, and no benefit exclusions due to preexisting conditions; Expanded Medicaid eligibility and the creation of health insurance exchanges: standardized information on all insurance options; Mandates enforced by penalties that require individuals to maintain coverage and firms to offer affordable plans; Reduction in Medicare spending to fund coverage for non-Medicare recipients; New federal taxes: a private insurance plan tax, surtaxes on high-income taxpayers and investment income, excise taxes on high-cost plans, a revenue tax on medical device manufacturers, and mandate taxes.

c. The major accomplishment of the reform as pointed out by the ACA is the increased insurance coverage (PPT Slides 19 & 20). d. The unexpected results of the ACA include access problems, affordability issues (e.g., keeps healthy young people out of the exchanges and populates with older and sicker individuals), and increased consolidation among providers (PPT Slide 20). The fully integrated system reduces competition, increases bargaining power, and results in higher prices. e. Changes in the system since passage: Two Supreme Court rulings in 2012 upholding the constitutionality of the act were as follows: 1) the federal government could force residents to purchase insurance because the federal government has oversight responsibility over interstate commerce and 2) the Medicaid expansion and the federal government threat to withhold the matching grants to states that did not expand the program (PPT Slide 21). III. Ten key economic concepts: Scarcity and choice; Opportunity cost; marginal analysis; self-interest; markets and pricing; competition; efficiency in economics; market failure; comparative advantage. IV. Summary and conclusions: Medical care delivery has a limitation that there are too few primary care physicians and too many specialists. The Patient Protection and Affordable Care Act of 2010 was designed to close gaps in health insurance coverage that limit reliable access for the 30 million who remain uninsured. (PPT Slide 26). [return to top]

Teaching Suggestions •

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Consider breaking out your class into groups of three to five students. Each group will discuss the following for 5 to 10 minutes: What do I hope to get out of this class? Students with different backgrounds will have different expectations. It is good to know what students want before you get too far into the course. I use this breakout technique throughout the semester, calling it 3x3 or 5x5—meaning groups of 3 for 3 minutes or groups of 5 for 5 minutes. Students, especially those without an economics background, seem to enjoy a class discussion of the history of medical delivery and the emergence of the modern medical care system. A brief graphical discussion of spending metrics and how they are used in economics will help to avoid losing students who are unfamiliar with the core principles of economics Discuss the future of the ACA, its major accomplishments and its unintended consequences. Discuss changes to the ACA since it was passed and the current debate on new reform and its impact on access, quality, and cost.

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Take the time to go over the 10 key economic concepts. A brief introduction helps develop continuity. Depending on your class makeup, you may spend a lot or a little time on this chapter. Students without much economics knowledge should focus on the underlying theories addressed in the chapter.

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Additional Questions for Discussion and Evaluation 1. Discuss the historical developments of medical care delivery and medical care systems, both in the United States and in the rest of the world. 2. Go over the basics of economic modeling and analysis, as they pertain to medical care systems. 3. What are the similarities and differences between medical care and other economic goods and services? 4. How big is the role of the federal government in health care delivery in the financing in the United States? How big should it be? 5. Present an overview for financing medical care. 6. Discuss the Patient Protection and Affordable Care Act, and its importance to the U.S. health care system. What are its major accomplishments? And where has it failed to attain its original goals? 7. Why was the ACA deemed necessary to the United States? What were the medical care issues that it attempted to solve? 8. Discuss changes in to the ACA since it was passed and the current debate on new reform and its impact on access, quality, and cost. 9. How does the ACA fit in with the overall debate on medical care systems design.

Multiple Choice 1.

Opportunity cost is a measure of a. foregone opportunities. b. value based on the alternative not chosen. c. value in terms of the cost of production. d. the difference between production cost and resource cost. e. both a and b. The opportunity cost of investing in a new lithotripter (a machine that pulverizes kidney stones with sound waves) is a. defined by the dollar cost of the equipment. b. the same for every health care provider. c. measured by the difference between the expected revenues from selling the services of the lithotripter and the invoice cost of the machine. d. defined by the next best use of the money invested in the equipment. e. impossible to calculate.

3. What percentage of Americans considered the complete repeal of the Patient

Protection And Affordable Care Act of 2010 a good thing? a. 20 percent b. 30 percent c. 40 percent d. 50 percent e. 60 percent 4. By 2020, what was the forecasted percentage amount of health care spending paid by individuals? a. 6 percent b. 10.4 percent c. 11.6 percent d. 17.4 percent e. Whatever amount we are currently spending

Charging higher prices for one category of patients in order to provide free or subsidized care to another group is called? a. price discrimination. b. cost-shifting. c. categorical costing. d. reprehensible and unethical. e. creative accounting.

The 1974 federal legislation that exempted employers from certain state laws governing health insurance was a. COBRA b. ERISA c. CON d. HIPAA e. SCHIP

Which of the following statements is based on positive analysis? a. Individuals without health insurance have less access to physicians’ services than those who have health insurance. b. The high cost of health insurance places U.S. firms at a competitive disadvantage with their foreign competitors. c. Employers should be required to provide health insurance for all full-time workers and their dependents.

d. none of the above. e. Both a and b.

8. The key elements of the Affordable Care Act (ACA) passed in 2010 included all of the following except: a. a mandate that required individuals and employers provide a qualified health plan at an affordable price, or face penalties. b. expanded insurance regulations include guaranteed issue, guaranteed renewability, and no exclusions for pre-existing conditions. c. the establishment of insurance exchanges where individuals could receive subsidies to purchase private coverage. d. a federal requirement that states extend Medicaid coverage to lower income individuals. e. price controls on brand name pharmaceuticals. 9. Approximately how many of all employees who participate in group insurance plans work for firms that self-insure? a. one-fourth b. one-third c. one-half d. two-thirds e. three-fourths 10. Which of the following is not a characteristic that makes medical care different from other commodities? a. Demand for medical care is irregular. b. Sellers have more information than buyers. c. Third-party payers abound. d. For-profit providers play a major role in delivering medical care. e. The transaction itself if filled with uncertainty.

Structured Discussion: 1. Resolved: The U.S. system of health care delivery is in a state of crisis. 2. Resolved: The recent slowing of health care spending as a share of gross domestic product will continue. In other words, the relative size of the health care sector has reached a natural limit. [return to top]

Table of Contents Instructor Manual ................................................................................................................................. 1 Table of Contents ....................................................................................................................... 1 Purpose and Perspective of the Chapter ................................................................................. 2 Cengage Supplements ............................................................................................................... 2 Chapter 2: Health Care Spending Issues.................................................................................. 2 Chapter Outline.......................................................................................................................... 2 Chapter Objectives .................................................................................................................... 5 Complete List of Chapter Activities and Assessments ............................................................ 5 Key Terms ................................................................................................................................... 6 What's New in This Chapter ...................................................................................................... 7 Teaching Suggestions ................................................................................................................ 7 Suggested Approaches to End-of-Chapter Questions ............................................................ 9 Additional Questions for Discussion and Evaluation ............................................................ 10 Multiple Choice ..................................................................................................................... 10 Appendix 2A: Using Indexes to Adjust Medical Spending for Inflation ............................... 13 Appendix Outline ..................................................................................................................... 13 Appendix Objectives ................................................................................................................ 13

Purpose and Perspective of the Chapter The purpose of this chapter is to introduce students to one of the biggest issues in health care: spending. With national health expenditures exceeding 4 billion dollars in 2020 and continuing to consume a larger proportion of U.S. gross domestic product (GDP), it is important to understand this upward trend. This chapter helps equip students with a basic understanding of health care spending, how it is measured, and what is being purchased. A specific focus on the American situation then addresses the question of why the United States spends more on medical care than any other country in the world. Though sustained spending growth has caused great anxiety in terms of affordability and the opportunity costs of health care costs, the text reminds students of the benefits that high prices have yielded as incentives for innovation.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter 2: Health Care Spending Issues This chapter introduces students to the basics of health care spending. It begins with a discussion about the trend of rising health care costs among developed nations, how health care spending is measured, how quickly spending is increasing, and how the money is spent. The text then turns to analyze the U.S. situation and the factors that may have contributed to continually increasing health care expenditures. The chapter finishes with an appendix that focuses on different indices to adjust health care spending for inflation.

Chapter Outline I.

Health Care Spending: The Basics: The major concern over health care spending is continuing upward spiral. The United States spends more on medical care by virtually every measure than any other country in the world (say, the average cost per hospital stay was over $10,000, and Americans spent over $4.0 trillion on health care) (PPT Slides 4 & 5). a. Health care spending is high and rising, and per capita spending adjusts for population size and exhibits slower growth. Some increase in spending as a percentage of GDP is due to shifting priorities and productivity advances in other parts of the economy and some due to changing population demographics (PPT Slides 6 and 22). b. Many factors contribute to a decline in health care spending growth over the past three decades: structural changes in delivery system, the Great Recession, a temporary decline in inflation. Since full implementation of the ACA in 2014, spending has grown at a compound annual rate of 5.8 percent.

II.

c. The overall spending by category in 2020 is 20 percent: Nursing home care accounted for $183.2 billion, dental services $148.3 billion, and other professional services $114.8 billion. Public health spending (almost $100 billion), investment in research ($58.6 billion), and spending on structures and equipment ($132 billion) brought total spending to over $4 trillion (PPT Slides 8 & 9). Why Do Americans Spend So Much on Health Care? U.S. per capita spending on medical care in 2020 is over 50 percent higher than in most other developed countries. Percentage of output devoted to spending depends on three factors: income, associated benefits to costs, and the quality of care, whose indicators are life expectancy and infant mortality and others contributing to demographic and social factors affecting health (PPT Slides 12 and 23). a. The health care spending problem arises from the inefficiencies in delivery system and affordability and access—from an economic perspective—and rising spending—from a political perspective. Some challenges in medical spending are as follows: inappropriate care resulting from misallocated resources (e.g., too many high-priced procedures, not enough primary and preventive care, too much basic care, and delayed care); high pricing (lack of price transparency and price discrimination); high administration cost: keeping track of multiple private payers and prices negotiated with the large number of providers; and fraud payments to providers (PPT Slide 7). b. Concerns over high and increasing spending arise from expensive health care services, health and lifestyle problems, insurance coverage, local provision of services and an integrated delivery system (i.e., the accountable care organization), and competitive pricing and procedures. The role of pricing (including inflation and spending as a percentage of GDP) and factors by recent studies associated with spending growth (the five-factor Dieleman study, population demographics, lack of technology, and increased patient sharing) should be considered to control spending (PPT Slides 13, 14, and 18). c. Baumol’s model of unbalanced growth considers two sectors in economy: the progressive sector where we observe regular productivity growth and the non-progressive sector where productivity lags. Slow growth of health care spending relative to the rest of the economy began in the 1990s and experienced two disruptions corresponding to the two recessions in the 2000s, so downturns in the overall economy tend to widen the gap (PPT Slides 19, 20, and 26–32).

III.

Summary and Conclusions: The medical care industry in the United States is large and growing in relative size. There are costs and benefits to the new treatments that encourage high spending (PPT Slides 21 and 35).

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Chapter Objectives The following objectives are addressed in this chapter: 1. Explain the issue of rising health care spending. 2. Understand the different ways to measure health care spending. 3. Recognize why the United States has the highest health care spending in the world. 4. Understand BSMEmol’s Model of Unbalanced Growth in the context of health care spending.

Complete List of Chapter Activities and Assessments Chapter Objective

Activity/Assessment

Source (i.e., PPT slide)

Duration

2-1 Explain the basics of health care spending.

Additional Discussion Questions #3–5

Instructor’s Manual

5–10 mins

Knowledge Check 1 Activity

PPT Slide 10

5–10 mins

Knowledge Check 1 Answer

PPT Slide 11

5 mins

Discussion Activity

PPT Slide 14

10–15 mins

Knowledge Check 2 Activity

PPT Slide 15

5–10 mins

Knowledge Check 2 Answer

PPT Slide 16

5 mins

Self-Assessment

PPT Slide 34

10–15 mins

Additional Discussion Questions #2, 6, & 7

Instructor’s Manual

5–10 mins

Discussion Activity

PPT Slide 14

10–15 mins

Knowledge Check 3 Activity

PPT Slide 24

5–10 mins

Knowledge Check 3 Answer

PPT Slide 25

5 mins

2-2 Analyze the extent of the health care spending problem.

Chapter Objective

Activity/Assessment

Source (i.e., PPT slide)

Duration

Self-Assessment

PPT Slide 34

10–15 mins

2-3 Evaluate the factors associated with spending growth.

Additional Discussion Question #1

Instructor’s Manual

5–10 mins

Polling Activity

PPT Slide 33

5–10 mins

2-4 Describe the nature and causes of the health care cost disease.

Polling Activity

PPT Slide 33

5–10 mins

Self-Assessment

PPT Slide 34

10–15 mins

Key Terms Premium: A periodic payment required to purchase an insurance policy. Gross domestic product (GDP): The monetary value of the goods and services produced in a country during a given time period, usually a year. Third-party payers: A health insurance arrangement where the individual, or agent of the individual, pays a set premium to a third party (an insurance company, managed care organization, or the government), which in turn pays for health care services. Primary and preventive care: Routine medical care and screening generally provided by physicians specializing in family practice, general internal medicine, and pediatrics. Price transparency: Readily available and easy-to-understand information on the actual prices paid for medical care services. The actual price paid is essential if consumers are to value and rank alternative treatment options and make informed decisions on the care they receive. Price discrimination: The practice of selling the same good or service to two different consumers for different prices. The price differential is not based on differences in cost. Dead weight loss: Cost to society stemming from a market failure to efficiently allocate resources. The resulting equilibrium fails to produce the socially optimum quantity of a good or service. Often cSMEsed by government actions such as taxes, subsidies, price controls, or other restrictions on the market.

Accountable care organization (ACO): An integrated care network of physicians, clinics, hospitals, and other health care providers who coordinate to provide comprehensive medical care to a well-defined population of patients. Disease incidence: The occurrence of new cases of a specific disease over a specific period of time. Equilibrium: The market-clearing price at which every consumer wanting to purchase the good finds a willing seller. Correlation: A simple association between two variables. The actions are related to one another without either one causing the other. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • •

Up-to-date discussion on rising health care spending among developed countries New perspective on the specific factors driving the increase in U.S. health care spending Additional appendix on the use of indices to account for inflation in health care expenditure data

Teaching Suggestions •

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In recent years, national media attention has periodically focused on the problems of the medical care sector. The “crisis” in medical care is well documented. Discuss the various meanings of the term crisis. Students will have some interesting perspectives on this issue. If you like to emphasize the incentives created by our third-party payment mechanism, make sure you at least mention “Spending Somebody Else’s Money.” When people spend their own money, they spend it differently than when they spend someone else’s money. Students will remember this example the entire semester and beyond. To make sure students have a strong footing for later chapters, it can be useful to list the various costs associated with each category of spending. That, along with a solid explanation, can help the class differentiate between the types of expenses and which ones account for the majority of national health spending. Students can often be overcome at first by the enormity of the health care spending question. Taking time to explain and discuss this issue can help your class better understand the arguments on both sides and why there is no right amount of health care expenditures.

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Real world examples are usually the best way to explain how we model health care spending, including Baumol’s model.

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Suggested Approaches to End-of-Chapter Questions 1. A crisis is defined in the dictionary as a critical time or occasion, or even an emergency. Students will approach this question differently. At this early juncture, many will be influenced by their own experience with the health care system. Those arguing that the United States has a health care crisis will likely cite the following: 1) rising costs and spending, 2) the changing demographics of the population, 3) the number of uninsured, and 4) health status comparisons with other developed countries. Those arguing against a health care crisis will likely argue that 1) even the uninsured have access to care through public hospitals and emergency rooms, 2) medical technology is more widely available in the United States than anywhere else in the world, and 3) confounding factors make international comparisons suspect. 2. Medical care spending is absorbing an increasing share of national output, at least up until the past two or three years. Whether this recent slowing in the percentage share of GDP will continue is debatable (and a good structured discussion topic). The reasons for high and rising spending include 1) the increased use of medical technology; 2) rising medical input prices; 3) an aging population; 4) the cost of medical malpractice litigation; and most importantly, 5) the third-party payment mechanism. 3. Cost containment is an important policy goal, as the health of the U.S. population is not the only important national goal. But cost containment may not be the most important national health care goal. The pursuit of cost-effective delivery makes more sense from an economic perspective. Other health care goals include improving access for the uninsured and quality for everyone. Note, however, that these latter goals tend to drive up costs. 4. Scarcity in economics is the recognition that all resources are limited relative to wants that are unlimited in the aggregate. Scarcity forces us to make choices. Unpredictability will be present in any complex system, and the health care market is certainly a complex system. Additionally, it contains contradictions, and there are some questions for which we simply don’t have the answers. Entry barriers include providers’ market power; inefficient provider systems; and in some areas, insufficient competition. Because a patient does not have medical knowledge, the patient must trust in the physician to act for the patient’s interest above the physician’s own interest. But many physicians today have diagnostic “side” businesses through which they earn money when they refer patients. Patients do not have the complex medical knowledge to make decisions and thus suffer from asymmetric information. Each insurer has its own system of payment, co-payment, life-time caps, and so on. All of these distortions appear in other markets, as well. [return to top]

Additional Questions for Discussion and Evaluation 1. Outside of government itself, the largest industry in the United States is health care. Over the past several decades, costs in the health care industry have been increasing at a much faster rate than the rate of inflation in general. Why? Cite relevant empirical evidence to support your answer. 2. How much do Americans spend on medical care? Why do they spend so much? How does U.S. spending compare with that of other developed countries? Are we getting our money’s worth? Be somewhat specific. 3. Give consumers more information and let them choose the best provider and the resulting competition will help to squeeze out costly waste and ineffective care. After all, markets work pretty well for other goods and services. The notion has some appeal, and a dose of market medicine would help some of what ails the nation's health care system. But as a cure, the approach rests on the belief that health care is—in most respects—like any other product. a. How is medical care different from other nonmedical goods and services? How is it the same? b. What are the essential characteristics that are required for a market to exist? c. How can the medical marketplace be made more efficient? 4. Discuss the following: The demand for medical care is irregular, resulting primarily from the onset of an illness; there are widespread information problems; uncertainty is exceptionally problematic; there is a reliance on not-forprofit providers; and we pay for it with other people’s money. 5. The 1980s were characterized by a dramatic change in the way Americans paid for medical care—retrospective to prospective. Define the two concepts and explain how the way we pay affects the care we receive. [The two concepts are defined in the glossary: Retrospective payment establishes incentives to overtreat. Prospective payment creates incentives to withhold care.] 6. Discuss the opportunity cost of health care in terms of education. Why do you suppose taxpayers are willing to invest in an inefficient health care system with excess hospital capacity but unwilling to invest in an underfunded education system? 7. “Nobody spends other people’s money the way they spend their own money.” Comment on this statement. The president’s health policy adviser Zeke Emanuel said the following about the U.S. healthcare system in a November 23, 2008, Washington Post article, “We have the most expensive system in the world per capita, but we lag behind many developed nations on virtually every health statistic.” Comment on the two parts of his statement. Provide evidence to support your answer.

Multiple Choice 1.

The “invisible hand” using Adam Smith’s terminology refers to

a. b. c. d. e. 2.

government control of the market. market forces working through the price mechanism. the money supply that serves to keep the economy working smoothly. the role of innovation in maintaining a steady rate of growth. “behind-the-scenes” policy making to influence how markets allocate scarce resources. According to recent public opinion polls, what percentage of Americans are satisfied with the quality of the medical care they receive? a. 15 percent b. 40 percent c. 65 percent d. 70 percent e. 90 percent According to economic theory what is the optimal percentage of GDP to be spent on medical care? a. 6 percent b. 8 percent c. 10 percent d. 12 percent e. There is no widely accepted way to determine the optimal percentage. The 1974 federal legislation that exempted employers from certain state laws governing health insurance was a. COBRA. b. ERISA. c. CON. d. HIPAA. e. SCHIP. Which of the following statements is based on positive analysis? a. Individuals without health insurance have less access to physicians’ services than those who have health insurance. b. The high cost of health insurance places U.S. firms at a competitive disadvantage with their foreign competitors. c. Employers should be required to provide health insurance for all full-time workers and their dependents. d. none of the above e. both a and b Economists use the term marginal to describe costs and benefits a. that are minimal and hardly worth noting. b. that are incremental and thus relevant to decision making. c. that are noteworthy but not the most important. d. whose importance can be minimized through hard work.

e. none of the above Which of the following is not a characteristic that makes medical care different from other commodities? a. Demand for medical care is irregular. b. Sellers have more information than buyers. c. Third-party payers abound. d. For-profit providers play a major role in delivering medical care. e. The transaction itself is filled with uncertainty.

8. Which of the following represents the largest category of health care spending in the U.S.? a. Physicians’ services. b. Hospital care. c. Prescription drugs. d. Home health care. e. Public health. 9. Which of the following measurements of health care spending adjusts for the population size? a. Nominal. b. Real. c. Per capita. d. Percentage of GDP. e. National. 10. Suppose you are a politician being criticized in a debate for your commitment to reducing the growth of medical spending. Which of the following is the most appropriate response? a. There is empirical evidence that medical spending should be capped at 15% of GDP. b. High health care spending is harmful to our economic well-being. c. Other developed nations spend far less of their GDP on health care. d. Fixing treatment prices will lead to greater innovation. e. Reducing wasteful health care spending could provide additional funding to the education sector.

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Appendix 2A: Using Indexes to Adjust Medical Spending for Inflation This appendix introduces students to the difference between nominal and real terms when reporting medical care spending data. It discusses the use of indices to account for inflation, such as the personal consumption expenditure (PCE) price index and the medical care price index (MCPI).

Appendix Outline a. Measuring price changes with index numbers b. CPI-U and PCE price indexes graph 1. MCPI-U and PCE health price indexes graph 2. Medical care price index c. Summary and conclusions d. References

Appendix Objectives 1. 2. 3. 4.

Understand the difference between nominal and real data. Explain how indexes can be used to account for inflation. Recognize the different types of health price indexes. Specify which indexes are more appropriate for the different measurements of health care spending.

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Table of Contents Instructor Manual ................................................................................................................................. 1 Table of Contents ....................................................................................................................... 1 Purpose and Perspective of the Chapter ................................................................................. 2 Cengage Supplements ............................................................................................................... 2 Chapter 3: Health Care Markets: Can They Work? .................................................................. 2 Chapter Outline.......................................................................................................................... 2 Chapter Objectives .................................................................................................................... 6 Complete List of Chapter Activities and Assessments ............................................................ 7 Key Terms ................................................................................................................................... 8 What's New in This Chapter .................................................................................................... 10 Teaching Suggestions .............................................................................................................. 11 Suggested Approaches to End-of-Chapter Questions .......................................................... 11 Additional Questions for Discussion and Evaluation ............................................................ 12 Multiple Choice ..................................................................................................................... 14 Appendix 3A: Causal Inference in Economics ....................................................................... 18 Appendix Outline ..................................................................................................................... 18 Appendix Objectives ................................................................................................................ 18

Purpose and Perspective of the Chapter The purpose of this chapter is to familiarize students with the underlying principles of economic theory. By introducing concepts such as optimization, supply, demand, and equilibrium, students will have the tools to start analyzing medical care markets and systems. A framework is then outlined to get students thinking about the many facets and areas of focus in health economics. To end the chapter, a substantial appendix explains several of the common methods and concepts associated with causal inference in economic research.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter 3: Health Care Markets: Can They Work? This chapter introduces the basic economics model of supply and demand and examines its use in the study of health care issues. A discussion of the principles of optimizing behavior sets the stage for the development of the model of demand and supply. Equilibrium and the essential elements for markets to function properly are then outlined before the text turns to examine health care markets and introduce the groundwork for health economics.

Chapter Outline I.

Economics as Science: Economic efficiency—a point at which average product is maximized and average variable cost is minimized—is considered from the fact that there are never enough resources to provide all the goods and services (termed scarcity). It is pursued in a way that maximizes the total benefit from the available resources considering opportunity cost (i.e., the potential benefit derived from its next-best alternative use) (PPT Slide 5). a. Economics is practiced through certain critical assumptions (rational behavior and rational ignorance), the scientific method (involving observations, an inquiry, theory, hypothesis formulation, and hypothesis testing), model building (e.g., models can study how demand for a test varies based on cost), problem solving (relying on rationality observations and optimization), and economic optimization (an optimal choice in line with objectives). Resolving the economic problem—what to produce, how to produce it, and who receives it—can be done by maximizing profits (given the technology and cost) and maximizing satisfaction subject to income and prices consumed (PPT Slides 6–8).

II.

III.

b. Recognizing an opportunity cost and self-interest (individuals are motivated or incentivized to promote their own interests) is an important aspect in economics. In an opportunity cost, every resource consumed in one activity cannot be used elsewhere; in developing self-interest, appropriate incentives can lead to cost-conscious decision making and the efficient use of resources (PPT Slides 9–12, 59, & 60). Basic Model of Supply and Demand: Supply and demand are the two most useful concepts in economics. Some factors affecting demand are the price of the commodity, the number of consumers, and consumer income, preferences, and expectations (PPT Slides 16 & 17). a. Demand going down with price increase is known as the substitution effect, while spending more for one item affecting spending for everything else is known as the income effect. Perfectly elastic demand occurs if demand falls to zero for any change in price (the condition at which consumers are intolerant of even small changes in price and refuse to buy the item if its price goes up) (PPT Slide 18). b. The law of supply states that the amount of a commodity is directly related to the reward for making it available. A change in any of the factors that affect the level of supply results in a shift in the supply curve and a change in the availability of the commodity or service at any given price (PPT Slides 19 & 20). c. The equilibrium price is the market price when the quantity demanded equals the quantity supplied. It is when buyers seek the lowest price that producers are willing to accept and sellers seek the highest price that consumers are willing to pay (PPT Slides 21 & 22). d. There are certain elements for markets to work: buyers and sellers being free to exchange in an open market; buyers being able to understand the nature of goods, quality, and all applicable prices; and buyers in a position to spend their money wisely, in a cost-conscious manner. Cost-conscious spending is defined as spending one's own money that enables one seeking the greatest value with cost-benefit analysis (PPT Slides 25 & 26). The Medical Care Marketplace: Proponents of more government involvement in medical care argue that the U.S. system has remained market based, realizing that government-run programs are costly. The preamble to the original Medicare bill actually prohibited any federal “supervision or control over the practice of medicine or the manner in which medical services are provided” (PPT Slides 28 & 29).

a. The following contribute to the uniqueness of medical care as a commodity: unpredictability in demand (we can rarely predict the onset of an injury or illness), asymmetric information (there are difficulties in collecting information about a product), trusting providers (because of information imbalance), barriers to entry (there are licensing requirements and educational standards for providers) and payment practices (patients seldom pay directly but through third-party insurance). Another interesting feature of the market for medical care is the widespread reliance on not-for-profit providers; "not-for-profit" means decision making without the influence of self-interest on the part of providers (PPT Slides 30 & 35). b. Medical care has the following characteristics similar to other markets: unpredictability (we can predict the number of people suffering from a particular medical condition within a large group of individuals), asymmetric information (we get our information from advice of friends and family, print media, and the Internet), trusting providers (as we place our well-being in the hands of bus drivers, mechanics, and food handlers), barriers to entry (many occupations require extensive training and credentialing), and payment practices (if insurance functions as insurance, the market distortions would be minimized). The challenge faced in using economic theory—understand resource allocation and pricing decisions—is not whether the theory is applicable but how to apply it (PPT Slides 31–34). c. Health economists examine a range of issues from the nature and production of health to the microeconomic evaluation of health care interventions and strategies. The economic framework that considers medical care as one of the factors (Grossman, 1972) encompasses nine elements: 1. Nature of Health (measuring health and quality of life); 2. Production of Health (income, wealth, education, genetics, and medical care); 3. Population Health (individual behavioral and physiological risk factors interact with socioeconomic and environmental factors to create disparities in health outcomes); 4. Microeconomic Evaluation; 5. Demand for Health Care (considering improving health to be one way to increase future productivity); 6. Supply of Health Care (production theory, input markets, and industrial organization); 7. Market Equilibrium (allocating scarce resources effectively to be productive by establishing price); 8. Macroeconomic Evaluation (system performance, accessibility, affordability, and quality compared to other developed countries); 9. Health Policy and Planning (the interaction of private sector, government, and nongovernmental

IV.

organizations in setting national goals and establishing rules) (PPT Slides 38, 43–46, 49–58, 61–64, & 67). Summary and Conclusions: Knowing and applying economics involves analyzing opportunity cost and responding to incentives and constraints (by economizing behavior and then improving efficiency and equity by costconscious behavior, self-interest, and competition (substitutes are available, and demand is sensitive to price changes). As concern over the growth in spending escalates, it is important to understand economic theory and how to apply it (PPT Slide 40).

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Profile: Kenneth J. Arrow Issues in Medical Care Delivery • Economics versus Epidemiology •

Is “Safe” Sex Really Safe?

•

Spending Somebody Else’s Money

•

A New Form of Competition in Medical Markets: Medical Travel John Snow and the Beginning of Epidemiology

•

Back-of-the-Envelope • Using Game Theory to Study Economic Behavior • How to Survive Supply and Demand

Applied Micro Methods • The Effect of Financial Incentives on Organ Donations • Effect of the Dependent Mandate on Insurance Premiums • Does Maternal Bed Rest Improve Birth Outcomes? • Does Obesity Increase Medical Care Spending? • Does the Consumption of Trans -Fat Contribute to Heart Disease? • How Do Minimum Age Laws Affect Alcohol, Tobacco, and Marijuana Use?

Chapter Objectives The following objectives are addressed in this chapter: 1. 2. 3. 4. 5.

Explain the relevance of economics in studying health care issues. Summarize the basics of how markets work. Analyze the nature of cost-conscious behavior. Analyze problems associated with medical care markets. Apply the structure and applications of health economics.

Complete List of Chapter Activities and Assessments Chapter Objective

Activity/Assessment

Source (i.e., PPT slide)

Duration

3-1 Explain the relevance of economics in studying health care issues.

Additional Discussion Questions #2 & 4

Instructor’s Manual

5–10 mins

Knowledge Check 1 Activity

PPT Slide 13

5–10 mins

Knowledge Check 1 Answer

PPT Slide 14

5 mins

Additional Discussion Questions #1, 5, 6, 8, & 10

Instructor’s Manual

5–10 mins

Knowledge Check 2 Activity

PPT Slide 23

10–15 mins

Knowledge Check 2 Answer

PPT Slide 24

5–10 mins

3-3 Analyze the nature of costconscious behavior.

Additional Discussion Question #9

Instructor’s Manual

5–10 mins

Polling Activity

PPT Slide 27

5–10 mins

3-4 Analyze problems associated with medical care markets.

Additional Discussion Questions #3, 6, & 7

Instructor’s Manual

5–10 mins

Knowledge Check 3 Activity

PPT Slide 36

5–10 mins

Knowledge Check 3 Answer

PPT Slide 37

5 mins

Knowledge Check 4 Activity

PPT Slide 47

5–10 mins

Knowledge Check 4 Answer

PPT Slide 48

5 mins

Knowledge Check 5 Activity

PPT Slide 65

5–10 mins

3-2 Summarize the basics of how markets work.

Chapter Objective

3-5 Apply the structure and applications of health economics.

Activity/Assessment

Source (i.e., PPT slide)

Duration

Knowledge Check 5 Answer

PPT Slide 66

5 mins

Additional Discussion Question #9

Instructor’s Manual

5–10 mins

Key Terms Economic efficiency: Producing at a point at which average product is maximized and average variable cost is minimized. Scarcity: A situation that exists when the amount of a good or service demanded in the aggregate exceeds the amount available at a zero price. Opportunity cost: The cost of a decision based on the value of the foregone opportunity. Invisible hand: A metaphor introduced by Adam Smith describing the role that markets play in promoting the efficient allocation of resources. Prisoner’s dilemma: A paradox in game theory where players acting in their own selfinterest choose their dominant strategies and do not achieve the optimal outcome. In such cases, cooperation, not competition, will result in a more profitable outcome. Nash equilibrium: A situation that emerges when all players in a noncooperative game choose their dominant strategy and have nothing to gain (and can only lose) by changing from their initial strategies. Rational behavior: A key behavioral assumption in neoclassical economics that decision makers act in a purposeful manner. In other words, their actions are directed toward achieving an objective. Microeconomics: The study of individual decision making, pricing behavior, and market organization. Rational Ignorance: A state in which consumers stop seeking information on a prospective purchase because the expected cost of the additional search exceeds the expected benefits. Incentives: Anything that motivates individuals to take certain actions.

Economizing behavior: When individuals choose to limit their demand for goods and services voluntarily to save money. Optimizing behavior, or optimization: A technique used to determine the best or most favorable outcome in a particular situation. Economic problem: A problem of resource allocation faced by all decision makers: what to produce, how to produce it, and who receives it. Marginal cost: The change in total cost resulting from a one-unit change in the level of output. Marginal benefit: The change in total benefits resulting from a one-unit change in the level of output. Quality-adjusted life years (QALY): A measure of the effectiveness of a medical treatment that captures improvements in the quality of life as well as extensions in the length of life. Risk: A state in which multiple outcomes are possible, and the likelihood of each possible outcome is known or can be estimated. Self-interest: A behavioral assumption of neoclassical economics that individuals are motivated to promote their own interests. Substitution effect: Describes how a change in the price of a good changes the quantity of a good demanded resulting from the consumer’s willingness to shift demand to goods that have become relatively cheaper. Income effect: Describes how a change in the price of a good can change the quantity of a good demanded resulting from the change in the consumer’s purchasing power. Not-for-profit: A business classification that is exempt from paying most taxes. In return for this tax-exempt status, the firm is restricted in how any operating surplus may be distributed among its stakeholders. Observational study: Studies where the researcher observes the effect of a treatment on individuals without trying to influence who receives the treatment. Randomized controlled trial (RCT): A study where participants are randomly assigned into treatment and control groups. The only expected difference between the two groups is the outcome. Treatment group: As part of an experiment, the group that actually receives the treatment, sometimes called the experimental group. Control group: As part of an experiment, the group that receives the standard treatment, a placebo, or no treatment at all.

Causation: Indicates a cause and effect relationship; in other words, a particular action results in a specific outcome: action A causes outcome B. Endogeneity: Introduces bias in an empirical estimate when there is a correlation between the covariates and the error term in the model. Treatment effect: Causal effect of a given intervention or policy change on an outcome, affecting one group (the treatment group) and not others (the control group). Covariates: Characteristics of the participants in an empirical study (not including the treatment effect), such as demographic information and other confounding variables. Identification strategy: The approach used to identify a control group that approximates random selection when using observational data. Average treatment effect (ATE): A value used to compare the difference in the average outcome of an intervention between members of the treatment group and the control group. Parallel trends: An essential assumption required to implement the difference-indifferences methodology. The outcome being studied must exhibit the same pretreatment trend in the two comparison groups. Common shocks: Required assumption that both treatment and control groups experience the same external shocks during the study period (except of course the actual treatment effect itself). Applied research: Research whose purpose is typically the commercialization of a product. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • • •

Improved presentation of the basic economic principles An in-depth discussion of Arrow’s unique characteristics of medical care as a commodity and their relevance almost 60 years later New and updated case studies to help reinforce the learning objectives through applied thinking A thorough appendix that outlines key concepts in causal inference and common empirical strategies used to reduce selection bias

Teaching Suggestions •

• • •

•

Consider breaking out your class into groups of three to five students. Each group will discuss the following for 5 to 10 minutes: economic efficiency, opportunity costs, equilibrium and scarcity. Discuss how to start analyzing medical care markets and systems, using the tools we have presented in this chapter. Students, especially those without an economics background, seem to enjoy a class discussion of “How to Survive Supply and Demand.” Most have good intuition and just need to be reassured that it is useful in an economics class. A brief graphical discussion of nominal vs. real terms is a good way to introduce the concept of inflation in reporting health care spending. It will help to avoid losing students who are unfamiliar with the core principles of economics. Depending on your class makeup, you may spend a lot or a little time on this chapter. Students without much economics knowledge should focus on the underlying theories addressed in the chapter. If you have more advanced students, you may want to spend some time discussing the statistical appendix at the end of this chapter. While most of my advanced students have had a class in econometrics, even they seem to appreciate the review.

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Suggested Approaches to End-of-Chapter Questions 1. a) Classifying tobacco as an addictive substance will cause the demand curve to shift to the left; price and quantity will go down. b) Raising the excise tax on tobacco products is shown by a leftward shift in the supply curve; prices will rise and quantity will fall. c) Destruction of the tobacco harvest is depicted by a leftward shift in the supply curve; prices will rise and quantity will fall. d) Settlement of the lawsuit will increase the cost of making tobacco products available to consumers. This is depicted by a leftward shift in the supply curve; prices will rise and quantity will fall. e) The information raises the cost of drinking coffee. When the cost of a substitute increases, the demand for cigarettes rises. This is depicted by a rightward shift in the demand curve; price and quantity rise. 2. Economics provides guidelines for resource allocation decisions. By considering the implications of scarcity of resources, economics brings a measure of objectivity into the discussion. We are limited by the equity-efficiency trade-off, especially in health care delivery, where issues of life and death and pain and suffering are frequently addressed.

3. False. Immutable may be too strong for the statement. We see policies, decisions, and actions that affect supply and demand curves all the time. Excise taxes affect supply curves. Subsidies and advertising affect demand curves. 4. a. b. c. d. e.

Normative (but may be based on positive research). Normative. Positive. Positive. Normative (but may be based on positive research).

5. a. The coefficient 0.11 indicates that a $1,000 increase in per capita

national income will result in a $110 increase in health care spending. b. Complete the table. Income $10,000 20,000 30,000 40,000 50,000

Health Care Spending $ 561.7 561.7 2,761.7 3,861.7 4,961.7

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Additional Questions for Discussion and Evaluation 1. What are the likely consequences of the following events in the U.S market for cosmetic surgery? Does the supply curve or the demand curve shift? In which direction? State whether the equilibrium price and quantity increase, decrease, or stay the same. Show the changes using a standard diagram with an upwardsloping supply curve and a downward-sloping demand curve. a. Health insurance coverage is expanded to cover all elective procedures, such as tummy tucks, nose jobs, and liposuction. b. The Food and Drug Administration (FDA) takes all silicone-based implants off the market fearing a connection with certain connective-tissue diseases. c. Personal finance companies start a nationwide lending program for cosmetic procedures not covered by health insurance. d. Medical malpractice insurance premiums increase for plastic surgeons. e. Medical schools announce that residents in plastic surgery can be licensed after only five years instead of the current seven years. 2. As an economist, how do you define the optimal rate of output? How well are the criteria for optimization met in medical care?

3. How does the difficulty in acquiring and understanding medical information affect the price and quality of medical care? How will the widespread access to the Internet affect medical care delivery in the future? 4. Some critics of using economics in medical decision making confuse resource allocation with resource rationing. What is the difference between the two concepts? 5. The following table depicts the weekly demand and supply of office visits at a local children’s clinic staffed by four physicians. Price per visit $20 25 30 35 40 45 50

Quantity demanded 300 275 250 225 200 175 150

Quantity supplied 150 175 200 225 250 275 300

a. What are the equilibrium price and quantity of office visits per week? b. If one of the physicians moves to another city, reducing quantity supplied by 25 percent, what are the price and quantity at the new equilibrium? c. Assuming the original four physicians, if a price ceiling is set at $25 per office visit, how many office visits will be demanded per week? How many will be supplied? Describe the outcome of such a policy. 6. Using supply and demand analysis, show graphically and explain verbally some of the factors that may have led to rising health care expenditures in the United States between 1960 and 1999. 7. A number of different factors are responsible for the health care price increases. Draw a supply and demand diagram of the market for health care and mark the initial equilibrium price and quantity. Then explain and show the effects of: a. new medical treatments b. minimum hospital stays c. resistance to mandatory referrals before seeing a specialist d. higher payments to doctors 8. Draw a supply and demand diagram of the market for health care and mark the initial equilibrium price and quantity. Then explain and show the effects of: a. higher deductions from employees' pay for health care b. charging patients more for more costly treatments c. preventive health care

9. Most developed countries have some form of a national health plan. A number of possible plans have recently been proposed in the United States with price tags of upward of $200 billion per year (depending on the extent of coverage). An important question in choosing among such plans is how their adoption will affect demand (moral hazard). The empirical question is how large the increase in demand might be. 10. Estimates of the price elasticity of demand for medical services vary with –0.2 to –0.40 being a representative range. A figure in this range might be a starting point in predicting the effect of health insurance on medical demand. Of course, the above figures apply to all medical services, and, as we know, some price elasticities are likely to differ (such as demand for hospital stays v. office visits to physicians). On the other hand, estimates of price elasticities for more discretionary services (dental care, ophthalmologic care, and psychiatric counseling) tend to be higher. a. Interpret a price elasticity coefficient of –0.2. b. Does the relatively high-price elasticity of demand for some medical services imply that these services are not really "necessary”? Should health care planners use such elasticity estimates as a guide for the kinds of services people really need, or are there important drawbacks to basing such a judgment on people's responses to prices? How would you judge what medical services are really necessary for a person's well-being? c. Isn't the use of demand concepts in the health care field inappropriate because physicians, not the patient, determine a great deal of medical demand? Is there any reason for physicians to take the price of a service into account when deciding what to prescribe?

Multiple Choice 1.

An inferior good a. has a negative income elasticity. b. is one where the demand curve shifts to the left when income goes up. c. exists only in theory. d. is a low-quality good. e. both a and b. Which of the following will not change the demand for office visits to the physician? a. Unusually cold and damp weather during the winter b. A change in the price of an office visit c. Layoffs at the local plant, causing a decrease in the number of people with health insurance in the community d. Television advertising by drug manufacturers to promote a new over-the-counter influenza treatment e. All these responses change the demand for office visits.

3. Which of the following will not cause a shift in the medical care supply curve?

a. A change in the cost of medical school tuition b. A change in the percentage of the population with health insurance c. A change in the amount of student aid available to promising undergraduate students studying biology d. A change in the number of high-profile medical malpractice lawsuits brought against physicians increasing the premiums on malpractice insurance e. A wave of union activity that increases the average salaries of nurses nationwide Supply curves are positively sloped because of a. inefficient allocation of resources. b. the law of diminishing returns. c. economies of scale. d. self-interested suppliers seeking economic profit. e. all of the above. A shortage of hospital beds will likely lead to a. an increase in the supply of hospital beds. b. a decrease in the demand for hospital beds. c. an increase in the price of a hospital stay. d. a decrease in the price of a hospital stay. e. none of the above. Suppose angioplasty and coronary artery bypass graft (CABG) surgery are substitute treatment alternatives for coronary artery disease. What should happen to the equilibrium price and quantity of angioplasty procedures if a new CABG technique is introduced that is less invasive (requiring a 4-inch incision under the breast bone rather than cracking open the patient’s rib cage) and requires one-third the recovery period of regular CABG surgery? a. Both price and quantity will increase. b. Both price and quantity will decrease. c. Price will increase and quantity will decrease. d. Price will decrease and quantity will increase. e. The introduction of a new CABG procedure should have no effect on the price or quantity of angioplasty procedures. Suppose the market for hospital outpatient treatment is in equilibrium when a price ceiling is set below the equilibrium price. What do you expect to happen? a. A surplus will develop. b. A shortage will develop. c. Quantity demanded will decrease. d. The number of outpatient visits will rise. e. The demand for outpatient procedures will fall.

8. A physician’s office expenses increase 10 percent, so they decide to raise the price of office visits. Assuming the demand curve for office visits does not shift, what will happen to the total number of office visits and practice revenues? a. Office visits and total revenue stay the same if demand is elastic. b. Office visits and total revenue rise if demand is inelastic. c. Office visits and total revenue fall if demand is inelastic. d. Office visits will fall and total revenue will rise if demand is inelastic. e. Office visits will rise and total revenue will fall if demand is elastic. For questions 9–12, use the following scenario. You are a consultant and have been employed by Urban General, a large inner-city hospital, to estimate the demand for its services. Your research indicates that the income elasticity of demand for the target market is +0.50; the price elasticity of demand is –0.15; and the cross-price elasticity of demand with respect to the price of services at St. Elsewhere, a near-by hospital, is +0.35. Answer the following questions.

9. The price of services at St. Elsewhere falls by 10 percent. What happens to the quantity of services demanded at Urban General? a. Quantity demanded rises by 35.0 percent. b. Quantity demanded falls by 3.5 percent. c. Quantity demanded falls by 1.5 percent. d. Quantity demanded rises by 5.0 percent. e. Quantity demanded stays the same. 10. The price of services at Urban General falls by 10 percent. a. Quantity demanded at Urban General increases by 15.0 percent. b. Quantity demanded at Urban General increases by 1.5 percent. c. Quantity demanded at St. Elsewhere rises by 3.5 percent. d. Quantity demanded at St. Elsewhere falls by 5.0 percent. e. Quantity demanded at Urban General rises by 5.0 percent. 11. Area income increases by 20 percent. a. Quantity demanded at Urban General does not change. b. Quantity demanded at Urban General falls by 10.0 percent. c. Quantity demanded at Urban General rises by 10.0 percent. d. Quantity demanded at St. Elsewhere rises by 7.0 percent. e. There is not enough information to tell what happens to quantity demanded at either hospital. 12. What is the cumulative effect of a simultaneous increase in area income of 5 percent and a 10 percent increase in prices at Urban General? a. Quantity demanded at Urban General falls by 4 percent. b. Quantity demanded at Urban General rises by 4 percent. c. Quantity demanded at Urban General rises by 1 percent. d. Quantity demanded at Urban General falls by 1 percent.

e. Quantity demanded at Urban General does not change. 13. Suppose the demand curve for medical care services is perfectly inelastic. What will happen to the equilibrium price and quantity if supply increases? a. Price and quantity will rise. b. Price will stay the same and quantity will rise. c. Price and quantity will fall. d. Price will fall and quantity will increase. e. Price will fall and quantity will stay the same. 14. Within the framework of economics, optimization means providing a good or service until a. total benefits are maximized. b. total benefits and total costs are equal. c. marginal benefits exceed marginal costs by the greatest amount possible. d. marginal benefits and marginal costs are equal. e. total benefits are greater than total costs at any level. 15. The dead-weight loss from an excise tax a. is greater if demand is perfectly inelastic. b. is caused by a shift in consumer preferences when the tax is raised. c. is the lost surplus that results from higher prices and lower output resulting from the tax. d. is of little concern to policy makers since all excise taxes are “sin” taxes. e. is the difference between consumer surplus and producer surplus. 16. Suppose the U.S. Drug Enforcement Agency steps up its efforts to control the illegal importation of cocaine into the United States. What is the likely effect on the market for illegal drugs in the United States? a. The price of cocaine and the quantity imported will both increase. b. The price of cocaine is likely increase and the quantity entering the country decrease. c. The price of marijuana, a cocaine substitute grown domestically, will fall. d. The policy will have the least impact on those individuals whose demand for drugs is elastic. e. Demand for drugs is highly inelastic and these policies have little or no effect on consumption. 17. Suppose robotic technology improves the results of abdominal surgery—less

time to perform the surgery, faster recovery times, and fewer mistakes. What is the impact on the market for abdominal surgery using this new technology? a. Demand for robot-assisted surgery will increase. b. Hospitals will be slow to adopt the new technology, fearing that it may result in lower prices. . c. The demand for surgical assistants will increase. d. All of the above.

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Appendix 3A: Causal Inference in Economics This appendix presents key concepts related to causality. The first section addresses issues related to selection bias in observational studies, while the second describes some of the more common empirical strategies employed by economists to reduce the bias. [return to top]

Appendix Outline 1. Selection bias in observational studies: Correlation is not causation a. Observational studies versus randomization b. The RAND Health Insurance Experiment 2. Empirical strategies to reduce selection bias a. Difference-in-differences approach b. Propensity score matching c. Instrumental variables d. Synthetic control e. Regression discontinuity 3. Summary and conclusions 4. References [return to top]

Appendix Objectives 1. Understand the difference between causation and correlation. 2. Recognize the issue of selection bias in observational studies. 3. Become familiar with empirical strategies used to reduce selection bias. [return to top]

Table of Contents Purpose and Perspective of the Chapter..................................................................................... 2 Cengage Supplements .................................................................................................................. 2 Chapter 4: Welfare Implications in Medical Markets .................................................................. 3 Chapter Outline ............................................................................................................................. 6 Chapter Objectives ........................................................................................................................ 2 Key Terms ....................................................................................................................................... 3 What's New in This Chapter .......................................................................................................... 6 Teaching Suggestions .................................................................................................................... 9 Suggested Approaches to End-of-Chapter Questions ................................................................ 9 Additional Questions for Discussion and Evaluation ............................................................... 10 Multiple Choice ........................................................................................................................ 11 Structured Discussion:............................................................................................................. 14 Appendix 4A: The Economics of Consumer Choice .................................................................. 14 Appendix Outline ......................................................................................................................... 14 Appendix Objectives.................................................................................................................... 14 Appendix 4B: Production and Cost in the For-Profit Sector..................................................... 14 Appendix Outline ......................................................................................................................... 15 Appendix Objectives.................................................................................................................... 15

Purpose and Perspective of the Chapter The purpose of this chapter is to give students an understanding of competitive markets and the imperfections that can impede their efficiency and equity. It also outlines some of the various interventions that governments have attempted in order to address imperfections and the results they have had on the market. By teaching the costs and benefits associated with market-based and government-regulated systems, students will have the tools to critically analyze real-world issues in medical markets.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Understand the concept of social welfare in the market. 2. Apply the economic models of perfect and imperfect competition to medical markets. 3. Define market failure and understand its causes. 4. Recognize the role of imperfect information in creating market failure. 5. List the major arguments supporting government involvement in medical care. 6. Identify the costs of government regulation and the dangers of government failure.

Complete List of Chapter Activities and Assessments Chapter Objective 4-1 Explain the welfare implications of competitive markets.

4-2 Describe the impediments that prevent markets from promoting efficient

Activity/Assessment Additional Discussion Questions 1, 3, and 7 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment Additional Discussion Questions Knowledge Check 2 Activity Knowledge Check 2 Answer

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 7

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PPT Slide 46

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Instructor’s Manual PPT Slide 21

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PPT Slide 22

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Chapter Objective outcomes. 4-3 Evaluate the results of government intervention to address market failure. 4-4 Analyze the causes and consequences of market failure in medical markets.

Activity/Assessment Self-Assessment Additional Discussion Questions Knowledge Check 3 Activity Knowledge Check 3 Answer Self-Assessment Additional Discussion Question Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment

Source (i.e., PPT slide) PPT Slide 46 Instructor’s Manual PPT Slide 37

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PPT Slide 38

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PPT Slide 46 Instructor’s Manual PPT Slide 44

10–15 mins 5–10 mins

PPT Slide 45

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PPT Slide 46

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Key Terms Bilateral monopoly: When there is monopoly on the seller’s side of the market and monopsony on the buyer’s side. Monopsony: A situation in a market where there is only one buyer. Monopoly: An entity that is the sole supplier in a market and has total control of the supply of the goods or services produced. Market failure: A situation in which a market fails to produce the socially optimal level of output. Technical efficiency: Efficiency in production, or cost efficiency. Allocative efficiency: The situation in which producers make the goods and services that consumers desire. For every item, the marginal cost of production is less than or equal to the marginal benefit received by consumers. Case fatality rate (CFR): The number of deaths from a particular disease relative to the number of people diagnosed with the disease. Consumer surplus: A measure of consumer welfare calculated by the difference between the price that consumers are willing to pay and the price they actually pay.

Producer surplus: The total welfare a producer receives by producing and selling a good, measured by the difference between the net price they receive less the minimum price they are willing to accept (typically the cost of production). Optimal output level: A market equilibrium in which the marginal benefit received from every unit of output is greater than or equal to the marginal cost of producing each unit. The social optimum is that output at which the marginal benefit of the last unit produced is equal to its marginal cost. Monopoly power: When a firm is in a market where it can determine the price it charges. Herfindahl–Hirschman Index (HHI): A commonly used measure of market concentration comparing the market share of a firm relative to other firms competing in the same market. Positive analysis: A factually based statement whose validity can be tested empirically. Normative analysis: An economic statement based on opinion or ideology. Externality: A cost or benefit that spills over to parties not directly involved in the actual transaction and is thus ignored by the buyer and seller. Incidence: See disease incidence. Merit good: A good whose benefits are not fully appreciated by the average consumer and should thus be provided collectively. Non-rival good: A good or service that does not, when consumed by one individual, limit the amount available to anyone else. Nonexcludable good: A good or service that is difficult to limit to a specific group of consumers. In other words, if the item is available to anyone, it becomes available to everyone. Free rider: An individual who does not buy insurance, knowing that in the event of a serious illness, medical care will be provided free of charge. Dead-weight loss: Cost to society stemming from market failure to efficiently allocate resources. The resulting equilibrium fails to produce the socially optimum quantity of a good or service. Often caused by government actions such as taxes, subsidies, price controls, or other restrictions on the market. Price ceiling: A maximum price established by law, contract, or agreement. Type I error: Rejecting a hypothesis that is true. Type II error: Accepting a hypothesis that is false.

Asymmetric information: A situation in which information is unequally distributed between the individuals in a transaction. The person with more information will have an unfair advantage in determining the terms of any agreement. Price transparency: Readily available and easy to understand information on the actual prices paid for medical care services. The actual price paid is essential if consumers are to value and rank alternative treatment options and make informed decisions on the care they receive. Price discrimination: The practice of selling the same good or service to two different consumers for different prices. The price differential is not based on differences in cost. Moral hazard: Insurance coverage increases both the likelihood of making a claim and the actual size of the claim. Insurance reduces the net out-of-pocket price of medical services and thus increases the quantity demanded. Adverse selection: A situation where different parties in a transaction have access to different information that may be relevant to the exchange, placing one at a distinct advantage in the trade. Production function: A way to depict the relationship between the inputs in a production process and the resulting output. Isoquants: Literally “equal quantity.” A contour line that shows the different combinations of two inputs that produce the same level of output. Marginal rate of technical substitution (MRTS): As the amount of one input in a production process increases, the amount of the other input can be decreased without changing the level of output. Variable inputs: Inputs in the production process that are easily incremented. Fixed inputs: Inputs in the production process that are difficult to increment. Long run: The period of time where all inputs are variable. Short run: The increment of time where at least one input is fixed. Average product: Output per unit of input. Marginal product: The change in total product resulting from a unit change in input. Total product: Total output that results from using different levels of an input. Law of diminishing returns: The empirical observation that expanding the use of one input (holding all others constant) will eventually result in a decreasing rate of change in marginal productivity.

Isocost curve: A locus of points that shows the various combinations of inputs that have the same cost. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • •

•

A completely new chapter to focus solely on market imperfections and the effects of government intervention New and up-to-date case studies to help reinforce students’ understanding of welfare implications in medical markets An updated discussion of externalities, including the transference of costs related to transmission of COVID-19 and the lack of a market mechanism to address them Expansion of the section on Imperfections in Medical Markets to discuss issues related to pricing practices and third-party payers

Chapter 4: Welfare Implications in Medical Markets This chapter examines the applicability of the perfectly competitive model to medical markets. The causes and consequences of market failure in medical markets and the role of government in correcting these shortcomings are addressed. Strict reliance on government remedies is cautioned, as there is no guarantee that government can do any better than the market in the efficient and equitable allocation of scarce medical resources.

Chapter Outline I.

II.

Welfare Implications in Competitive Markets: In perfectly competitive markets, when everyone pays the same price for the good, there is no way to reallocate consumption without lowering overall consumer welfare, thus guaranteeing technical efficiency (efficiency in production or cost efficiency) and allocative efficiency (efficiency in the final distribution of consumption). Health care is subject to an equity-efficiency trade-off, and competitive markets are desirable to satisfy consumer preferences and have alternative sources of supply, thus adding the value of the goods and services in equilibrium (as marginal values and prices converge) (PPT Slides 5 & 6). Measuring Economic Welfare: Consider demand as the maximum price that consumers are willing to pay and supply as the minimum price that providers are willing to accept. a. Value depends on the consumer’s willingness to pay: In free markets, consumers do not pay more for a good than the subjective value they place

III.

IV.

on it. Consumer surplus is a condition in which consumers enjoy surplus value when time the value placed on an item exceeds its price. b. The opportunity cost used in production determines a producer’s willingness to provide goods and services. Producer surplus is defined as the difference between the price that is received and the minimum price that producers are willing to accept. Impediments to Market Efficiency: a. Market imperfections are exercise of market power (supply-side and demand-side imperfections), externalities (negative externality: external costs that consumers force others to pay; positive externality: marginal private benefit is less than the marginal social benefit), public goods (nonrival good: a good or service that does not limit the amount available to anyone else; nonexcludable good: a good or service that is difficult to limit to a specific group of consumers; free rider: one who does not buy insurance), and welfare implications (market power on the seller side: price less than monopolist—consumer surplus and dead weight loss; market power on the buyer side: price less than equilibrium—producer surplus and dead weight loss; external costs ignored by sellers and buyers result in total surplus as a fraction they enjoy; external benefits: non-buyers receive benefits from buyers who are unable to capture them; public goods provision: paying for good includes nonexcludable and non-rival, and government takeover results in too high price) (PPT Slides 9–20). b. Government involvement in health care results in regulations (price controls: quantity shortage as legal price is less than equilibrium; entry restrictions: regulators expanded restrictions and limit the number of suppliers; regulations on drugs and devices: Type I error: effective drug is rejected and Type II error: unsafe drug is approved), tax policy (income tax exclusions: more demand for insurance and overconsumption due to paying insurance premiums with before-tax dollars; excise taxes (rises the price of commodity; consumers buy less due to high price); subsidies: consumers purchase more and providers charge more), and welfare implications (price ceilings; entry restrictions; excise taxes; subsidies) (PPT Slides 23–36). c. Optimal decision making on the part of government will not occur for competing public policies. Imperfect government or imperfect markets should address effectiveness and fairness. Imperfections in Medical Markets: (PPT Slide 39) a. Asymmetric information occurs if distributed between the individuals in a transaction. All but a minority of consumers do not spend time and money to acquire information, so it is required to incentive them (PPT Slide 40).

b. Price transparency is readily available and easy to understand information on the actual prices paid for medical care services, and price discrimination is the practice of selling the same good or service to two different consumers for different prices. Government has the ability to improve efficiency in medical markets by eliminating the practice of price discrimination (PPT Slide 41). c. Moral hazard is defined as the subsidy provided by insurance distorts the desires of those who have insurance. Adverse selection is a situation where different parties in a transaction have access to different information that may be relevant to the exchange, placing one at a distinct disadvantage in the trade (PPT Slides 42 & 43). Summary and Conclusions: With complete knowledge of consumer preferences and producer capabilities, central planners could solve the efficiency problems. Markets sometimes fail to produce the optimal level of output, so policymakers should intervene only in those situations in which government action can improve welfare (PPT Slide 47).

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Teaching Suggestions •

• •

•

If you have not already done so, make sure you talk specifically about the goals of a medical care delivery system—low cost, wide access, and high quality. Economics is about trade-offs. Is there a better example of the dilemma facing policy makers? Before launching into a discussion of market failure, make sure you set up the conditions that must be present for markets to work efficiently. Spend some time discussing the common imperfections in medical markets— interdependence of supply and demand, third-party payers, and information problems. This is a good place to introduce government alternatives—regulation and collective provision. For balance, at least mention the concept of government failure. Collective action does not always solve the problem or sometimes creates new ones. If you make extensive use of indifference curves and isoquants, make sure you spend some time with the two appendices at the end of this chapter.

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Suggested Approaches to End-of-Chapter Questions 1. Market failure occurs when the level of output in a market is not optimal, when marginal benefits do not equal marginal costs for the last unit of output provided. Failure in medical markets is caused primarily by information problems, including provider-induced demand, moral hazard, adverse selection, and the third-party payment structure. 2. Evidence of market failure cited by proponents of a government-run system include exceptionally high administrative costs of a private insurance system, poor access for those without insurance, asymmetric information problems that give providers too much power in the decision-making process, and the free rider problem. 3. Since market failure in medical markets is primarily an information problem, proponents of government involvement argue that the only way to provide balance is through government action. If markets are failing to provide the optimal level of output, government can intervene by regulating prices to bring output closer to the optimal level or by subsidizing consumption of low-access groups. 4. Price controls work on changing the quantity demanded and the quantity supplied. Prices can be set through legislation, affecting quantities provided in the market and thus overall spending. Use the diagram shown in “Price Floors and Price Ceilings” on page 41.

5. Services are not standardized across providers, the number of providers is limited by licensing, and information is not easy to access or understand. These limitations provide at least a degree of market power for providers, giving them downward-sloping demand curves and the ability to charge prices that are greater than the marginal cost. [return to top]

Additional Questions for Discussion and Evaluation 1. What assumptions of the perfectly competitive economic model are violated that may lead one to question its validity in studying medical markets? 2. What is government failure? What are the possible reasons that government solutions may be no better than market solutions in medical care? 3. What are the three areas objectively used to evaluate the effectiveness of medical care delivery? Why are they important? [Cost, access, and quality.] 4. What is monopsony? What is the significance of an expansion of monopsony power in the medical marketplace? [Monopsony is a single buyer. As buyers get more powerful, they are better able to negotiate with large, powerful providers.] 5. One of the significant problems in medical care markets may be the information problem. Asymmetric information has led to two important defects in the medical marketplace. What are they? How do these defects affect medical markets? [Moral hazard and adverse selection.] 6. When President Obama signed the ACA, he declared it would "lower costs for families and for businesses and for the federal government." The early evidence contradicts his claim—private insurance costs are up, estimated health care spending is up, and Congress is already considering regulations to give states the power to reject rate requests that are considered “unreasonable.” To solve the spending problem, we must understand the causes. We have a strong consensus that health care spending is too high and growing too fast, but this has not led to agreement on the causes or the appropriate responses. a. What are the main cost drivers causing high and rising spending? b. Can we reduce spending and expand access to an additional 40 million Americans simultaneously? Explain. c. Are price controls the answer? How will they affect the health care market? 7. What are the benefits of a mass population vaccination program? What are the risks? Why do U.S. public schools require that students be vaccinated against certain diseases? Should citizens be free to choose whether to receive a vaccination? 8. Policymakers are divided on whether a “public option” should be included in the overall reform plan. Proponents argue that insurance companies do not really compete with each other and a government-run plan is the only way to ensure competitive markets.

a. What are proponents of the public option hoping that competition will accomplish? b. What are the essential factors that must exist for a new rival to increase competition in any market? Do these factors exist in this case? c. Name several examples of markets where the government competes directly with private firms. d. Do you think a government option increase competition in the insurance market? Explain.

Multiple Choice 1.

If a hospital is experiencing economies of scale, a. its average cost curve is positively sloped as output increases. b. its average cost curve is negatively sloped as output increases. c. it should reduce its output level to lower costs. d. quality is falling as output is rising. e. both b and c are true. When a physician knows more about alternative treatments than her patients, we say that _______ exists. a. rational ignorance b. perfect information c. asymmetric information d. moral hazard e. adverse selection Under which of the following circumstances is the principal–agent problem likely to be most serious? a. Between general practitioners and patients b. Between surgeons and patients c. Between hospitals and nurses d. Between dentists and physicians e. Between physicians and lawyers A patient has a medical condition, but he doesn’t know what it is. The physician he sees diagnoses his illness correctly. What term applies to this situation? a. Principle-agent problem. b. Rational ignorance. c. Externalities. d. Asymmetric information e. The substitution effect.

The market for medical care relies primarily on: a. For profit providers. b. Not for profit providers. c. Co-ops.

d. Hospitals. e. The substitution effect. 6.

Which of the following results from providers having more information about treatment alternatives than their patients? a. Principle-agent problem. b. Rational ignorance. c. Externalities. d. Adverse selection. e. The substitution effect. Nonexcludable and nonrival goods are known as a. Public goods. b. Private goods. c. Efficient goods. . d. Those which are the last to be purchased. e. There is no such thing as goods which are both Nonexcludable and nonrival. The optimal level of output may be defined as that level of output where a. average benefit exceeds average cost by the greatest amount. b. total benefit equals total cost. c. marginal benefit exceeds marginal cost by the greatest amount. d. the marginal benefit of the last unit purchased equals its marginal cost. e. it is impossible to define optimal in any meaningful way.

Inoculation programs against certain diseases such as small pox, polio, and whooping cough create a. b. c. d. e.

public goods. positive externalities in consumption. nonrival goods. nonexcludable goods. external costs to society equal to the costs of the program. 10. In which of the following countries would an increase in per capita income likely

result in the most improvement to health status of the population? (2006 per capita incomes in PPP dollars shown in parentheses.) a. b. c. d. e.

Mexico ($13,383) New Zealand ($26,068) Germany ($32,900) United Kingdom ($34,084) United States ($44,639)

11. Which of the following would likely lead to the greatest improvement in health

status of the population in the United States? a. Higher per capita incomes. b. More spending on public health, such as improved water supply and sanitation. c. More medical care spending overall.

d. Improved lifestyles, including reductions in the use of tobacco, alcohol, and drugs. e. More rural hospitals. 12. What measures would likely lower infant mortality rates in the United States? a. Prenatal care programs in low-income neighborhoods. b. Reduced drug use among expectant mothers. c. Better nutrition. d. Delaying childbearing beyond the teen-age years. e. All of the above. 13. Approximately what percentage of total health care spending goes toward

hospital care? a. b. c. d. e.

One-tenth. One-fifth. One-fourth. One-third. One-half.

14. Approximately what percentage of total health care spending goes toward physicians’ services? a. One-tenth. b. One-fifth. c. One-fourth. d. One-third. e. One-half. 15. A system financed primarily through retrospective fee-for-service insurance

reimbursement is: a. b. c. d. e.

A closed system. An open-ended system. A cost-plus system. An efficient system. Both b and c. 16. Which of the following might cause a market to produce a quantity that is less

than optimal? a. A price ceiling above the market equilibrium price. b. Market control by a monopolist. c. A subsidy to low-income consumers. d. None of the above. 17. Prospective payment in the hospital sector a. resulted in the hospital keeping any surplus payment. b. resulted in the hospital absorbing any loss from the payment. c. changed the incentive structure completely. d. all of these are true.

18. The government agency that controls the development and availability of new

medical discoveries, including pharmaceutical drugs is a. b. c. d. e.

the Health Care Financing Administration. the Food and Drug Administration. the Centers for Disease Control. the National Institutes for Health. the Federal Emergency Medical Administration.

Structured Discussion: 1. Resolved: Since government failure is inherently more serious than market failure, government regulation of the medical care industry should be kept to a minimum. 2. Resolved: Expenditures on health care in the United States are greater than is socially optimal. [return to top]

Appendix 4A: The Economics of Consumer Choice This appendix presents the theory of consumer behavior. Representing preferences and constraints, indifference curves and the budget line are used to illustrate how the consumer reaches equilibrium. [return to top]

Appendix Outline a. b. c. d. e.

Consumer preferences: Indifference curves Consumer constraints: The budget line Consumer choice: The concept of equilibrium Implications of the model Conclusions

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Appendix Objectives 1. Summarize the theory of consumer behavior. 2. Understand the role of consumer preferences and limited income in determining consumer equilibrium. 3. Identify situations where the model of consumer behavior may be applied. [return to top]

Appendix 4B: Production and Cost in the For-Profit Sector This appendix presents the theory of the firm in a for-profit environment. The model illustrates how the firm operating in a perfectly competitive market can maximize profit

using the least-cost combination of inputs in its production process. The connection between the firm’s cost curves and its production function is addressed, distinguishing between the short run and the long run. [return to top]

Appendix Outline a. b. c. d. e. f. g. h. i.

Production with two variable inputs Production isoquants Production in the short run Optimal input use Extensions of the model Estimating production functions Production to cost Long-run costs Conclusion

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Appendix Objectives 1. 2. 3. 4.

Summarize the economic theory of the firm. Use the graphical model of firm behavior to explain the theory of optimal input use. Explain how cost curves are derived from the model of short-run production. Develop the theory of long-run cost.

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Table of Contents Instructor Manual ................................................................................................................................. 1 Table of Contents ....................................................................................................................... 1 Purpose and Perspective of the Chapter ................................................................................. 2 Cengage Supplements ............................................................................................................... 2 Chapter Objectives .................................................................................................................... 2 Complete List of Chapter Activities and Assessments ............................................................ 2 Key Terms ................................................................................................................................... 3 What's New in This Chapter ...................................................................................................... 5 Chapter 5: Economic Evaluation in Health Care ...................................................................... 5 Chapter Outline.......................................................................................................................... 5 Teaching Suggestions ................................................................................................................ 7 Suggested Approach to End-of-Chapter Questions ................................................................ 8 Additional Questions for Discussion and Evaluation ............................................................ 14 Multiple Choice ..................................................................................................................... 16 Appendix 5A: Modeling Cost Effectiveness ............................................................................ 18 Appendix Outline ..................................................................................................................... 18

Purpose and Perspective of the Chapter The purpose of this chapter is to educate students on how decision makers use economic evaluation to help them choose between different programs and treatments. By describing some of the most common methods of economic evaluation, students should start to look at health care decisions from a researcher's perspective and to understand when and how to apply each type of analysis.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Understand the role of economic evaluation in health care. 2. Identify the different types of economic evaluation and recognize their distinctive characteristics. 3. Explain why scarcity and choice has culminated in the need for sound techniques of economic evaluation. 4. Apply the techniques of economic evaluation to simple resource allocation decisions. 5. Appreciate the importance of economic modeling in formulating a costeffectiveness study.

Complete List of Chapter Activities and Assessments Chapter Objective 5-1 Explain the inevitability of trade-offs in resource allocation.

Activity/Assessment Additional Discussion Question #7 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 11

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PPT Slide 12

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PPT slide 30

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Chapter Objective 5-2 Summarize the different types of economic evaluation and the necessary steps to carry out each approach.

5-3 Analyze the contribution of economic evaluation studies toward the allocation of scarce resources. 5-4 Evaluate the similarities and differences between costeffectiveness and comparative effectiveness.

Activity/Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 26

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PPT Slide 27

5 mins

PPT Slide 29 PPT Slide 30 PPT Slide 47

10–15 mins 10–15 mins 5–10 mins

PPT Slide 48

5 mins

Instructor’s Manual PPT Slide 29

5–10 mins

Self-Assessment Knowledge Check 3 Activity

PPT Slide 30 PPT Slide 39

10–15 mins 5–10 mins

Additional Discussion Questions #3, 5, 9, and 10 Self-Assessment

Instructor’s Manual PPT Slide 30

5–10 mins

Additional Discussion Question #8 Knowledge Check 2 Activity Knowledge Check 2 Answer Discussion Activity Self-Assessment Knowledge Check 4 Activity Knowledge Check 4 Answer Additional Discussion Question #4 Discussion Activity

5–10 mins 5–10 mins

10–15 mins

Key Terms Cost-of-illness studies: Value of the resources spent on a particular disease category; often called the burden of disease. Cost benefit: A procedure that compares the cost of undertaking a course of action and the resulting benefits expected to flow from that action. Cost-effectiveness analysis (CEA): Measuring the change in the cost of undertaking a specific course of action (compared to the next best alternative action) relative to the change in the health outcome of that action (compared to that same alternative).

Clinical pathway: Guide to evidence-based medical practice used to direct clinicians to follow recommended clinical procedures when treating patients with certain conditions. Marginal social benefit: The incremental benefit to society of producing and consuming an additional unit of a particular good. Marginal social cost: The incremental cost to society of producing and consuming an additional unit of a particular good. Rate of return: The amount earned on an investment translated into an annual interest rate. Basic research: Research whose purpose is to advance fundamental knowledge. Incremental cost-effectiveness ratio (ICER): A ratio used in cost-effectiveness analysis that compares the difference in the expected costs of two interventions relative to the difference in expected outcomes. Efficacy: The ability to achieve the desired result in an ideal setting under controlled conditions. Effectiveness: The ability to achieve the desired result under real-world conditions. Markov decision model: A mathematical model used to depict a situation where outcomes are partially determined by disease progression and partially under the control of a decision maker. Complete life: A utilitarian construct promoted by certain bioethicists that places a chronological age limit on the life worth living. After we reach a certain age (some say 75 years), our physical and mental capacity diminishes and we should not waste scarce medical resources to prolong life. Indirect cost: A cost that reflects the value the time taken from normal activities to receive medical care and recover from a procedure. Intangible cost: A cost that is not easily quantified, such as pain and suffering, anxiety, and disfigurement. Surrogate measure: A marker, or reliable substitute, for a disease process. Usually a laboratory measure such as high blood pressure and elevated cholesterol levels as a surrogate for heart disease. Intermediate measure: An outcome that occurs on the way to the final outcome, including heart attack, stroke, and scores on evaluative exams. Final outcome: The long-term results of a medical intervention, such as medical events prevented, deaths avoided, or life years saved.

Clinical endpoint: Usually represents a clinical outcome, such as survival, disease mitigation, or avoidance of a clinical event (such as heart attack or stroke). Often, more subjective measures, such as symptom scores or quality of life measures, are used. Standard gamble: Serves as the theoretical basis for expected utility theory. A measure of a person’s willingness to accept the risk of certain death to avoid the disutility of a particular health state. Decision tree: A tool that depicts a model of decisions and their consequences visually depicted by a treelike diagram that traces cause and effect. Markov model: A model used in health care evaluation to depict a disease process that evolves and progresses over time. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • •

Additional section of the text to explain comparative effectiveness analysis Updated applications in the Issues in Medical Care Delivery material to keep the text relevant to emerging questions in the medical field A new appendix to focus solely on modeling cost effectiveness and how economic evaluation works in the real world

Chapter 5: Economic Evaluation in Health Care This chapter introduces the student to the principles of economic evaluation as it is currently applied in health care. Focusing on cost-effectiveness analysis, the preferred technique for evaluating medical technologies worldwide, the chapter provides a basic overview of the economic evaluation process.

Chapter Outline I.

II.

Rationale for Economic Evaluation: Health benefits are an important part of the evaluation process, but resource costs must consider the value of the alternative uses of those resources. The change in costs has to be compared relative to the change in benefits against threshold. Types of Economic Evaluation: The quantification of the economic burden of a specific disease provides information on the cost structure related to that disease for a specific population in a well-defined geographic area. A different approach to economic evaluation should be followed for optimal resource allocation. a. Cost-benefit analysis involves two aspects: valuing benefits (always in monetary terms, but in practice, it uses the willingness-to-pay approach) and choosing a discount rate (the appropriate discount rate-the risk-adjusted rate

III.

IV.

of return on the next-best investment alternative-used to evaluate an investment depends on the opportunity cost of funds). One of the early applications of cost-benefit analysis in medical care is the classic study of poliomyelitis (Weisbrod, 1971). b. Cost-effectiveness analysis is a way to quantify trade-offs between resources used and health outcomes achieved without having to value in monetary terms. The incremental cost-effectiveness ratio compares the differences in costs and effectiveness of two treatment options. c. Comparative effectiveness research is a method that evaluates the benefits and harms of alternative methods to prevent, diagnose, treat, and monitor a clinical condition or improve the delivery of care (say, in terms of efficacy and effectiveness or using the Markov decision model). Supporters of the ACA felt that if the focus shifted from clinical effectiveness to cost effectiveness, it would result in health care rationing. Case Studies: a. The risk profile of the lung cancer screened population affects the cost effectiveness of the program. Even with the prospective life-saving consequences of CT screening, age and smoking status may not represent high enough risk factors to make population-based screening cost effective. b. Widespread screening of cervical cancer (the leading cause of death among women in the United States) has declined to less than 8 per 100,000. In a study of the social costs and quality-adjusted life expectancy of different testing strategies for cervical cancer, maximum benefit in terms of QALYs saved results from Pap plus HPV testing every two years until death with an incremental cost of $76,183. c. Eliminating the transmission of HPV types 16 and 18 through a widespread vaccination program would seem to eliminate cervical cancer. Kim and Goldie (2008) analyze the cost-effectiveness of vaccinating preadolescent girls compared with the current cytologic screening practices. d. A study in 2003 reviewed several studies on the effectiveness of donepezil and found that patients who received the drug recovered in less time in more severe states and improved quality of life. Donepezil was a costeffective treatment when prescribed to patients with mild to moderate Alzheimer’s disease. e. When measured by its cost-effectiveness, breast cancer screening is increasingly more expensive. In a study in 2009, strategies 1 and 2 are costeffective using standard guidelines, and strategy 5 is ACS guideline screening with the cost per added QALY still very high. Summary and Conclusions: CEA is the most effective technique for evaluating the economic efficiency of medical treatment options. The challenge for

supporters of applying cost-effectiveness methodology to resource allocation decisions in health care must address equity concerns, how to quantify them, and how to incorporate them into the decision-making process. [return to top]

Teaching Suggestions 1. I recommend that you devote at least two class sessions to this chapter—the first to introduce the theory of economic evaluation and the second to solve some problem. 2. I have my students do their first critical review paper on a published paper that incorporates a cost-effectiveness analysis. Use any good search engine, such as EconLit, and type “Cost effectiveness” and your favorite disease. The result should be a number of articles that are appropriate for your students to read and discuss. 3. Introduce this question early in the first session to stimulate discussion: The medical evidence is clear: Cervical cancer screening saves lives. Much of the focus of cost-effectiveness research addresses issues concerning the appropriate screening interval. D. M. Eddy (Screening for cervical cancer, Annals of Internal Medicine 113, 214–226, 1990) studied the issue and estimated that annual screening for a hypothetical cohort of 1,000 22-year-old women screened until age 75 would cost $1,093,000 and would save 27.6 life years. If screened every three years instead, the cost would be $467,000 and 26.8 life years would be saved. Is annual screening cost effective? First, lead the students through an exercise in calculating the ACER for one-year and three-year intervals. The ACER for annual screening is $39,600 and that for three-year screening is $17,425. You can have a little fun with the students by trying to get them to recommend the annual screening program, as a life-year is most definitely worth $39,600. Try to convince them that the appropriate way to look at this issue is by using marginal analysis. Then calculate the ICER (626,000/0.8): $782,500 pretty expensive for a life-year in almost everyone’s view. 4. For those interested in pursuing more complicated problems using decision tree and Markov decision models, download a 21-day trial version of DATA™ 4.0 Student from the TreeAge Web site at http://www.treeage.com. You can contact them at TreeAge Software, Inc., 1075 Main Street, Williamstown, MA, 01267, for information on site licensing options. [return to top]

Suggested Approach to End-of-Chapter Questions 1. The health authorities are considering the treatment alternatives for three types of diseases: heart disease, cancer, and infectious disease. Each year there are 10,000 new cases of heart disease, 10,000 new cases of cancer, and 5,000 new cases of infectious disease. For each diagnosis, there are a number of mutually independent treatment alternatives (including no treatment) as shown in the table below. Treatment Heart Disease A B C D E F Cancer G H I J K L M Infectious Disease N O P R

Cost per treatment

QALYs Gained

ICER=C/E

0 100 300 400 600 800

0 2 8 8 12 15

NER 300/8=37.5 Dominated NER 500/7=71.4

0 200 400 500 600 700 800

0 8 10 12 9 14 15

200/8=25 NER 300/4=75 Dominated 200/2=100 NER

0 100 350 650

0 2 4 6

100/2=50 250/2=125 300/2=150

NER = not economically rational due to extended dominance

a. Identify all dominated treatment alternatives. Explain why each is dominated. b. Calculate the incremental cost, incremental QALYs, and incremental costeffectiveness ratios (ICERs) for all economically rational strategies (ICER = incremental cost/incremental QALYs). Why are these considered economically rational? c. Using separate graphs for heart disease, cancer, and infectious disease, show the alternative treatment options, label the dominated options, and show the economically feasible alternatives. (Place QALYs on the vertical axis and cost per treatment on the horizontal axis.)

Heart Disease

0 0

100

300

400

600

800

Cancer

0 0

200

400

500

600

700

800

Infectious Disease

0 0

100

350

650

d. The local health district has asked your opinion on the “best” strategy from a public health perspective (disease covered, treatment strategy). What do you tell them? How much will it cost? 2. A recent article in JAMA by Mandelblatt et al. (2002) compared the societal costs and benefits of human papillomavirus (HPV) testing, Pap testing, and their combination to screen for cervical cancer. The paper studied 18 different population screening strategies—Pap testing alone, HPV testing alone, and Pap plus HPV testing—every 2 or 3 years for women beginning at age 20 and continuing to 65 years, 75 years, and death. The following table summarizes

some of the results (low cost to high cost). Costs include screening and treatment costs, discounted over the individual’s expected lifetime. Strategy

Cost ($)

QALYs Saved

Incremental Cost

Incremental QALY

Incremental CE ratio

0. No screening 1. Pap every 3 years to age 75 2. HPV every 3 years to age 75 3. Pap every 2 years to age 75 4. Pap + HPV every 3 years to age 75 5. HPV every 2 years to age 75 6. Pap + HPV every 2 years to age 75

5,000 6,825

26.87 27.02

1,825

.15

$12,137

6,950

27.02

125

Dominated

7,275

27.04

.02

22,500

7,400

27.04

325 450 125

Dominated

7,450

27.04

Dominated

7,925

27.05

475 650

.01

65,000

a. Identify all dominated screening strategies. Explain why each is dominated. b. Calculate the incremental cost, incremental QALYs, and incremental CE ratios for all economically rational strategies (incremental CE = incremental cost/incremental QALYs). Why are these considered economically rational? c. The local health district has asked your opinion on the “best” strategy from a public health perspective. What do you tell them? 3. The following information has been gathered on the costs and effectiveness of the two treatments, A and B. In this problem, costs and consequences are not discounted.

Mortality rate Life expectancy for survivors Initial treatment cost Follow up costs, year 1 Annual follow up costs, all subsequent years

Treatment A

Treatment B

2% 20 years $10,000 $5,000 $1,000

5% 10 years $3,000 $1,000 $500

a. What is the total cost for the survivors receiving treatment A? $34,000 For decedents (assuming sudden death)? $10,000 b. What is the total cost for survivors receiving treatment B? $8,500 For decedents? $3,000 c. What is the expected cost for those patients receiving treatment A?

A = (.02)(10,000) + (.98)(34,000) = 200 + 33,320 = 33,520 d. Treatment B? B = (.05)(3,000) + (.95)(8,500) = 150 + 8,075 = 8,225 e. Draw a simple decision tree showing the costs and consequences of each treatment option. f. Calculate the incremental cost and incremental benefit of the treatment alternatives. C = 33,520 – 8,225 = 25,295 E = 19.6 – 9.5 = 10.1 g. What is the ICER? ICER = C/E = 25,295/10.1 = 2,504 A new treatment is discovered that improves survival probability from 85 percent to 95 percent. Discuss the different ways a researcher might look at these results versus the way that the marketing department might discuss them. What is the difference in the way you would view a new treatment that improves survival probability by the same absolute magnitude, say, from 5 percent to 15 percent? How does cost–benefit analysis (CBA) differ from cost-effectiveness analysis (CEA)? The main difference is the way in which benefits are measured. With CBA, benefits are measured in currency units. With CEA, benefits are measured according to outcomes. Why has cost-effectiveness analysis become the method of choice for health economists around the world? It’s distasteful to put a monetary value on life. In what sense is a cost-of-illness study a technique of economic evaluation? In what sense is it not? What is the primary motivation for doing a cost-of-illness study? Calculating costs in an economic evaluation is very important. Classify the following costs as direct (D), indirect (ID), or intangible (IT). Cost

Classification

Transportation (ambulance or personal auto) Sick leave Informal care performed by spouse Visit to private practitioner Inpatient hospital stay Nursing home stay Reduced productivity at work Pain and suffering Home health care services Diagnostic test Surgical intervention Grief and anxiety

D ID ID D D D ID IT D D D IT

8. How would you explain the concept of a QALY? When is it appropriate to use QALYs instead of simply improved life expectancy as the outcome measure in an economic evaluation? 9. The following table represents the costs and benefits of four alternative clinical programs designed to treat a single disease. Benefits are measured in terms of the number of lives saved. Program

Cost ($)

Lives Saved

ICER

ACER

A B C D

100,000 100,000 200,000 200,000

10 12 12 15

Dominated Dominated 100,000/3 = 33,333

10,000 8,333 16,337 13,333

a. Finish the table. Which is the best program? In terms of the number of lives saved? In terms of the ICER per life saved? In terms of number of total lives saved, D is the best. In terms of average cost per life saved, B is the best. b. How does the cost-effectiveness ratio defined as the average cost per life saved differ from the ICER? Note the values are in terms of lives saved, not life years saved. c. Which program would an economist favor? What would your argument be? When comparing A v. B and C v. D, the call is an easy one. Almost everyone, not just economists would prefer B and D. Is a life worth $33,333? 10. A controversial new device, the implantable cardiac defibrillator (ICD), was used in a clinical trial to determine if it improved survival for heart attack patients over the standard drug treatment. The trial provided the following information. Two years after the first heart attack, 85 percent of the ICD patients were still alive, compared to 70 percent of the drug treatment group. No additional data is available after the 24-month trial. a. What is your best guess on survival probability after the trial is over? 4 years, 8 months b. Calculate the improvement in life expectancy during the trial. What is your best estimate of improved life expectancy after the trial? Improved LE during trial = ½ (15)(2) = 15 years Improved LE after trial = ½ (15)(4.67) = 35.025 years c. Graph the mortality function for both the ICD group and the drug therapy group. Shown below d. What is the difference in life expectancy between the two groups? 50.025 years

11. Choices in health care delivery must be made at two levels: (1) The individual physician prescribing a course of treatment for an individual patient, and (2) the policy maker determining the availability of medical care to an entire group of patients or a community. One way to choose among alternative treatment regimes and community programs is by using the criterion of economic efficiency. Briefly describe the three types of economic evaluation that enter into medical decision making. Discuss the unique features of each and describe their basic strengths and weaknesses. [return to top]

Additional Questions for Discussion and Evaluation 1. The public health director of a large city has a discretionary budget of $500,000 and wants to spend it to save as many lives as possible. Two of the approaches being considered seem most promising: high-blood pressure screening of the population and mobile cardiac arrest units. Medical studies indicate the following results for the two alternatives. High-blood pressure screening Age cohort Cost Total Lives Saved

Mobile cardiac units Units Cost

Over 65 55–64 45–54 35–44 25–34

1 2 3 4 5

$100,000 200,000 300,000 400,000 500,000

30 50 65 75 80

$100,000 200,000 300,000 400,000 500,000

Total Lives Saved 100 150 175 190 200

The public health director hires you to solve a dispute among members of her staff. A vocal segment of the staff argues that the entire budget be spent on mobile cardiac units (saving a total of 200 lives) rather than on high-blood pressure screening (saving only 80 lives). What do you recommend? What economic principle did you use? 2. The Food and Drug Administration (FDA) is expected to revoke approval of the drug Avastin for the treatment of stage IV breast cancer. The drug is expensive (about $93,000 per year) but it works—shrinking tumor size by as much as 50 percent, slowing the disease progression, and extending life. But after examining patient outcomes, the FDA’s Oncology Drug Advisory Committee could find no significant increase in “overall survivability.” If Avastin’s approval is revoked, this will be the first time that the FDA has taken a cancer drug off the market solely for this reason. a. In her article, “The Era of Rationing Begins,” Pacific Research Institute’s Sally Pipes views these actions the first steps toward rationing. Is she right, or is it simply a result of following the logic of comparative effectiveness research? b. For patients known as “super responders,” the drug extends life by years. How should this be factored into the FDA decision? c. Are cost considerations legitimate when patients’ lives are at stake? Explain. 3. In his film Sicko, Michael Moore laments that a man died when he didn’t receive a bone marrow transplant for his kidney cancer (a process considered experimental). Similarly, on her blog, Sarah Palin called those who weigh costs and benefits of expensive health care interventions “death panelists,” saying that a health care system that rations care based on cost is “downright evil.” a. Describe in your own words what is meant by an “experimental treatment.” Should private insurance pay for experimental treatments? Why or why not? If not, then who pays, and why?

b. Other than the obvious answer that she is a “crazy conservative,” why did Palin voice her concern over death panels? Is it a legitimate concern? c. Describe the basic premise behind comparative effectiveness analysis. What role will it play in the future health care framework in the United States? What evidence can you provide in support of your answer? 4. One of the main features of the Patient Protection and Affordable Care Act is that it requires all plans to cover proven preventive services with no cost sharing. Assume the following concerning annual physical exams: 1) physicians charge $120 for all the services associated with a physical, 2) one-half of the population gets an annual physical exam, 3) the price elasticity of demand for physicals is –0.5, and 4) administrative overhead for private insurance is 20% of spending. a. Does prevention really save money? Why or why not? b. What is the effect on expected spending [E(S)] if physical exams are free? [Note that E(S) = πpq, where π is the probability that a person will get a physical, p is price of the physical, and q is quantity of exams per year.] c. What is the subsequent impact on the insurance premium of “free” physicals? 5. A recent study examined the effects of five different breast-cancer screening strategies on costs and mortality in a cohort of women. The strategies differed in terms of starting age, screening interval, and stopping age. Strategy

Age Group

A 50–70 B 40–70 C 50–70 D 50–75 E 50–65 * in years ** life-years saved

Interval* 2 2 1.3 2 3

Cost

$ 9,320 13,840 13,120 10,600 5,320

LYS** 0.610 0.640 0.700 0.645 0.410

a. Identify all dominated screening strategies. Explain why each is dominated. b. On a graph, sketch out the frontier of economically rational strategies. c. Calculate the incremental cost, incremental LYS, and incremental CE ratios for all economical rational strategies. Why are these considered economical rational? d. Which strategies do you consider appropriate from a public health perspective? 6. A paper presented at a recent conference claimed that the increase in medical care spending over the past 40 years has been worth it. The authors examined life expectancy figures and found that, on average, a person born in 1960 could expect to live 70 years, whereas someone born in 2000 has a life expectancy of 77 years, a gain of seven years. But for the person born in 1960, lifetime medical spending was only $13,943; the figure for someone born in 2000 was $83,307. (To make each year

comparable, the study adjusted amounts to the dollar's inflation-adjusted value in 2002.) Of course, healthier behavior could also account for longevity gains. So, the researchers estimated that approximately half of the years gained—about 3.5— were directly due to medical care. Based on their analysis, each one of those extra 3.5 years cost about $19,900. The cost of each added year of life went up from $7,400 in the 1970s to $36,300 in the 1990s. This, say the authors, is a good value—based on health economists' widely accepted figures of cost effectiveness in health care that consider a person's lifetime of economic productivity and the value placed on staying alive. a. How do economists determine whether improved and more costly health care is worth the increased expenditure? Discuss economic productivity and the value of staying alive. b. Use marginal benefit and marginal cost of medical expenditures to determine whether increased expenditures are worthwhile. What is the marginal benefit of increased expenditures? c. The study found that as one gets older, gains in life expectancy are not as steep, and costs start to pile up. For example, a person aged 65 in 1960 could have expected to live an additional 14.4 years, whereas a 65-year-old in 2000 can expect an extra 18 years, a gain of about 3.5 years. But the cost per year of life gained through medical care was, on average, $84,700. The cost between 1960 and 1970 was $75,100, whereas between 1990 and 2000 it was $145,000. For people who have reached the age of 65, are gains in life expectancy that can be attributed to improved health care worth the cost? Use marginal analysis to answer the question.

Multiple Choice 1.

The direct costs in an economic evaluation include the all the following except a. hospitalization. b. medical devices. c. transportation to and from the physician’s office. d. reduced productivity at work. e. all of the above. When measuring effectiveness of a treatment, surrogate measures reflect clinical efficacy and include a. recurrence of the disease. b. death. c. bone-mass density (BMD). d. hip fractures. e. scores on standard evaluative exams such as EuroQol or SF-36. Which of the following measures of effectiveness is not a surrogate measure? a. Cholesterol level b. Blood pressure

c. Tumor size d. Hip fracture e. Bone-mass density (BMD) The intangible costs associated with reduced quality of life include a. pain and suffering. b. lost productivity at work. c. The cost of home remodeling to accommodate a physical handicap. d. potential income lost due to premature death. e. all of the above. Suppose that you are asked to use the standard time trade-off approach to measuring quality of life and are given the following information. An individual is faced with living the remaining 10 years of her life suffering from severe osteoporosis. She reveals that she would be willing to give up four of those years to live the remaining six in perfect health. What is the utility of one year in the chronic health state relative to perfect health? a. 0.4 b. 0.6 c. 4 d. 6 e. There is not enough information to determine the utility of life in this case. Researchers estimate QALYs in a number of different ways. One popular approach is called the a. probability approach. b. QoL approach. c. standard gamble. d. standard measure of well-being. e. utility of life approach. The standard cut-off for cost per QALY is ______ per capita income. a. equal to b. 2 times c. 3 times d. 4 times e. 5 times Cost-effectiveness considerations are more formally integrated into health policy making in a. the UK. b. Australia. c. Europe. d. Canada. e. b, c, and d. Steps in performing a cost-effectiveness analysis include all of these EXCEPT a. ranking the alternative treatment options. b. prioritizing the alternative treatment options.

c. calculating the ICER between each treatment option and the next most expensive one. d. eliminating treatment alternatives that are strictly dominated. 10. Researchers use cost-of-illness studies to a. study the burden of a disease. b. determine the low-cost option to treat a disease. c. compare two or more treatment options when the medical outcome is identical. d. increase public awareness of cost of treating certain diseases. e. do all of the above. [return to top]

Appendix 5A: Modeling Cost Effectiveness This appendix is designed to give students a basic understanding of how cost-effectiveness analysis is set up and performed. It includes sections explaining the ICER, measurement issues for costs and benefits, and the steps necessary to carry out a cost-effectiveness analysis. The use of modeling and how economic evaluation works in the real world are also discussed.

Appendix Outline 1. Economic evaluation in practice a. Measures of cost b. Measures of effectiveness c. Steps in performing a cost-effectiveness analysis 2. Modeling framework a. Decision trees 3. Markov models 4. Markov decision models 5. Sensitivity analysis 6. Using cost effectiveness to address health care spending 7. Summary and conclusions 8. References

Table of Contents Instructor Manual ................................................................................................................................. 1 Table of Contents ....................................................................................................................... 1 Purpose and Perspective of the Chapter ................................................................................. 2 Cengage Supplements ............................................................................................................... 2 Chapter Objectives .................................................................................................................... 2 Complete List of Chapter Activities and Assessments ............................................................ 2 Key Terms ................................................................................................................................... 4 What's New in This Chapter ...................................................................................................... 5 Chapter 6: Demand for Health and Medical Care ................................................................... 5 Chapter Outline.......................................................................................................................... 5 Teaching Suggestions ................................................................................................................ 7 Suggested Approaches to End-of-Chapter Questions ............................................................ 8 Additional Questions for Discussion and Evaluation .............................................................. 9 Multiple Choice ..................................................................................................................... 10 Structured Discussion: ......................................................................................................... 14

Purpose and Perspective of the Chapter This chapter discusses the demand for health care in America. Americans value health; in fact, their pursuit of good health is a multibillion-dollar business. In addition to the money spent on medical care, consumers spend countless dollars on health foods, fitness videos, and weight-loss programs. This chapter introduces Michael Grossman’s (1972) characterization of medical care demand as a derived demand. It also looks at evidence presented by Robert Fogel (2000) that the amount spent on health care tends to rise as income rises. Following Grossman’s use of medical care as an input in the production function of health, the determinants of health status are discussed. The alternative approach, which views medical care as a final product, is presented and the factors influencing the demand for medical care are addressed. Empirical issues in measuring medical care demand by estimating demand functions and calculating elasticities are also presented.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives Compare and contrast the two ways suggested by Grossman to view medical care: as an input in the production function for health and as an output produced by medical providers. 1. Describe the various measures of health status. 2. Understand the importance of factors other than medical care in determining health status. 3. Recognize the role of the public health service in promoting a healthy environment. 4. Summarize the main factors determining the demand for medical care. 5. Describe the potential for and importance of physician-induced demand. 6. Summarize the empirical literature measuring the demand for medical care.

Complete List of Chapter Activities and Assessments Chapter Objective 6-1 Explain the model for health production. 6-2 Explain the importance of

Activity/Assessment

Duration

Additional Discussion Question #7 Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 40

Additional Discussion Questions #1, 3, 6, & 8

Instructor’s Manual

5–10 mins

5–10 mins 10–15 mins

Chapter Objective factors other than medical care in determining health status.

6-3 Analyze the different measures of health.

6-4 Summarize the main factors determining the demand for medical care. 6-5 Evaluate the different measures of demand for medical care.

Activity/Assessment Knowledge Check 1 Activity Knowledge Check 1 Answer Knowledge Check 2 Activity Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment Additional Discussion Question #2 Knowledge Check 3 Activity Knowledge Check 3 Answer Additional Discussion Question #3

Additional Discussion Questions #4 & 5 Knowledge Check 5 Activity Knowledge Check 5 Answer

Source (i.e., PPT slide) PPT Slide 9

Duration

PPT Slide 10

5 mins

PPT Slide 16

5–10 mins

PPT Slide 32

5–10 mins

PPT Slide 33

5 mins

PPT Slide 40 Instructor’s Manual PPT Slide 25

10–15 mins 5–10 mins

PPT Slide 26

5 mins

Instructor’s Manual

5–10 mins

Instructor’s Manual PPT Slide 38

5–10 mins

PPT Slide 39

5 mins

5–10 mins

Key Terms Iatrogenic disease: An injury or illness resulting from medical treatment. Mortality: The probability of death at different ages, usually expressed as the number of deaths for a given population, either 1,000 or 100,000, or the expected number of years of life remaining at a given age. Morbidity: The incidence and probability of illness or disability. Disability-adjusted life expectancy (DALE): The valuation of life expectancy weighted in terms of the lost value of the years marked by disability. Public health: Collective action undertaken by government agencies to ensure the health of the community. These efforts include the prevention of disease; identification of health problems; and the assurance of sanitary conditions, especially in the areas of water treatment and waste disposal. Financial risk: The risk associated with contractual obligations that require fixed monetary outlays. Deductible: The amount of money that an insured person must pay before a health plan begins paying for all or part of the covered expenses. Coinsurance: A standard feature of health insurance policies that requires the insured person to pay a certain percentage of a medical bill, usually 10 to 30 percent, per physician visit or hospital stay. Copayment: A standard feature of many managed care plans that require the insured person to pay a fixed sum for each office visit, hospital stay, or prescription drug. Principal–agent relationship: A relationship in which one person (the principal) gives another person (the agent) authority to make decisions on his or her behalf. Physician-induced demand: A situation in which providers take advantage of uninformed consumers by providing services that are largely unnecessary. Cross-price elasticity: The sensitivity of consumer demand for good A as the price of good B changes. Income elasticity of demand: The sensitivity of demand to changes in consumer income, determined by the percentage change in quantity demanded relative to the percentage change in consumer income. Luxury or superior goods: Goods are considered superior if an increase in consumer income causes the percentage of the consumer’s income spent on the good to increase and vice versa. Necessity: A good or service with an income elasticity between zero and one.

[return to top]

What's New in This Chapter • •

• •

The following elements are improvements in this chapter from the previous edition: New evidence from Robert Fogel (2000) in the introduction to this chapter is introduced as evidence for rising income as it relates to health care expenditures. A more in-depth discussion of the production of health is presented, particularly as an injury or illness as a result from medical treatment. The sections about mortality and morbidity have been updated and expanded, taking into account the plateauing of U.S. life expectancy; the decrease in heart disease and cancer as a cause of death; and the increase in unintentional injuries, suicide and chronic respiratory disease and others. The text also briefly touches on the COVID-19 pandemic.

Chapter 6: Demand for Health and Medical Care This chapter introduces Michael Grossman’s (1972) characterization of medical care demand as a derived demand. Following Grossman’s use of medical care as an input in the production function of health, the determinants of health status are discussed. The alternative approach, which is to view medical care as a final product, is also presented. Using medical care as a final product, the factors influencing the demand for medical care are addressed. The empirical issues of measuring medical care demand by estimating demand functions and calculating elasticities are also presented.

Chapter Outline I.

The Demand for Health: Medical care is one of many inputs contributing to improving the health of the population. Two important aspects are 1) the most efficient way to produce and distribute health and 2) the incremental contribution of medical care to the production of health. a. The production of health model shows how inputs combine to produce output and then the relationship between health status and medical care spending (the process of improving health being subject to the law of diminishing returns). Two ways of improving health status are spending more on medical care (iatrogenic disease results from too much medical care) and making better lifestyle (PPT Slides 5–8). b. The main determinants of health are income and education (socioeconomic status is a strong indicator of health; the relation between health and socioeconomic status is not direct but indirect with actual determinants of poor health), environment and lifestyle (illness is associated with lifestyle and environmental factors), and genetics (the inheritance of a particular gene

II.

greatly increases the risk of acquiring certain diseases, but a common disease in certain families may be due to environment or lifestyle instead of genetic) (PPT Slides 11–13). c. Quantifiable measures of health to study the relationship between health and medical spending are mortality (heart disease and cancer have been responsible for over half of the deaths annually; common measures are life expectancy at birth and infant mortality rate—considered a poor indicator), morbidity (six physiological measures to analyze the health status were diastolic blood pressure, serum cholesterol concentration, electrocardiogram abnormalities, abnormal chest X-rays, presence of varicose veins, and a periodontal index), and quality of life (common measures are qualityadjusted life year, or QALY—combines quality of life and survival duration into an index—and the disability-adjusted life expectancy—the number of years of life living in poor health or lost because of an illness or injury) (PPT Slides 18–22). d. Four major sources that contribute to the decline in mortality rates in Europe and North America are living standards, intervention of public health authorities, reduced exposure and increased natural immunity, and advances in medical science. In developed countries, better lifestyle decisions and a cleaner environment may do more to improve health than increased availability of medical care, while in less-developed countries, better sanitation, potable water, and improved living conditions (PPT Slides 14 & 15). The Demand for Medical Care: Factors determining self-interest to invest in health improvements (on the demand-side approach): the current cost of medical care, the size of the future payoff, the time span over which we realize the payoff, and individual time preference. a. The major factors that influence medical care demand are patient factors (health status, demographic characteristics—aging, sex, and lifestyle factors, and economic standing—high income, income level, and education; health insurance features: deductibles—the initial amount the policyholder must pay before insurance payment, coinsurance—the percentage of the total that the policyholder pays, and copayments—a fixed dollar amount charged directly to the patient at the time of treatment) and physician factors (the principal-agent relationship, standard economic analysis, and demand inducement) (PPT Slides 27–31). b. Three approaches to measures of demand are estimating demand functions (demand is estimated through regression analysis; the way of transactions, i.e., market exchange or purchasing power parity exchange rates, affects the results), calculating demand elasticities (demand for medical care in most

cases is inelastic with respect to price; if income elasticity of demand is greater than 1, it is a luxury good and if that is less than 1, it is a necessity), and the RAND health insurance study (a study addressing the effect of the insurance coverage on health outcomes indicated no substantial difference in health across the cost-sharing groups, or the chronically ill experienced a negative shock for high cost-sharing percentage) (PPT Slides 23, 24, & 34–37). Summary and Conclusions: The production of health is determined not only by medical care but also by environmental, lifestyle, and genetic factors. Patient factors—including health and demographic characteristics, age, race, and sexand physician factors—involving the physician–patient relationship—play a key role in determining the demand for medical care.

III.

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Teaching Suggestions •

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Evidence from Robert Fogel (2000) examines the changing structure of overall U.S. consumption between 1875 and 1995. The share of income spent on food, clothing, and shelter fell from 74 to 13 percent. In contrast, the share of income spent on health care rose from 1 to 9 percent. What does this reveal about health care demand? The implied long-term income elasticity for health care is well above unity, 1.6 using Fogel’s approach. An income elasticity that is greater than 1 means that as income rises, a larger percentage of that income will be spent on health care. What does this say about the more recent trend toward decreasing health care expenses as a percentage of GDP, particularly as a result of ACA? The research by Michael Grossman [“On the Concept of Health Capital and the Demand for Health,” Journal of Political Economy 80(2), March/April 1972, 223– 255] is important in the development of the economic framework for the study of the demand for health and medical care. Take some time discussing this contribution. You may even want your more advanced students to read the article. A good way to organize discussion of the materials in the first part of the chapter is to consider two related issues: 1) What is the most efficient way to produce and distribute health? 2) What is the incremental contribution of medical care to the production of health? Students who are unfamiliar with health issues are generally surprised with the discussion of the “Most Common Causes of Death.” Take every advantage to surprise, shock, and inform them. In your discussion on the determinants of health status, those of you who like to emphasize the importance of lifestyle considerations may want to present a wonderful piece by Victor Fuchs [“Some Economic Aspects of Mortality in Developed Countries,” in Mark Perlman, ed., The Economics of Health and Medical

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Care, London: Macmillan, 1974, 174–193]. Using a simplistic approach, Fuchs contrasts mortality in Nevada and Utah, emphasizing that health habits promote good health. In your discussion on the demand for medical care, make use of the many papers, especially those coauthored by Willard Manning, that use the results of the RAND Health Insurance Experiment. Students are sometimes surprised that economic research can incorporate the use of control groups in a meaningful way.

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Suggested Approaches to End-of-Chapter Questions 1. Elasticities measures suggest that: a. Cigarette consumption will fall by 3 to 4 percent and spending on cigarettes will rise by 5.6 to 6.7 percent. b. A 50 percent rise in incomes would lead to a 25 percent rise in cigarette consumption. Assuming the income elasticity will remain constant over a decade is questionable anyway. Ignore the advice. 2. Following Arrow’s (1963) approach, demand for medical care is irregular, characterized by information problems, and subject to widespread uncertainty. The industry is dominated by not-for-profit providers and financed by third-party payers. 3. The answer to this question will be based on the student’s opinion, depending on the way they view the importance of equal availability. Someone who strongly believes that access based on ability to pay is unfair will be against the wealthy spending large sums of money to get better care. Those who are more interested in individual freedom will think it is an appropriate use of private funds. Realistically, this happens everywhere, not just in the United States. Every developed country has a safety valve where those with more money have access to care that is not available to the masses. 4. There is a limit to the amount of money that can be spent to keep someone alive. If Americans spent the entire GDP for health care, per capita spending could only be about $30,000. What’s your fair share? Other related issues include cost effectiveness of the spending and maybe quality of life of the recipient. 5. Flat-of-the-curve spending is spending where marginal cost exceeds marginal benefit. Providers recommend care that offers little improvement in health status and sometimes even makes the patient worse off. Patients who bear little of the extra cost of the treatment are not concerned with full cost, so their marginal cost-marginal benefit comparison is made with only their own out-ofpocket in the calculation. Most less-developed countries spend so little per capita that they even modest increases in spending reap sizable benefits. 6. Individual demand is driven by provider recommendations as indicated by principal–agent theory. Even though patient factors may be secondary, they

cannot be considered irrelevant. Patients do consider the impact of their decisions, even those concerning medical care, on their own welfare. Simply noting that medical care decisions are often complicated by emotions does not imply that economic models are inapplicable. 7. If individuals have the ability to value medical services and rank those values, they can determine how much they are willing to pay for those services. Those with money to spend can actually benefit from a market in health services. 8. Health care is an investment to the extent that it enhances a person’s future productivity—market and non-market. Except for those whose looks are their livelihood, cosmetic surgery is probably pure consumption. 9. The advantage of using price elasticity of demand to classify goods is its objectivity. The drawbacks include measurement problems. The studies referenced in this chapter show how estimates vary by study design. The real question may be: What is gained by such a classification scheme? 10. McKeown’s research discussed beginning on page 180 provides a good outline for answering this question. 11. Note the leading causes of death vary by age cohort in 2009. Age 1–4 Accidents, congenital malformations, and assault Age 5–14 Accidents, malignant neoplasms, and congenital malformations Age 15–24 Accidents, assault, and suicide Age 25–44 Accidents, malignant neoplasms, and diseases of the heart Age 45–64 Malignant neoplasms, diseases of the heart, and accidents Over 65 Diseases of the heart, malignant neoplasms, and chronic lower respiratory disease Members of different age cohorts will try to influence government spending to benefit their members. Government sponsored research projects are likely to have some political base. 12. The greatest improvement in health status of a population comes from improving potable water and wastewater disposal. In a less-developed country context, death rates from air- and water-borne diseases are typically the major causes of death. 13. An income elasticity greater than 1 implies a superior good. When income increases, health care spending as a percentage of income increases A price elasticity closer to 1 indicates that demand is more responsive to changes in price and less responsive to moral hazard. [return to top]

Additional Questions for Discussion and Evaluation 1. What factors would you use to estimate the level of demand for medical care for the typical individual? How would your choice of variables differ if you were estimating demand for an entire country?

2. Policymakers often use infant mortality rates and life expectancy at birth when evaluating the efficacy of health care systems. In addition to living and dying, what other aspects of health status are important? How does the choice of measurement tool change our perspective when evaluating health care systems? 3. The stated premise behind the production function for health is that medical care when combined with other inputs and a person’s own time produces good health. What is the marginal contribution of medical care to the production of health in the United States? How would your answer change if you were studying health in a less-developed country? 4. Is medical care a luxury good or a necessity? Why should it matter to policymakers? What is the empirical evidence? 5. The RAND Health Insurance Study was set up to examine the effect of economic incentives on medical care demand. What were the major findings of this study? 6. In general, how does medical insurance affect an individual’s demand for medical care? Does insurance normally result in an increase or decrease medical spending? 7. What is the production function for health? How would you use the concept of a production function for health to offer suggestions for decreasing medical expenditures? 8. When people are sick, they often have very little idea of what is wrong with them or what the most promising treatment is. They may place themselves under a physician's care in the belief that the physician is better qualified to make decisions regarding the proper course of treatment. The physician acts as an agent for the patient. For many treatments, the physician offers the only access to the treatment, e.g., prescription drugs and surgery. a. Are there any reasons that the physician acting as agent for a patient might not choose exactly what a fully informed patient would choose? b. A number of studies have gathered evidence on physician-induced demand, and most have reported rather small but statistically significant effects. Isn't it rather cynical to seriously advance the notion of physician-induced demand? What factors might control the extent of physician-induced demand? c. If surgeons really increase the demand for operations, which kinds of operations do you think would be most affected? How would you decide which were unnecessary? Can you think of any examples from your own experience or reading?

Multiple Choice 1.

Many economists consider medical care a superior good. Which of the following statements is true regarding a superior good? a. Consumers want more of a superior good, regardless of its price. b. When the price of a superior good increases, consumers demand more of it.

c. As consumer income increases, a larger percentage of that income is spent on superior goods. d. A superior good has an income elasticity of demand greater than 1. e. Both c and d are true of superior goods. A critical assumption in the model of demand and supply is the independence of demand and supply curves. If the two are not independent, a shift in the supply curve can lead to a shift in the demand curve referred to as a. supply-side economics. b. supplier-induced demand. c. supply shocks. d. ceteris paribus. e. the fallacy of supply. The top ten causes of death in the United States in 2010 included all of the following except a. heart disease. b. cancer. c. suicide. d. kidney failure. e. AIDS.

The accompanying diagram depicts the relationship between health status and medical care spending for a particular country. Which of the following statements is true?

a. At the current spending level of S1 on TP1, this society can get a greater improvement in health status by increasing spending to S2 than by shifting TP to TP2. b. S1 levels of spending may be described as spending on the flat-of-the-curve. c. Social pressures will move the health care system to spend S2. d. All statements are true. e. All statements are false. Health care that actually harms the patient, such as an adverse reaction to a prescription drug, is called a. morbidity-related response. b. defensive medicine. c. adverse selection. d. iatrogenic disease. e. moral hazard. The number one cause of death in the United States in 1980 was a. AIDS. b. heart disease. c. cancer. d. stroke. e. homicide and accidents. Health insurance features that tend to reduce moral hazard include a. deductibles. b. coinsurance c. copayments d. all of the above. The concept quality-adjusted life year (QALY) a. is a multidisciplinary approach to measuring health status. b. has little application to medical decision making. c. is used extensively in the United States to evaluate health care programs.

d. is used extensively to evaluate medical care resource allocation within government-run programs on fixed budgets, especially in Europe. e. none of the above. 9. Suppose the recipient of a kidney transplant has stated that she would prefer 5 years of perfect health to the 10 years she expects to live with her transplant. For this person, each of her remaining 10 years of life has a QALY value of a. ½. b. 2. c. 5. d. 10. e. 50. 10. If health care spending is already on the flat-of-the-curve, it may not be possible to buy improved health status by increasing spending. In this situation, the best way to improve health status may be to a. increase the availability of government health insurance. b. invest in biotechnology to determine the genetic factors that improve health. c. improve life-style decisions by reducing smoking, alcohol consumption, and drug use. d. improve access to medical care. e. improve overall educational attainment so people can better follow the advice from the medical community. 11. McKeown’s (1976) research attributed the majority of the secular decline in mortality rates in Europe and North America to a. better nutrition and housing. b. improved sanitary conditions. c. clean water and waste disposal. d. reduced exposure to diseases. e. better medical care. 12. Factors affecting medical care demand include a. health status. b. demographic characteristics. c. economic standing. d. physician factors. e. all of the above. 13. A physician’s ability to induce demand is greatly enhanced when a. patients pay their own medical bills. b. patients request follow-up visits. c. patients have difficulty gathering and processing information. d. the physician follows strict treatment guidelines. e. treatment options are limited. 14. The RAND Health Insurance Study a. examined cross-section data to estimate the demand function for medical care.

b. was the most extensive controlled experiment in health insurance ever conducted in the United States. c. was based on individual decisions in voluntarily choosing health insurance coverage, like most economic studies. d. was flawed due to severe self-selection bias. e. was set up to study medical outcomes when individuals were free to choose the type of health coverage they desired. 15. The following diagram depicts the market for physicians’ services that is originally in equilibrium at point a with demand and supply at D0 and S0. As physician supply increases from S0 to S1, a concurrent shift in demand from D0 to D1

a. b. c. d. e.

may be the result of physician-induced demand. will cause overall spending on physicians’ services to increase. will force physicians to limit the number of patients they see. both a and b. all of the above.

Structured Discussion: 1. Resolved: Physicians have the power to influence their patients’ demand for health services and the likelihood of their using this power varies inversely with the level of competition in the medical market.

2. Resolved: Widespread use of state-of-the-art screening and other diagnostic tools and techniques would result in a significant reduction in the rate of growth of health care expenditures. [return to top]

Purpose and Perspective of the Chapter The purpose of this chapter is to give students an understanding of the health of the overall U.S. population and to analyze and examine the basic dimensions of population health. Researchers, medical practitioners, and policymakers are all talking about population health. The concept is not new. By teaching the various health outcomes and their disparities among certain ethnic groups, this chapter will give students the ability to examine topics like mortality measures, causes of death, and morbidity and then discuss the confounding risk factors associated with socioeconomics and the physical environment. Students will have the tools to place the U.S. health care experience in an international context, comparing population health metrics with six developed countries around the world.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter 7: Population Health This chapter analyzes population health by examining its basic dimensions. Using U.S. data, it examines health outcomes and their disparities among certain ethnic groups. It discusses mortality measures, causes of death, and morbidity. The confounding risk factors associated with the socioeconomics and the physical environment are also discussed, followed by the individual risk factors. Finally, it places the U.S. health care experience in an international context by comparing these population health metrics with six developed countries across the world.

Chapter Objectives The following objectives are addressed in this chapter: 1. Examine basic dimension of population health. 2. Examine health system priorities and health disparities as well as metrics used to evaluate population-based health outcomes, such as mortality measures and morbidity measures. 3. Use data to compare health outcomes and health disparities among certain ethnic groups. 4. Describe the various measures population-based health outcomes. 5. Identify confounding risk factors associated with the socioeconomics, the physical environment, and individual behaviors. 6. Compare and contrast the U.S population health outcomes with other developed countries.

Complete List of Chapter Activities and Assessments Chapter Objective 7-1 Identify the priorities of the health system.

7-2 Evaluate some of the major health disparities that exist within the United States.

7-3 Explain the metrics for assessing population health. 7-4 Analyze the disparities in health outcomes between the United States and other developed nations.

Activity/Assessment Additional Discussion Questions #1 & 2 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment Knowledge Check 2 Activity Knowledge Check 2 Answer Knowledge Check 3 Activity Knowledge Check 3 Answer Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 12

Duration

PPT Slide 13

5 mins

PPT Slide 37 PPT Slide 21

10–15 mins 5–10 mins

PPT Slide 22

5 mins

PPT Slide 23

5–10 mins

PPT Slide 24

5 mins

PPT Slide 35

5–10 mins

PPT Slide 36

5 mins

PPT Slide 37 PPT Slide 37

10–15 mins 10–15 mins

5–10 mins 5–10 mins

Key Terms Disease prevalence: The percentage of a population that has a specific disease at a point in time. Amenable mortality: Premature death that could have been avoided with timely access to high-quality health care. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: 1. By introducing two new robust sections on health system priorities and health disparities, the author recognizes their importance and their effect on the U.S. health system. 2. There is also more discussion about mortality and morbidity and their relative importance on the overall population. 3. Finally, while not downplaying their importance, the author has only lightly touched on the issues of drugs, alcohol, and obesity, citing them as “other risk factors.”

Chapter Outline I.

II.

III.

Health System Priorities: The three elements of the triple aim are the health level of a well-defined population, the experience of care, and the per capita cost of providing that care. The passage of the Affordable Care Act (ACA) shifted the emphasis from treating the individual to managing the health of populations within delivery systems, where socioeconomic and environmental factors play a vital role (PPT Slides 5–9). Health Disparities: a. Some mortality factors include life expectancy at birth, the relative risks of death across ethnic groups (there are health disparities across socioeconomic groups), infant mortality, and social gradient (exists in the developed world in the form of government-run or private-run health care). Studies show that gradient level is inversely related to the mortality rate (PPT Slides 14 & 15). b. Morbidity, expressed as disease prevalence or incidence rates, is a statistic measuring the percentage of a population with a particular disease condition. Health-related quality of life (QoL) measures the self-perceived health status of an individual or group (PPT Slides 16 & 17). c. Population health can be managed by individual factors such as behavioral and physiological factors (e.g., adolescent pregnancies, alcohol consumption, smoking, and gonorrheal rates) and the socioeconomic and physical environment (living and working in a high-risk environment increases the probability of injury or death from exposure to those risks) (PPT Slide 25). Cross-Country Comparisons: Per capita spending in the United States was 45 percent higher than spending in Switzerland and more than double spending in other countries. a. To measure the value of health care across various countries, life expectancy and infant mortality rate are considered. Over half of the gap in life

IV.

expectancy between the United States and the other developed countries was due to external causes of death, and the United States had the highest infant mortality rate among the seven advanced countries. Factors considered in infant mortality rate are early deaths, high infant mortality rates among ethnical minorities, and high infant mortality due to low birth weight (PPT Slides 26–30). b. Other individual behavioral and physiological factors include cost to society in terms of health problems and low productivity. For tobacco use, over 480,000 deaths occur per year and more than 500,000 women die each year; for alcohol use, it is a double-edged sword: even moderate alcohol consumption leads to severe health risks or is associated with protection against arterial damage caused by the bad cholesterol; and for obesity and its consequences, there is an association between obesity and decreases in life expectancy (PPT Slides 10, 11, 18–20, & 30–34). Summary and Conclusions: Overall health outcomes can be studied from disparities between population groups and differences across countries. The United States experiences highest rate of amenable mortality and need to address the health consequences of poor access to quality health care (PPT Slide 38).

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Profile: Jonathan Gruber Issues in Medical Care Delivery

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Supersize Mine

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Is Addiction Rational?

Back-of-the-Envelope •

The Income/Health Gradient Are Cigarette and Alcohol Consumption Sensitive to Price Increases?

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Alcohol Consumption and Traffic Deaths: The Case for Higher Excise Taxes

Applied Micro Methods •

Does More Income Lead to Longer Life Expectancy?

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Can a Nearby Walmart Store Make You Healthier?

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The Impact of a Trans Fat Ban on Health

The Question of Drug Legalization

Teaching Suggestions 1. Population health refers to health outcomes of a group of individuals, including the distribution of such outcomes within the group. 2. Discuss the determinants of health: • Socioeconomic factors • Environmental factors • Individual behaviors • Physiological factors 3. Discuss the most popular metrics used to measure population-based health: • Mortality measures • Morbidity measures 4. Engage students in a discussion on the impact of social class on population health outcomes. 5. Use the tables provided that are listed below for an international comparison: • Health care spending (Table 7.5) • Life expectancy (Tables 7.6, 7.7) • Infant and maternal health (Table 7.8) • Teen pregnancy (Table 7.9) 6. Discuss the concept of health disparities in the United States. 7. Discuss individual behaviors in the United States versus internationally. • Tobacco and alcohol use (Table 7.10) • Obesity: Its causes and consequences (Table 7.11) [return to top]

Suggested Approaches to End-of-Chapter Questions 1. Using data provided in this chapter on the determinants of health that directly impact health outcomes can help answer this question. Example of social issues that increase the demand for health care and contribute to the health care spending crisis are provided in this chapter.

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Social economics issues such as poverty, education, employment, and social support impact health outcomes. Existing data support that income and life expectancy are positively correlated. Individuals with a higher income have better health outcomes and a higher life expectancy. The same relationship is observed with level of education, employment status, and social support. Physical environment Living and working in a high-risk environment contribute to the deterioration of health outcomes, which increase the demand for health services. Individual behavior According to the text, excessive alcohol consumption is responsible for approximately 40,000 deaths in the United States each year. In 2010, excessive alcohol use cost the U.S. economy $249 billion, according to the Centers for Disease Control (CDC). Tobacco use is also associated with health problems. The CDC estimates that the health-related economic costs associated with tobacco use average $75 billion in direct medical costs per year and over $90 billion in lost productivity. Other social issues that increase health care spending are obesity, teen pregnancy (risk of low birth weight, preterm deliveries, and risk of infant mortality), gays and bisexuals (with a high prevalence of HIV infection) also increase the demand for health care and contribute to the health care spending crisis in the United States.

2. An article that provides a good insight into answering this question has been published by the National Institute on Drug Abuse (NIDA). (2014, July 1). “Drugs, Brains, and Behavior: The Science of Addiction.” Retrieved from https://www.drugabuse.gov/publications/drugs-brains-behavior-scienceaddiction on September 30, 2017. 3. Data provided on the following sites can assist in answering these questions: • Centers for Disease Control and Prevention (CDC): The cost of excessive alcohol use in the United States reached $249 billion in 2010. https://www.cdc.gov/features/costsofdrinking/ Tobacco use: Each year, the United States spends nearly $170 billion on medical care to treat smoking-related disease in adults.

https://www.cdc.gov/tobacco/data_statistics/index.htm •

The National Institute on Drug Abuse site NIDA. (). Cocaine. Retrieved from https://www.drugabuse.gov/drugsabuse/cocaine on September 30, 2017. 4. This is an opinion-based question and better suited for class discussion. It is these types of questions where the legalists and the moralists will get into interesting debate. 5. Review Appendix 9A: Medical Malpractice

The United States spends two to three times more than the other developed countries in the world to settle tort (malpractice) disputes.

6. Review Appendix 9A: Medical Malpractice: Medical malpractice law is designed to encourage physicians to act as responsible agents for their patients and only expose them to a level of risk that a fully informed patient would accept willingly. 7. This is an ethical question suited for class discussion. A question that you can ask during the discussion is whether rationing is avoidable when resources are limited. Should we keep spending resources on patients who are near the end of life? 8. This is an opinion-based question and better suited for class discussion. The answer will be based on the students’ opinion. 9. This is a good topic for students to research for a classroom discussion. [return to top]

Additional Questions for Discussion and Evaluation •

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Discuss the current health policy in the United States and its impact on population health outcomes. Has quality of care improved since the inception of the Affordable Care Act? Discuss the U.S health care quality improvement initiatives.

Multiple Choices 1.

Kindig and Stoddart (2003) defined population health as “health outcomes of an entire population, including the distribution of such outcomes within a group of individuals.” a. True b. False Which of the following is not the World Health Organization (WHO) index to measure health system performance? a. Disability-adjusted life expectancy b. Morbidity c. Health disparities

d. Responsiveness e. Fairness 3.

Which of the following is not part of the three dimensions of health care delivery known as the “triple aim”? a. Improving patients experience of care b. Improving the health of the population c. Expanding health insurance d. Reducing the per capita costs 4. Mortality rate and morbidity are the most popular metrics used to evaluate population-based health outcomes. a. True b. False 5. From 2001 to 2011, life expectancy for the total U.S population increased from: a. 75.3 to 79.0 years. b. 77.2 to 81.4 years. c. 78.7 to 81.4 years. d. 77.2 to 78.7 years. 6. Whites have experienced an increase in life expectancy that is more than twice that of Blacks. a. True b. False 7. Which ethnic group has the highest life expectancy in the United States? a. Blacks b. Hispanics c. Whites 8. People with higher income are less likely to have better health outcomes and have a higher mortality rate. a. True b. False 9. The rate at which members of a group are newly diagnosed with a disease is called a. mortality rate. b. morbidity rate. c. QOL. 10. Teen pregnancy is a concern among public health officials and policy makers because of the follow associated problems except for a. low birth weight. b. preterm deliveries. c. poverty. d. risk of infant mortality. 11. Obesity prevalence in the United States is the highest in the developed world and has worsened since the 1960s. a. True

b. False 12. The United States has the highest rate of low-birth-weight infants than other developed countries. a. True b. False 13. Perinatal mortality is defined as late fetal death plus deaths in the first __ days after birth. a. 10 b. 15 c. 30 d. 45 14. On average, smoking decrease life expectancy by 10 years. a. True b. False 15. One of the reasons that women live longer than men in most societies is that a. women exercise more than men. b. women eat healthier than men. c. men smoke more regularly than women. 16. Alcohol consumption can cause premature death and play a significant role in all violent crime, but in some individuals, moderate consumption can have some health benefits, including a. higher life expectancy. b. higher HDL type cholesterol. c. better health outcomes. d. all of the above. [return to top]

Table of Contents Instructor Manual ................................................................................................................................. 1 Table of Contents ....................................................................................................................... 1 Purpose and Perspective of the Chapter ................................................................................. 2 Cengage Supplements ............................................................................................................... 2 Chapter Objectives .................................................................................................................... 2 Complete List of Chapter Activities and Assessments ............................................................... 2 Key Terms ................................................................................................................................... 3 What's New in This Chapter ...................................................................................................... 5 Chapter 8: The Market for Health Insurance ........................................................................... 5 Chapter Outline.......................................................................................................................... 5 Teaching Suggestions ................................................................................................................ 8 Suggested Approaches to End-of-Chapter Questions ............................................................ 8 Additional Questions for Discussion and Evaluation .............................................................. 9 Multiple Choice ..................................................................................................................... 11 Structured Discussion .......................................................................................................... 14

Purpose and Perspective of the Chapter The purpose of this chapter is to introduce students to the design and functioning of health insurance markets as a key financing mechanism in the U.S. health care system. The text also discusses the problem of asymmetric information in health insurance and how it can lead to market failure. To give a more complete perspective on the system, the chapter additionally addresses the practice of self-insurance as well as the provision of medical care for the uninsured.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Explain the theory of risk and the approaches to insurance. 2. Explain the emergence of employer-sponsored health insurance in the United States. 3. Identify how information problems lead to market failure in medical markets and the responses of insurers and regulators. 4. Analyze the scope of the uninsured problem.

Complete List of Chapter Activities and Assessments Chapter Objective 8-1 Explain the theory of risk and the approaches to insurance.

8-2 Explain the emergence of employersponsored health insurance in the United States.

Activity/Assessment Additional Discussion Questions #2, 4–6, 8, & 10 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment Additional Discussion Questions #7, 9, 12 Knowledge Check 2 Activity Knowledge Check 2 Answer Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual

Duration

PPT Slide 13

5–10 mins

PPT Slide 14

5 mins

PPT Slide 50 Instructor’s Manual PPT Slide 23

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PPT Slide 24

5 mins

PPT Slide 50

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5–10 mins

Chapter Objective 8-3 Identify how information problems lead to market failure in medical markets and the responses of insurers and regulators. 8-4 Analyze the scope of the uninsured problem.

Activity/Assessment

Source (i.e., PPT slide) Instructor’s Manual

Duration

PPT Slide 42

5–10 mins

Polling Answer Self-Assessment

PPT Slide 43 PPT Slide 50

5 mins 10–15 mins

Additional Discussion Questions #12 & 14 Knowledge Check 3 Activity Knowledge Check 3 Answer Self-Assessment

Instructor’s Manual PPT Slide 48

5–10 mins

PPT Slide 49

5 mins

PPT Slide 50

10–15 mins

Additional Discussion Questions #1, 3, 11, & 13–15 Polling Activity

5–10 mins

Key Terms Underwriting: The insurance practice of determining whether or not an application for insurance will be accepted. In the process, premiums are also determined. Preexisting condition: A medical condition caused by an injury or disease that existed prior to the application for health insurance. Indemnity insurance: Insurance based on the principle that someone suffering an economic loss receives a payment approximately equal to the size of the loss. Social insurance: Serves as the basis of all government redistribution programs. An insurance plan supported by tax revenues and available to everyone regardless of age, health status, and ability to pay.

Experience rated: Basing health insurance premiums on the utilization experience of a specific insured group. Premiums may vary by age, gender, or other risk factors. Community rated: Basing health insurance premiums on the health care utilization experience of the entire population of a specific geographic area. Premiums are the same for all individuals regardless of age, gender, risk, or prior use of health care services. Uncertainty: A state in which multiple outcomes are possible but the likelihood of any one outcome is not known. Probability: The likelihood or chance that an event will occur. Probability is measured as a ratio that ranges in value from zero to one. Expected value of an outcome: The weighted average of all possible outcomes, with the probabilities of those outcomes used as weights. Risk-averse: Describes a person who prefers to avoid uncertain outcomes. Major medical: Health insurance to provide coverage for major illnesses requiring large financial outlays, characterized by payment for all expenses above a specified maximum out-of-pocket amount paid by the insured (often $2,000–$5,000). Preferred provider organization (PPO): A group of medical providers that has contracted with an insurance company or employer to provide health care services to a well-defined group according to a well-defined fee schedule. By accepting discount fees, providers are included on the list of preferred providers. Self-insurance: A group practice of not buying health insurance but setting aside funds to cover the projected losses incurred by one member of the group. Administrative services only (ASO): An arrangement between a self-insured employer sponsored health plan and an outside vendor, a third-party administrator, who manages all health insurance claims. Reinsurance: Stop-loss insurance purchased by a health plan to protect itself against losses that exceed a specific dollar amount per claim, per individual, or per year. Prisoner’s dilemma: A paradox in game theory where players acting in their own selfinterest choose their dominant strategies and do not achieve the optimal outcome. In such cases, cooperation, not competition, will result in a more profitable outcome. Nash equilibrium: A situation that emerges when all players in a non-cooperative game choose their dominant strategy and have nothing to gain (and can only lose) by changing from their initial strategies. Economic opportunism: When parties to a transaction practice some form of deliberate deceit to take selfish advantage to promote personal gain.

Cream skimming: A practice of designing insurance policies so that healthy (low-risk) individuals will purchase coverage and those with a history of costly medical problems (high-risk) will not. Employer mandate: A requirement that employers must offer a qualified health plan to every employee or pay a penalty (usually in the form of a payroll tax). Disproportionate share: A payment adjustment under Medicare and Medicaid that pays hospitals that serve a large number of indigent patients. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • •

Reorganized approach to the health care market beginning with an in-depth explanation of the theory of risk and insurance Additional case studies to teach students how to apply microeconomic methods to real-world situations as a means of analysis Updated discussions of issues in the health care market, specifically on informational problems and the number of uninsured individuals in the United States

Chapter 8: The Market for Health Insurance This chapter on health insurance is the first of three describing specific markets that play important roles in medical care delivery and finance. Because the private health insurance market is so critical in financing U.S. medical care, it is important to understand the principles that govern the provision of insurance. The theory of private insurance demand is presented using the utility-of-income framework made popular by Friedman and Savage (1948). Institutional features, including the provision of group insurance and the practice of selfinsurance, are also discussed. The plight of the uninsured is addressed—who they are, why they do not have insurance, and how their lack of insurance affects their access to medical care.

Chapter Outline I.

Insurance Design: Types of insurance are life insurance (if the insured person dies), property casualty insurance (if an insured asset is lost or damaged), and health insurance (paid for a given medical condition). Two problems with health insurance were 1) the difficulty in verifying the seriousness of the medical condition and 2) the wide variation in the cost of treating similar medical conditions; these problems led to development of the service-benefit policy. a. Two opposing views to health care financing dominate the current policy debate over health care reform: the indemnity, or casualty, insurance approach (high income individuals pay higher premiums; groups with healthy behavior pay less but not those with unhealthy behavior) and the social insurance approach. Premiums

are experience rated within the group, largely determined by past spending, community rated within groups and experience rated across groups, meaning everyone pays the same premium (PPT Slides 6–9). b. With large enough groups, or risk pools, the probability of someone in the group suffering from heart attack or stroke can be estimated. To know the actual income on a utility-of-income curve one will receive in a given period, expected income can be estimated: expected utility is the average of all possible utilities weighted by their respective probabilities (PPT Slides 10–12). II. The Emergence of Employer-Sponsored Insurance: A series of insurance services created till employer-sponsored insurance is as follows: 1798: Health insurance; 1847: the first company offered sickness insurance; the 1870s and 1880s: medical benefits; 1910: group health insurance; the 1920s: individual prepaid plans that covered hospital benefits; 1929: the Blue Cross plans; 1954: the Internal Revenue Service exempted contributions to health insurance benefits from employee taxable income; 1949: major medical benefits; the 1950s: dental care, prescription drugs, and vision care; 1965: Medicare and Medicaid; 2010: expansion of Medicaid to incomes below 138 percent of the federal poverty level (PPT Slides 20–22). a. Managed care organizations offer comprehensive health care coverage where the provider is responsible for the health care services of enrollees for a fixed fee. By 1985, over half of company-sponsored group insurance plans operated under Administrative Service Only (PPT Slides 15–19 & 41). b. Private employers who sponsor insurance plans self-insure by assuming all or a significant part of the financial risk. Many self-insured firms arrange for commercial insurance companies limit risk through reinsurance, a cap on spending at some stop-loss threshold. III. Information Problems and Market Failure: The premium paid by the policyholder is equal to the insured’s expected spending plus a markup called loading to cover administrative overhead and profit. If the likelihood of use of insurance is high and the costs are relatively low, the markup exceeds the value of the risk reduction, and the customer chooses not to buy insurance. a. The unequal distribution of information has several serious consequences: consumer information problems (most information is consumer to consumer by word of mouth with little formal advertising; cost-conscious decision making and price transparency are solutions), moral hazard, and adverse selection. Adverse selection arises because individuals have more information about expected medical expenditures than insurance companies do (concealing true risks results in a disproportionate number of insureds) (PPT Slides 25 & 27–37). b. Prior to the passage of the ACA, the insurer’s response to adverse selection was twofold: 1) Insurance companies would only underwrite prospective risk and refuse to provide insurance for known preexisting conditions and 2) The insurer attempted to determine the expected level of spending prior to entering into the contract and refused to cover a preexisting condition. The solution to cream skimming (a practice in which healthy individuals purchase insurance and those with a history of costly

medical problems will not) is not community-rated premiums but appropriate subsidies to those who cannot afford the actuarially fair premium) (PPT Slide 26 & 38–40). c. The ACA required that the benefit packages for all qualified health plans are designed and that insureds are able to choose among four metallic tiers of plans. Mandates impose significant economic and social costs on their intended beneficiaries (to correct deficiencies in the health insurance market and prevent adverse selection). IV. Medical Care for the Uninsured: A large percentage of the uninsured are lowwage workers, and others over 30 percent of the uninsured have incomes at least three times the FPL (they do not consider the purchase of health insurance a very good buy for the money). Individuals with incomes from 250–400 percent of the FPL are eligible for premium subsidies only, keeping their net premiums under 9.5 percent of their income (PPT Slide 44). a. There is evidence that more generous health insurance benefits have little effect on health outcomes and that the absence of insurance does not reduce the health status of the average American. Other research suggests that those lacking insurance have trouble accessing the medical care system. b. Surveys in 1998 estimated the count of the uninsured to be from 21.1 to 43.9 million Americans, or 9.1 to 18.4 percent of the population. The count varies by three factors: the duration of uninsurance (e.g., one-third of the uninsured for one year, people cycling into and out of an insurance pool, the uninsured without coverage for at least one year), demographics of the uninsured (e.g., level of income: 16 percent below the FPL, less than 3 percent over four times FPL, and annual incomes less than twice the FPL and race), and small group factors (insurance is expensive for small firms and perceived risk is higher; ACA established the health insurance exchanges for those who do not purchase insurance through an employer) (PPT Slide 45 & 46). c. Private hospitals have reduced free care for the uninsured in non-acute cases, but the uninsured can get it through Medicare disproportionate share payments. Universal insurance coverage requires accepting the principles of subsidization of those who cannot afford coverage and offering participation incentives to those who can (i.e., low-risk insureds have to subsidize those who are high risk) (PPT Slide 47). V. Summary and conclusions: The private sector insures over 214 million people, including those obtaining through the Blue Cross-Blue Shield, self-insurance, and prepaid health plans. Advocates of a government sector solution may have preferred a single-payer option instead of the ACA reform package, while those of a private sector solution prefer reducing the cost of private insurance to make it more affordable (PPT Slide 51). [return to top] Profile: Uwe E. Reinhardt

Issues in Medical Care Delivery •

• •

The Impact of the Affordable Care Act on Health Insurance Premiums Health Status Insurance Does Insurance Improve Health?

Back-of-the-Envelope • •

• •

The Economics of Opportunistic Behavior Adverse Selection in Health Insurance Markets The Economics of Employer Mandates The Welfare Loss from a Subsidy

Applied Micro Methods •

•

Employer-Sponsored Insurance and the Gender Wage Gap Who Pays for the ACA’s Dependent Mandate?

Teaching Suggestions • • •

•

This is another good place to introduce the “crisis” discussion. Does the United States have a health care financing crisis? Clearly distinguish between indemnity and social insurance. You will be laying the groundwork for future policy discussions. Why do people buy insurance? Spend some time developing the theory of private insurance demand using the utility-of-income approach. Most students have limited background in the theory of insurance. Here, economics majors and non-majors are generally on more equal footing. It is a technical discussion. Avoid the urge to gloss over the details. Your better students appreciate the rigor, and everyone ends up with a better appreciation of the purpose of insurance. A simple exercise in determining a premium for a group is instructive. The addition of a smaller group of high-risk participants drives home the effect on the premium everyone pays.

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Suggested Approaches to End-of-Chapter Questions 1. Medical losses are almost always a matter of pain and suffering, and, at times, life and death. The traditional indemnity insurance model where you suffer a loss, get a damage estimate, and fix the problem may not be totally applicable. 2. All of these concepts are defined in the glossary. Moral hazard, adverse selection, and asymmetric information make the task of underwriting risk more difficult. With respect to moral hazard, how much will quantity demanded increase when insurance is present? For the latter two, should individuals be able to hide their true health status and force insurance companies to sell them policies at premiums far below the expected loss? Third-party payers create the moral hazard problem and cream skimming is a way that insurers try to avoid high-risk users.

3. Deductibles and coinsurance are the insurance underwriters’ way of minimizing moral hazard. Unless premiums are charged based on the quantity demanded at a zero price, they are necessary. 4. The different types of insurance are discussed on pages 233–234. 5. Answers to these questions will vary depending on students’ perspective on the role of private insurance. A more advanced answer may refer to the mapping of genes undertaken by the Human Genome Project. After all 100,000 genes are mapped, every person is likely to have 6 to 10 defective genes. Does that mean that everyone will be denied insurance coverage? 6. This question may be answered with the discussion beginning on pages 252– 257. 7. Asymmetric information exists when there is an unequal distribution of information between the two parties in a transaction. One person has information that the other does not. Patients may try to hide their true health status from providers and insurers. 8. Self-insurance is a way of avoiding paying insurance loading costs, many state mandates, and participation in state-run high-risk pools. 9. At the level of economic development present in the United States, more medical care may not improve health status all that much. Obviously, free health care will improve the health status for the poor, leading to lower blood pressure levels, better oral health, and improved pulmonary health. It may not, however, result in significant improvements in mortality rates. 10. Deductibles and coinsurance are devices to increase out-of-pocket spending by patients. It is meant to counter the problem of moral hazard. 11. Out-of-pocket payments are designed to mitigate moral hazard. [return to top]

Additional Questions for Discussion and Evaluation 1. How should society deal with the conflict between genetic predisposition and insurability? 2. What is the difference between “experience rating” and “community rating” in insurance underwriting? What difference does the choice between the two methods of rating affect the availability of health insurance? 3. How do the provisions of the income tax code influence the health insurance decision—whether or not to insure, how much to buy, who pays? 4. “Health insurance policies that provide first-dollar coverage for medical expenses are not really health insurance policies at all. They are merely health plans providing pre-paid medical expenses.” Comment. 5. A “qualified health plan” under the Affordable Care Act may not include preexisting condition exclusions. People with chronic conditions may not be denied coverage because of their illnesses and insurance companies may not cancel a policy should a person become ill.

a. What is guaranteed issue? Guaranteed renewability? b. If policies have these features, what sort of behavior is encouraged? c. What added risk do insurance companies face if policies have these features? How is this risk mitigated? 6. Barry met with his company’s benefit manager to sign up for the health insurance provided through his employer. He had worked for the firm for over two years, but was one of many who chose not to take the offer to participate in the plan because he considered his share of the premiums too expensive. In the intervening interview, the subject turned to pre-existing conditions. Yes, Barry’s wife was eight months pregnant. Yes, he wanted insurance to cover the expenses of the impending childbirth (expected to cost $10,000). Barry was incredulous when he found out that there was a 90-day waiting period before any preexisting condition could be covered. “Well, something is really wrong with this country if you can’t even buy insurance when you need it.” a. Is Barry justified in his criticism? b. What is the purpose of insurance? Is Barry looking for insurance in this instance? What is he looking for? c. Why doesn’t insurance cover preexisting conditions? d. Using the appropriate terminology explain how the ACA deals with preexisting conditions? Will it work? 7. When employers pay for health insurance as part of the total compensation package provided to its employees, who really pays—employers, employees, taxpayers? Explain. 8. Over 75 percent of all Americans who have contracted HIV belong to one of two groups—gay and bisexual males or IV-drug users. Should sexual orientation or a history of drug use be a factor in determining whether a person can get health insurance coverage and the premium they pay? Explain. 9. How does provision of health insurance through place of employment contribute to increased health care spending? 10. Why do employers offer health insurance to their employees? (Note that the alternative is to increase salaries.) Discuss tax implications. Why is it better to buy insurance as a member of a group as opposed to purchasing an individual health insurance plan? 11. Explain how health insurance results in the overuse of health care. (The answer should discuss the moral hazard issue associated with health insurance.) Does health and prescription drug insurance result in inefficiently poor diets and little exercise? If so, how can we measure this inefficiency? 12. Explain why providers are willing to set prices for insurance companies and the government above marginal cost, but below average cost. Should the uninsured pay higher prices for medical procedures than those with insurance or should they pay rates negotiated by the government? Explain. 13. How does health insurance coverage affect the incentive to reduce medical expenses? For the insured person? For the provider of services? What happens

to the incentive to hold down medical expenses once the initial insurance deductible is met? 14. What happens to an employee’s incentive to hold down his or her medical expenses once the insurance deductible is met? 15. Define the two concepts of “moral hazard” and “adverse selection.” Describe separately how the existence of each affects the market for health insurance and medical care. What are some of the ways that insurance companies try to protect themselves against these two phenomena? 16. Addressing the needs of the uninsured and underinsured is the primary focus of the Democrats in passing the Affordable Care Act. In contrast, Republicans consider the fundamental problem to be rapidly rising spending and that the only way to ensure access to affordable health insurance is to control spending. Which one of these two problems do you consider the most important? Why? a. If you argue that the biggest problem is covering the uninsured, demonstrate your understanding of the problem by discussing the demographics of the uninsured, the reliability of the census estimates of the size of the group, the effect of not having insurance on the health of the uninsured, and other issues that you consider important. b. If you think spending as the main problem, address the size and nature of the spending problem and how you would go about slowing the rate of growth in U.S. health care spending.

Multiple Choice 1.

Early in U.S. history, most health insurance policies covered a. income loss due to disability or disease. b. hospital expenses. c. routine physicians’ services. d. the catastrophic cost of medical care, including hospitalization and physicians’ services. e. medical costs due to specific diseases such as tuberculosis and alcoholism. A prepaid hospital plan created by Baylor Hospital for a group of Dallas public school teachers in 1929 is considered the forerunner of what was later called a. managed care. b. Blue Cross. c. Blue Shield. d. the health maintenance organization. e. major medical insurance.

Mid-1960s amendments to the Social Security Act created a. managed care. b. Medicare and Medicaid. c. major medical insurance.

d. Blue Cross and Blue Shield. e. tax exemptions for health insurance as an employee benefit. 4. Indemnity insurance a. reimburses for certain types of losses including fire and theft. b. is the basis for most of the health insurance coverage in the U.S. c. is often experience-rated, with premiums based on expected losses. d. is sometimes called “casualty insurance.” e. is correctly defined by all of the above. 5. Social insurance a. is the basis for most government redistribution programs. b. is usually community-rated, with premiums based on ability to pay. c. is the basis of the provision of medical care to the poor, elderly, and other vulnerable population groups in the U.S. d. requires mandatory participation to be effective. e. is correctly defined by all of the above. 6. Premiums based on experience ratings a. are uniform across age groups. b. are based on the loss experience of the insured. c. vary depending on the income of the insured. d. are illegal in most states in the U.S. e. are only used in property-casualty insurance underwriting. 7. People buy insurance a. because they are risk averse. b. to defer consumption. c. because of externalities. d. to maximize their welfare. e. to ensure against poor health. 8. One result of asymmetric information in health insurance markets is a. an optimal number of insurance policies sold. b. adverse selection. c. externalities in consumption. d. a low marginal benefit of additional information for the buyer of insurance. e. the principal–agent problem. 9. Moral hazard and adverse selection are both examples of a. the principal–agent problem. b. externalities in consumption. c. efficiency in markets. d. perfect information. e. asymmetric information. 10. Insurers try to minimize moral hazard by a. only selling policies to individuals with high ethical standards. b. requiring advance payments of premiums. c. charging higher premiums to individuals than to groups.

d. charging deductibles and coinsurance. e. refusing to sell insurance to individuals with chronic illnesses. 11. The goal of health insurance is to a. redistribute income from the sick to the healthy. b. spread risk over a large group of people. c. equally distribute the probability of loss over a large number of people. d. collect sufficient premiums to cover all possible losses. e. equalize the availability of medical care across population groups. 12. Insurance works best in situations where a. there is a high probability of a small loss. b. there is a low probability of a small loss. c. there is a high probability of a large loss. d. there is a low probability of a large loss. e. the level of probability and the size of the loss are irrelevant. 13. Analysts cite figures on the number of uninsured in the United States as low as 10 million and as high as 60 million. Which of the following is a true statement? a. The uninsured are all free riders. b. Most of the uninsured have health problems and are not able to get private health insurance. c. Most of the uninsured have some labor-force connection—either working or as a dependent of someone who is working. d. The lack of health insurance means that the individual has virtually no access to medical care. e. Once you lose your health insurance, it is extremely difficult to get reinsured. 14. The highest incidence of those without health insurance occurs in which age category? a. Under 18 years of age b. 18–34 years of age c. 35–44 years of age d. 45–64 years of age e. Over 65 years of age 15. Many individuals without health insurance receive “free” care. What are the sources of most of the care they receive? a. Public hospitals and clinics b. Private, not-for-profit hospitals c. Private, for-profit hospitals d. Multi-specialty physicians’ practices e. Solo practitioners and their associates

16. A major factor contributing to the growth in employee-based health insurance in the United States has been a. greater than average economic growth leading to increased demand for labor. b. the tax free treatment of health insurance as an employee benefit.

c. legislation requiring all firms to provide health insurance to all full-time workers. d. the long-standing tradition of providing a generous package of benefits to all workers. 17. A group of 100 people seek out an insurance company to underwrite health insurance for its members. If expected medical spending for the group is $150,000, what will the average premium be if the health insurance company estimates the premium adding net loading costs of 20 percent? a. $1,200 b. $1,500 c. $1,800 d. $3,000 18. Continuing from the question above, an additional 10 people join the group who have expected medical spending of $5,000 per person on average. The new premium will be approximately how much? a. $1,500 b. $2,200 c. $2,500 d. $4,500 19. Firms self-insure a. to save money on premiums. b. to avoid state level insurance regulation. c. to create uniform benefit packages for employees who live in different states. d. for all of the reasons listed above.

Structured Discussion 1. Resolved: The fact that health insurance premiums are not taxable distorts the purchase decision. Thus, health insurance benefits should be treated as ordinary income for tax purposes. 2. Resolved: Health insurance premiums should be higher for smokers than for nonsmokers. 3. Resolved: Health insurance premiums charged to individuals born with genetic defects (that result in above average use of medical care) should be higher than those charged to individuals without such defects. 4. Resolved: Insurance companies should be required to cover all applicants regardless of health condition and not allowed to charge sicker individuals higher premiums. 5. Resolved: Third-party payment results in patients using services whose costs exceed their benefits, and this excess of costs amounts to a substantial percentage (3–5%) of total health care spending. [return to top]

Purpose and Perspective of the Chapter The purpose of this chapter is to introduce students to the various managed care models used in the United States as a large and growing alternative to traditional fee-for-service medical care delivery. It also discusses the importance and emergence of managed care in the U.S. economy. It starts by discussing health maintenance organizations, preferred provider organizations, and point-of-service plans and then introduces consumer-directed health plans (CDHPs) and the accompanying high-deductible health plans (HDHPs) and health savings accounts (HSAs) that were created by legislation in 2003. It also looks at the growing popularity of CDHPs since they were introduced. It ends by summarizing the costsaving features of managed care and the mixed empirical evidence for the claim that this form of delivery actually saves money.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. 2. 3. 4.

Explain the development of the managed care model. Analyze cost-savings strategies targeting providers. Evaluate market approaches to reduce spending. Evaluate the evidence related to managed care on spending and the quality of care. 5. Explain the future of managed care.

Complete List of Chapter Activities and Assessments Chapter Objective 9-1 Explain the development of the managed care model.

Activity/Assessment Additional Discussion Questions #1, 3, & 5 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 10

Duration

PPT Slide 11

5 mins

PPT Slide 44

10–15 mins

5–10 mins 5–10 mins

Chapter Objective 9-2 Analyze cost-savings strategies targeting providers.

9-3 Evaluate market approaches to reduce spending. 9-4 Evaluate the evidence related to managed care on spending and the quality of care. 9-5 Explain the future of managed care.

Activity/Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 19

Duration

PPT Slide 20

5 mins

PPT Slide 26

5–10 mins

PPT Slide 27

5 mins

PPT Slide 44 PPT Slide 42

10–15 mins 5–10 mins

PPT Slide 43

5 mins

PPT Slide 44 Instructor’s Manual PPT Slide 35

10–15 mins 5–10 mins

PPT Slide 36

5 mins

PPT Slide 44

10–15 mins

Additional Discussion Questions #

Instructor’s Manual

5–10 mins

Self-Assessment

PPT Slide 44

10–15 mins

Additional Discussion Questions #6–8 Knowledge Check 2 Activity Knowledge Check 2 Answer Knowledge Check 3 Activity Knowledge Check 3 Answer Self-Assessment Knowledge Check 5 Activity Knowledge Check 5 Answer Self-Assessment Additional Discussion Question #2 Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment

5–10 mins 5–10 mins

5–10 mins

Key Terms Fee-for-service: The traditional payment method for medical care in which a provider bills for each service provided. Health maintenance organization (HMO): A type of managed care organization that functions like an insurer and also arranges for the provision of care. Prepaid group practice: An arrangement through which a group contracts with a number of providers who agree to provide medical services to members of the group for a fixed, capitated payment.

Point-of-service plan (POS): A hybrid managed care plan that combines the features of a prepaid plan and a fee-for-service plan. Enrollees use network physicians with minimal outof-pocket expenses and may choose to go out of the network by paying a higher coinsurance rate. Consumer-directed health plan: A health plan that combines an HSA with a highdeductible insurance policy. Group-model HMO: A group of physicians—often a large, multispecialty group practice— that agree to provide medical care to a defined patient group, usually the employees of a corporation, in return for a fixed per capita fee or for discounted fees. Staff-model HMO: A managed care organization that serves as both payer and provider, owns its own facilities, and employs its own physicians. Independent practice association (IPA): An organized group of health care providers that offers medical services to a specified group of enrollees of a health plan. Practice guidelines: A specific statement about the appropriate course of treatment that should be taken for patients with given medical conditions. Utilization review: An evaluation of the appropriateness and efficiency of prescribed medical services. Selective contracting: An arrangement where health plan administrators contract with a select group of providers who agree on a predetermined fee schedule and certain medical practice patterns in return for a guaranteed patient cohort. Risk-sharing arrangement: Health insurance contracts where parties to a transaction share the risk of medical spending. Closed panel: A designated network of providers that serves the recipients of a health care plan. Patients are not allowed to choose a provider outside the network. Any willing provider: A situation in which a managed care organization allows any medical provider to become part of the network of providers for the covered group. Case management: A method of coordinating the provision of medical care for patients with specific high-cost diagnoses such as cancer and heart disease. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: •

Expansion and introduction to consumer-directed health plans (CDHPs) and the accompanying high-deductible health plans (HDHPs) and health savings accounts (HSAs)

• • •

A review of the growing popularity of CDHPs and what drives them, including a new section within the Market Approach to Reduce Spending Updated discussions of issues related to managed care and their importance in the U.S. economy Added case studies to teach students how to apply managed care problems to real world situations as a means of analysis

Chapter 9: Managed Care This chapter presents a brief history of growth and development of managed care as an alternative to traditional fee-for-service medical care delivery. The different varieties of managed care are discussed, including health maintenance organizations, preferred provider organizations, and point-of-service plans. The chapter also introduces consumerdirected health plans (CDHPs) and the accompanying high-deductible health plans (HDHPs) and health savings accounts (HSAs), as well as their growing popularity. The cost-saving features of managed care are listed and the mixed empirical evidence that this form of delivery actually saves money is summarized.

Chapter Outline I.

II.

The Managed Care Model: Health maintenance organizations (HMOs) were first formed in the 1920s to improve access to health care. The number of HMOs was limited to 40 throughout the 1960s as physicians were opposed to the concept of prepaid medical care, calling it "contract medicine," but it emerged as an alternative to traditional fee-for-service with the passage of Medicare and Medicaid in 1965 and then The Health Maintenance Organization Act of 1973 was formed to establish HMOs (PPT Slide 5). a. Managed care can be paid in advance similar to all-you-can-eat buffet. The problem with this approach is that the insured may seldom practice economizing behavior with more incentives (PPT Slides 6 & 7). b. Types of managed care plans are as follows: HMOs, preferred provider organizations (PPOs)—serve as broker between the purchaser of medical care and the provider, and cost is controlled by cost-conscious providers and the threat of dropping any non-adhering physician, point-of-service (POS) plans—incorporates many cost-control features of HMOs along with the provider-choice features, and consumer-directed health plans (CDHPs). The group-model HMO contracts with a multispecialty group practice, the staffmodel HMO with facilities and physicians, the network-model HMO with many facilities and hospitals, and the independent practice association with individual physicians or small groups (PPT Slides 8 & 9). Cost-Saving Strategies Targeting Providers: The objectives of cost-saving strategies are to place supply-side restrictions on certain kinds of medical care,

III.

IV.

to redirect medical care delivery to less-expensive locations, and to monitor the use of medical products, supplies, and services. The managed care utilizes a combination of provider-side provisions to control moral hazard and the spending associated with it: (1) selective contracting, (2) utilization review, and (3) risk-sharing arrangements (PPT Slide 12). a. Selective contracting is contracting with selected providers who agree on certain medical practice styles. The PPO allows the patient to choose a provider who is not part of the panel (PPT Slides 13 & 17). b. Controlling utilization requires some type of authorization for using hospital services: a preadmission review (establishes the appropriateness of a procedure), concurrent review (utilizes established guidelines to determine whether a patient should remain in the hospital), or retrospective review (examines the appropriateness of care after its completion). Three mechanisms of managed care plans: authorization review, second opinion, and case management (PPT Slides 14 & 18). c. Managed care utilizes various reimbursement schemes with the common goal of shifting (discourages overutilization of services) some of the financial risk to providers. Primary care physicians receive a fixed payment determined in advance to provide all primary and preventive care for a specific group of patients, and they can be incentivized or penalized depending on whether they provide care within predetermined budgets or not (PPT Slides 15–17). Market Approach to Reduce Spending: The market-oriented approach includes options that give the consumer patient more responsibility in the decision-making process (they may go for low-cost procedures). The financial model would include a high-deductible insurance policy supported by an HSA or a health reimbursement arrangement (PPT Slide 21). a. For the market to work in medical care, consumers must spend their own money for routine medical services. HRAs allow tax-free contributions into accounts for out-of-pocket medical spending, while HSAs allow buying a highdeductible policy (PPT Slide 22). b. In the mid-1990s, managed care plans increased the use of capitation, shifting some of the financial risk to providers and encouraging the incorporation of cost-reducing strategies into the delivery system. The Accountable Care Act provides incentives for provider groups to establish ACOs (the best example of innovative behavior on the delivery side) to better coordinate the delivery of care, improve quality, and lower cost (PPT Slides 23–26). Effect of Managed Care on Spending and Quality: Managed care competes more effectively with fee-for-service for adopting many cost-saving features.

VI.

VII.

More managed care systems allow recipients using providers outside a closed panel by paying higher deductibles and coinsurance rates. Managed Care Cost Savings: The extensive combination of features utilized by the various health care plans makes it difficult to control for the differences, making comparisons tricky, and has several important issues: selection bias, utilization of services, quality of care, and ability to control costs. Results of several studies confirmed the cost-saving potential of managed care when comparing HMO and fee-for-service costs. Savings were due to a few of several reasons: shorter hospital stays, fewer tests, the use of less costly medical procedures, increased use of drugs, fewer visits, and fewer hospital admissions (PPT Slides 28–30). a. Out of studies that compared managed care and traditional fee-for-service care, some found significantly better quality in managed care but others found worse. There is little evidence that managed care quality was lower than that found in fee-for-service plans and that managed care fared worse than fee-for-service (PPT Slides 31–33, 41, & 42). b. In the movie As Good as It Gets, a fictitious HMO denies care to Hunt's asthmatic son and the fee-for-service physician finally diagnoses and treats him sympathetically. The image problem (i.e., poor quality of care in contrast with empirical studies) may be due to delay in publishing of the article, the diversity of managed care arrangements the newer types of managed care plans, and the role of medical providers in influencing public perception about managed care (PPT Slide 34). The Future of Managed Care: The future of managed care is dependent in many ways on the changes ushered in by the ACO: 1) being accountable to care of Medicare beneficiaries of fee-for-service, 2) inclusion of a “shared savings” component, 3) having an integrated delivery system, 4) a significant change in physician and patient behavior, and 5) patients should be accountable for the cost of care. Even with all these changes, the cost-conscious consumer is still the best defense against excess spending (PPT Slides 37–39). Summary and Conclusions: Managed care emerged as the alternative payment and delivery mechanism to traditional fee-for-service indemnity insurance in the following ways: a one-size-fits-all solution is too restrictive as there are technology options and access restrictions; risk sharing is a challenge to autonomy for providers; Payers learned that cost control is unpopular and that medical care presents an image problem and corporal survival problem; Politicians learned that access restrictions and limits to spending cost votes and that expansions of treatment options and increases in spending win votes (PPT Slide 45).

[return to top] Profile: William B. Schwartz Issues in Medical Care Delivery

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Public Employees Shifting into Consumer Driven Plans

•

The Managed Care “Blues”

Applied Micro Methods •

Long-Term Effect of CDHP Enrollment on Health Spending

Teaching Suggestions • •

Most students have some experience with managed care. Poll the class to determine what type of health care coverage each student has. The incentive structure of managed care is quite different from that of fee-forservice. Describe how managed care uses capitated payment to general practitioner gatekeepers, coupled with risk sharing to control spending. Many of these risk-sharing arrangements include bonuses for meeting budgets in key areas, including specialty referral, hospitalization, and pharmacy. Some even require the physicians to reimburse the plan for a percentage of spending over the budgets. How does this affect provider behavior? Many students are somewhat dismayed.

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Suggested Approaches to End-of-Chapter Questions 1. All terms are defined in the glossary. Fee-for-service and capitation are opposites in the payment mechanism—fee-for-service encourages overtreatment and capitation under-treatment. Assignment forces physicians to accept lower fees for treating Medicare patients. This results in cost-shifting to private health insurance patients. 2. Providers share some of the financial risk in managed care, especially in those situations where capitated payment is used. Risk sharing changes the incentive structure. No longer is it profitable to provide more services. Physicians get more by providing less. The physician views the patient as a cost center, not a profit center. 3. The HMO is a provider and a payer. As an insurer, the HMO shares the financial risk of providing care. The HMO does have some control over the amount of care provided. 4. Cost-saving features include provider networks, payment by capitation, utilization management, and the use of gatekeepers. 5. Cost-conscious providers are continually searching for less expensive ways to provide care. Discounted fee-for-service, closed panels, required second opinions, and formularies will have an effect on the rest of the health care sector. A shift to inpatient care, moving recovering patients out of the hospital and into acute-care nursing homes, the provision of home health care, and hospice care will all increase. 6. The incentive is to provide less care, fewer hospital admissions, and shorter hospital stays. The empirical evidence all seems to point to these results. Overall health status does not seem to suffer. 7. These are terms that must be defined on a case-by-case basis by medical practitioners, not MBAs. Interpreting outcomes research can be tricky.

8. Risk sharing will make providers responsible for all spending greater than the capitated payment creating an incentive to limit equivocal care. [return to top]

Additional Questions for Discussion and Evaluation 1. How does capitation change the incentive structure in a managed care environment? 2. How has the move to managed care in the medical marketplace affected the quality of care? What is the evidence? 3. How does a consumer-directed health plan (CDHP) work? Can anyone save in a health savings plan (HSAs)? 4. Which of the following is an advantage of health savings accounts (HSAs) over health reimbursement accounts (HRAs)? 5. Describe the incentive structure of a fixed-budget medical care system. 6. How are incentives to providers different when they are paid on a capitated basis rather than a fee-for-service basis? Discuss the arguments (both pro and con) relating to placing physicians on risk-sharing contracts. 7. Describe the major features of a risk-sharing contract between a general practitioner (GP) and an HMO. How does the existence of such a contract change the incentive structure facing the GP? What are the pitfalls facing patient and physician under these circumstances? 8. It has been argued that medical practitioners have the ability to generate demand for their own services. What is the theory behind this hypothesis? What assumption of the perfectly competitive model must be violated? What is the empirical evidence used to support the theory of physician-induced demand?

Multiple Choice 1.

Kaiser-Permanente, the nation’s largest health maintenance organization, was founded a. to provide cost-effective medical care to Kaiser employees. b. to provide access to medical care to Kaiser workers in remote locations where medical services were in short supply. c. to slow the rate of growth in medical spending for Kaiser employees. d. as a group-model HMO. e. as a network-model HMO. Managed care a. establishes a system of retrospective payment determined ex ante. b. combines the responsibilities of payer and provider of medical services. c. attempts to shift a portion of the financial risk onto providers. d. attempts to shift a portion of the financial risk onto patients. e. both b and c.

Capitation a. creates pressures to provide fewer services. b. is a fixed payment determined in advance to pay for all medically-necessary care. c. is the maximum allowable fee in a fee-for-service system. d. shifts financial risk onto patients. e. both a and b. The health maintenance organization where the physicians are salaried employees of the HMO is called a. a group-model HMO. b. a staff-model HMO. c. a network-model HMO. d. an IPA. e. a direct-contract HMO. The health maintenance organization that contracts with individual physicians or group practices to provide care for a specified group of enrollees is called a. a group-model HMO. b. a staff-model HMO. c. a network-model HMO. d. an IPA. e. a direct-contract HMO. Network model HMOs use _______ to shift financial risk back onto providers. a. capitation b. contracts with physicians and hospitals c. open panels d. closed panels e. formularies Which type of managed care organization has the strictest cost control features? a. Group-model HMO b. IPA c. POS plan d. Closed-panel HMO e. PPO What is the motivation behind the cost-control features of managed care? a. To ensure access to specialty care through general practitioner gatekeepers b. To influence the way physicians practice medicine by changing the financial incentive structure of medical care delivery c. To shift the financial risk onto patients d. To eliminate all the guesswork from diagnoses by establishing practice guidelines e. To create competition by providing patients with a wide range of providers The RAND Health Insurance experiment compared costs of HMOs with the costs of indemnity insurers. The study a. confirmed the cost-saving potential of HMOs. b. Found no cost-saving by HMOs.

c. the HMO had per capita costs that were 28% lower than the indemnity d. both a and c. 10. Most empirical studies show that the cost-savings provided by managed care are accomplished by a. better preventive care. b. reducing the rate of hospitalization. c. denying access to costly specialty care. d. switching to generic drugs. e. all of the above. 11. To control moral hazard and the increased spending that accompanies it, managed care providers include _______ in contracts with providers. a. clinical rules b. capitation c. risk sharing d. all of the above 12. The most important aspect of the change from fee-for-service to capitation is that a. physicians get their money quicker. b. patients get faster service since physicians don’t have to worry about getting paid. c. physicians make less money. d. the most valuable patient is no longer the sickest, but the most healthy. 13. Which of the following statements is not true about managed care? a. Empirical evidence suggests that managed care can reduce health care spending. b. Most of managed care’s savings can be traced to reduced hospitalization. c. There is more emphasis on preventive care in managed care. d. There is no credible evidence to suggest lower quality of care for any group of patients in managed care arrangements.

Structured Discussion: 1. Resolved: If the entire U.S. health care system were transformed overnight into one where everyone belonged to a managed care organization, we would experience a one-time cost savings, only to find ourselves back on the same growth path within a short period of time. Resolved: The incentive structure created by capitation and withholds puts too much pressure on providers to reduce costs (and in turn quality) of medical care. Therefore, risk-sharing contracts should be illegal. [return to top]

Table of Contents Instructor Manual ................................................................................................................................. 1 Table of Contents ....................................................................................................................... 1 Purpose and Perspective of the Chapter ................................................................................. 2 Cengage Supplements ............................................................................................................... 2 Chapter Objectives .................................................................................................................... 2 Complete List of Chapter Activities and Assessments ............................................................... 2 Key Terms ................................................................................................................................... 3 What's New in This Chapter ...................................................................................................... 4 Chapter 10: The Physicians’ Services Market........................................................................... 4 Chapter Outline.......................................................................................................................... 5 Teaching Suggestions ................................................................................................................ 7 Suggested Approaches to End-of-Chapter Questions ............................................................ 8 Additional Questions for Discussion and Evaluation .............................................................. 8 Multiple Choice ..................................................................................................................... 10 Structured Discussion .......................................................................................................... 14 Appendix 10A: Medical Malpractice ....................................................................................... 14 Appendix Outline ..................................................................................................................... 14 Appendix Objectives ................................................................................................................ 14

Purpose and Perspective of the Chapter The purpose of this chapter is to acquaint students with the design and functioning of the market for the services of physicians and to briefly explore the market for other clinicians, including nurses and dentists. It will also give students a perspective of the current and future demand for physicians’ services and the expected shortage of these services based on the Affordable Care Act (ACA) legislation. As a primary determinant of the supply of physicians, the role of medical education is addressed. Important topics discussed include the shortage of physicians, international medical graduates, reform, etc.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives 1. 2. 3. 4.

Explain the marginal productivity theory of input pricing. Analyze the intricacies of physician compensation. Summarize the economic models explaining physician behavior. Identify the implications of incentives and regulation in medicine. 5. Explain the markets for nurses and dentists.

Complete List of Chapter Activities and Assessments Chapter Objective 10-1 Explain the marginal productivity theory of input pricing.

10-2 Analyze the intricacies of physician compensation.

Activity/Assessment Additional Discussion Question #1 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment Additional Discussion Questions #2 & 4 Knowledge Check 2 Activity Knowledge Check 2 Answer Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 10

Duration

PPT Slide 11

5 mins

PPT Slide 51 Instructor’s Manual PPT Slide 28

10–15 mins 5–10 mins

PPT Slide 29

5 mins

PPT Slide 51

10–15 mins

5–10 mins 5–10 mins

5–10 mins

Chapter Objective 10-3 Summarize the economic models explaining physician behavior. 10-4 Identify the implications of incentives and regulation in medicine.

10-5 Explain the markets for nurses and dentists.

Activity/Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 33

Duration

PPT Slide 34

5 mins

PPT Slide 51 Instructor’s Manual PPT Slide 42

10–15 mins 5–10 mins

PPT Slide 43

5 mins

PPT Slide 49

5–10 mins

Knowledge Check 5 Answer

PPT Slide 50

5 mins

Self-Assessment

PPT Slide 51

10–15 mins

Additional Discussion Question #3

Instructor’s Manual

5–10 mins

Self-Assessment

PPT Slide 51

10–15 mins

Additional Discussion Question #5 Knowledge Check 3 Activity Knowledge Check 3 Answer Self-Assessment Additional Discussion Questions #6 & 7 Knowledge Check 4 Activity Knowledge Check 4 Answer Knowledge Check 5 Activity

5–10 mins 5–10 mins

5–10 mins

Key Terms Marginal revenue product: The change in total revenue resulting from the sale of the output produced by an additional unit of a resource. Relative-value unit: Metric used to measure resource use (time, effort, and investment) involved in the production of physicians’ services. Components measured include work effort, practice expense, and the cost of professional liability insurance. Resource-based relative value scale (RBRVS): A classification system for physicians’ services, using a weighting scheme that reflects the relative value of the various services performed. Developed for Medicare by a group of Harvard researchers, the RBRVS considers time, skill, and overhead cost required for each service. When used in conjunction with a monetary conversion factor, medical fees are determined. Usual, customary, and reasonable (UCR) charges: A price ceiling set to limit fees to the minimum of the billed charge, the price customarily charged by the provider, and the prevailing charge in the geographic region.

Relative-value scale (RVS): An index that assigns weights to various medical services used to determine the relative fees assigned to them. Monetary conversion factor: A monetary value used to translate relative value units into dollar amounts to determine a fee schedule. Arbitrage: The practice of simultaneously buying a commodity at one price and selling it at a higher price. Price discrimination: The practice of selling the same good or service to two different consumers for different prices. The price differential is not based on differences in cost. Unbundling: Separating a number of related procedures and treating them as individual services for payment purposes. Clinical rule: Is a specific practice required of all participating physicians, such as a policy to refer patients only to a specific panel of specialists. Gatekeeper: A primary care physician who directs health care delivery and determines whether patients are allowed access to specialty care. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: •

• • •

New introduction and explanation of the pending physician shortage as more than 30 million people seek insurance over the next decade as a result of Affordable Care Act (ACA) legislation Reorganized approach to the marginal productivity theory of input pricing Updated and broader explanation of the market for physician services and the models for physician behavior Added case studies about the physician market as a means of analysis

Chapter 10: The Physicians’ Services Market This chapter focuses on the market for physicians’ services, followed by short discussions of nurses and dentists. Specialty mix and geographic distribution precede a discussion of physicians’ compensation issues. As a primary determinant of the supply of physicians, the role of medical education is addressed. Important topics discussed include the shortage of physicians, international medical graduates, and reform.

Chapter Outline I.

II.

The Marginal Productivity Theory: The standard economic theory of labor markets views individual marginal productivity as one of the main determinants of labor income. Because productivity determines wages, higher productivity translates into greater demand for labor services and higher wages. a The theory of input pricing is similar to the theory of pricing goods and services. The least-cost combination of inputs is required to produce the profit-maximizing level of output (inputs are paid equal to each input's marginal revenue product) (PPT Slide 5). b The demand curve is derived by determining the maximum price buyers are willing to pay to obtain the desired amount of the input. The MRP curve reflects two concepts determining input demand and the level of product demand (PPT Slides 6 & 7). c The potential earnings must be enough to overcome the huge cost of the investment. To determine whether medical school attendance is a good economic investment, we can calculate the rate of return on that investment (PPT Slides 8 & 9). The Market for Physicians’ Services: The changing demographics of the population have played an important role in determining demand and supply in the physicians’ services market (The U.S. medical market provides higher relative salaries and fewer practice restrictions than in other countries). The importance of foreign-trained physicians in staffing many rural and inner-city facilities highlights the potential impact of changes in U.S. immigration policy on physician supply (PPT Slides 12 & 13). a Several studies have examined the physicians’ services market and identified a mismatch between supply and demand (e.g., estimates of the expected shortage are as high as 130,000 by 2030 and 139,000 by 2033) conclusions, pointing to some challenging policy issues (PPT Slide 14). b The physician–population ratios are substantially lower in U.S. rural areas (say, the ratio was one-third in the 700 counties with fewer than 10,000 inhabitants). Providing medical care to low-density, remote areas will be a continuing challenge for the medical care delivery system (PPT Slide 15). c In the U.S. health care system, a more frequent use of the latest medical practices consumed large quantities of resources (general practitioners make 45 percent more than the average general practitioner in the comparison group) and physicians’ incomes (U.S. specialists make about 55 percent higher average income than specialists do in other countries) are the primary cause of high spending. Productivity metrics, including relative-value unit (RVU) and resource-based relative value scale (RBRVS), and evidence-based practice by the ACA—in terms of patient satisfaction, cost-effectiveness, and quality measures—have emerged as a key factor in determining physicians’ compensation (PPT Slides 16–19).

III.

As insurance became more popular, a pricing model was introduced that limited physicians’ fees to usual, customary, and reasonable (UCR) levels. Ways to control spending on payer's side are establishing a relative value scale (RVS) (weighting based on time taken for procedures and complexity, e.g., work effort measured by time, energy, and skill level, overhead cost, and liability insurance premiums), converting relative values to payment (applying a monetary conversion factor to the scale), and the effect of a fee schedule on physicians’ services (the RBRVS provides a neutral incentive structure for physicians, so physicians may change based on specialty and may refuse new Medicare patients) (PPT Slides 20–23). e Group practices lowers the overhead cost for physicians and increases the range of services. Studies found significant differences in utilization rates and differences in the rates of surgery—may be due to patient preferences for specific treatments—where variations may provide treatment alternatives so that the efficacy and efficiency of medical care delivery outweigh the losses caused by limiting the choice of treatment from the standardization of services (PPT Slides 24–27). Models of Physician Behavior: The characteristics of the market for physicians’ services should be considered to model physician behavior. There are certain imperfections in markets where providers have a certain degree of market power. a The market of physicians shares many characteristics of the standard model of monopolistic competition with many sellers, where the firms face downward-sloping demand curves. Demand curves of patients with insurance coverage have more price inelastic (but does not change the basic standard model), meaning physicians charge patients different prices for the same services based on the extent of their insurance coverage (lower prices for more elastic demand and higher prices for more inelastic demand) (PPT Slide 30). b The problem with a principal–agent model is that with the dual of the physician as an adviser and provider creates a conflict interest between what is best for the patient in terms of clinical efficacy and what is best for the physician in terms of financial reward (may recommend unnecessary procedures to the insured patient) (PPT Slides 31 & 32). c A model of physician behavior that incorporates the potential for demand inducement affects the well-being or utility of a physician who is at financial risk (three factors of utility are income, hours worked, and the extent of demand inducement, and the model is subject to some biases as there are various sources of variation leading to incorrect results). When capitation rates reflect only for age and sex differences, and not health status, this strategy results in lost income for the provider and encourages sick patients to change providers (patient dumping) (PPT Slides 35–41).

IV.

Briefly Explore the Markets for Other Clinicians: The markets for the services of other clinicians perform in much the same way as the physicians’ services market. a Efforts to curb the growth of health care costs are likely to have significant effects on the market for nursing services. By redesigning the medical workplace, hospitals will be able to use more nursing aides to provide much of the low-skill, routine care (PPT Slides 44–46). b Demand for dental services will grow as the baby boom generation ages. On average, this group has retained more of its teeth than previous generations and has more disposable income, and the demand for preventive care will remain solid (PPT Slides 47 & 48). Summary and Conclusions: Advocates of the market approach argue that the proper specialty mix and geographic distribution are better determined through market incentives. In a fee-for-service environment, the sickest patient is most valued and office visits, services, and procedures translate directly into more income for the physician, whereas in a capitated environment, the healthiest patient is most valued and generates the same income without consuming resources (PPT Slide 52).

[return to top] Issues in Medical Care Delivery

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Back-of-the-Envelope

The Future Physician Shortage

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An Endangered Species: The Male Gynecologist

Estimating Rates of Return for Schooling

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Differences in Treatment Patterns: Medicare versus Private Insurance

Is There an Optimal Physician– Population Ratio?

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Does Defensive Medicine Reduce Malpractice Claims?

• •

Price Discrimination in Medical Care

Do We Really Want Low-Cost Primary Care? The Demand for Dental Care Silicone Breast Implant Litigation: A Case of Rent-Seeking Behavior

Monopsony Power in the Market for RNs

Teaching Suggestions •

•

The material in this chapter may be presented in a very nontechnical way or you can upgrade the analytical rigor by focusing on the economics provided in the “Back-of-the-Envelope” discussions. Many students who are somewhat critical of the high salaries that physicians receive are usually surprised at the relative rates of return on education for doctors, lawyers, and business professionals. If you do not have pre-medical students in your class, you may choose to skip the discussion on medical education in the United States.

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Suggested Approaches to End-of-Chapter Questions 1. If there are few treatment alternatives or the procedures are minimally invasive, physicians have more power to induce patient demand. This would imply that the more price inelastic demand, the better able physicians are to induce demand. Calculate demand elasticities to determine where potential problems may be. The types of surgeries where physicians have more latitude may be speculative—CABGs, hernia repair. 2. Physicians must be monitored closely to ensure they do not recommend unnecessary treatments. 3. As advisers, they recommend treatments they provide. The possibility of demand inducement is increased when physicians are investors in diagnostic and testing facilities. This increases the likelihood of self-referral. Since patients are responsible for only a small percentage of the bill, they are not as critical in their oversight. Natural limits are determined by the integrity and ethics of individual physicians. 4. Supply is an important element of the medical market. In theory, we expect that an increase in supply (relative to demand) will lower price and increase quantity. The impact on physicians’ incomes will depend on the price elasticity of demand for physicians’ services. The evidence seems to indicate that the more physicians there are, the higher the price, while at the same time physicians’ incomes keep rising. 5. Who better to determine the scope of legitimate medical care activities than practitioners of the trade? Then again, it is in their best interest to limit competition and thus set standards so high as to disqualify all non-MD competition. 6. The issue is just how important high income is in the decision to enter the medical profession. High incomes are important, but so is a decent rate of return on the investment. This can also be improved by subsidies during medical school and reducing the training period. [return to top]

Additional Questions for Discussion and Evaluation 1. Many states prohibit the practice of lay midwifery, an unlicensed health care provider assisting in childbirth. What are the arguments in favor of such a prohibition? The arguments against? How is this lay midwifery any different from weight-loss counseling, ear piercing, and other activities provided by both licensed physicians and unlicensed lay practitioners? 2. It has been argued that medical practitioners have the ability to generate demand for their own services. What is the theory behind this hypothesis? What assumption of the perfectly competitive model must be violated? What is the empirical evidence used to support the theory of physician-induced demand?

3. Unions have improved wages and working conditions in many different employment settings. The decision to strike raises certain moral and ethical issues in medical care. The American Nurses’ Association once considered the use of strikes unprofessional, but in 1968 rescinded that position and now views the strike threat as a necessary part of collective bargaining. Moral and ethical issues aside, what is the economic impact of union activity in nursing? Use both the perfectly competitive and monopsony models to address this issue. 4. Do regional variations in surgeries mean that some physicians overtreat and other undertreat? Do these differences indicate inappropriate and unnecessary care? 5. One factor that enters the specialty choice of new medical school graduates is the income potential of the specialties. If these incomes are not determined in a competitive labor market, then the number entering a given specialty may not meet efficient level. The current system, dominated by Medicare and large insurance companies, is not competitive. Some claim that lack of competition in the market is responsible for shortages in some specialties. a. What are the conditions for a competitive market for specific medical specialties? Are these conditions met in our health care system? b. What factors influence the demand for medical services? Is it possible for patients to demand more physicians than government or private payers desire? c. Is there a shortage of primary care physicians? How do economists answer this question? How can we address this issue? 6. Consider the structure of the physicians’ services market. What features of this market differ from the assumptions of the perfectly competitive model? What changes would you suggest to improve the performance of this market? 7. The growing effort to involve consumers in reducing health care costs has been stymied by the fact that most people just don't know what medical care costs. Aetna Inc. plans to make available online the exact prices it has negotiated with Cincinnati-area doctors for hundreds of medical procedures and tests. The price schedules include every Cincinnati-area primary-care physician or specialist in Aetna's network and prices for 600 common services for which the Hartford, Connecticut-based insurer receives medical claims. For instance, an internist in the University of Cincinnati area charges Aetna or its members $161.32 for a visit from a new patient with moderate to severe problems, while another physician a few blocks away charges $132.23 for the same office visit. The first doctor also charges $41.89 for a chest X-ray taken from two angles, while the latter's price is $34.34. a. Why do prices vary from doctor to doctor? b. How will health care markets improve if patients know what doctors are charging for services? c. What other issues are important in determining your choice of doctor? Is price all that matters?

d. Do you think that it is possible to get the right information to consumers when they need it? Why or why not?

Multiple Choice Suppose the market for nursing services in a local community is so dominated by a singly community hospital that for all practical purposes it is considered a monopsony. Using the diagram below, answer questions 1 and 2.

What is the equilibrium wage and level of employment under monopsony? a. W1 and E1 b. W2 and E0 c. W0 and E0 d. W0 and E1 e. W0 and E2 If the market were perfectly competitive instead of dominated by a monopsonist, what would the equilibrium wage and level of employment be? a. W1 and E1 b. W2 and E0 c. W0 and E0 d. W0 and E1 e. W0 and E2 What is the most significant cost of attending medical school? a. Tuition and fees b. Books and incidentals c. The income foregone d. Room and board e. Pain and suffering Which of the following would increase the supply of physicians? a. Increasing the cost of attending medical school b. More scholarships and grants to cover medical school tuition c. Increasing the medical school entrance requirements to include 15 hours of economics d. Making it easier for plaintiffs to prove medical malpractice claims e. Paying medical schools to eliminate residency opportunities in some specialties Which of the following statements about the distribution of physicians among specialties is true in the United States? a. The majority of physicians specialize in general/family practice. b. There are twice as many generalists as there are specialists. c. There are twice as many specialists as there are generalists. d. The specialty distribution in the United States is similar to that of the rest of the world. e. None of the above. According to surveys by the Medical Group Management Association, the average primary care physician earned approximately _______ in 2010. a. $125,000 b. $150,000 c. $185,000 d. $200,00 e. $225,000.

Surgical specialists earn more than general/family practice physicians. Which of the following statements is not true regarding this income differential? a. Surgeons earn more because their practice costs, including medical malpractice insurance is higher. b. Surgeons earn more to compensate them for the extra years spent as residents. c. Physicians’ incomes are determined to a large extent by supply and demand conditions with respect to each specialty. d. Surgeons will always earn more than general practitioners because they are smarter than general practitioners. e. Surgeons earn more than general practitioners because cutting into people is messy. 8. The rate of return on an investment in medical education a. is inversely related to the length of time spent in formal schooling. b. is inversely related to income. c. will increase with an increase in the availability of student loans. d. is much higher than the rate of return on an undergraduate business degree. e. is inversely related to the number of years in the profession. 9. Physicians who own their own diagnostic testing facilities tend to order more tests, charge higher fees for them, and have higher total bills to patients. This practice of selfreferral is an example of a. moral hazard. b. adverse selection. c. res ipsa loquitur. d. physician-induced demand. e. cognitive dissonance. 10. The observed variations in practice patterns in different regions of the country are difficult to eliminate a. because of the many alternative treatment options available for most ailments. b. due to the localized nature of most medical practice. c. because it is difficult to change the preferences of physicians and patients. d. the observed variations are so minor that they are of little concern to policy makers. e. a, b, and c are true. 11. To address the shortage of physicians on the horizon, it will be necessary to a. build more medical schools. b. provide more grants and scholarships for medical education. c. allow the admission of more foreign-educated physicians. d. all of the above. 12. In 2010, the medical specialty that earned the highest rate of return on investment was a. general primary care. b. Internal medicine. c. Pediatrics. d. orthopedic surgery. e. none of the above.

13. Suppose the number of medical school graduates continues to increase over the next decade. Which of the following is true? a. Physicians’ salaries must fall. b. Physicians’ salaries must rise. c. Physicians’ salaries will fall only if the demand for medical services falls. d. Physicians’ salaries will fall if the demand for medical services rises more than the supply of physicians rises. e. Physicians’ salaries will rise if the demand for medical services rises more than the supply of physicians rises. 14. Physicians salaries increased substantially over the decade 1995–2005 from an average of $215,000 to $315,000. What is the best explanation for this? a. Physicians were smarter in 2005 than in 1995. b. The supply of physicians has increased. c. The supply of physicians has decreased. d. The demand for physicians has increased. e. The demand for physicians has decreased. 15. Starting salaries for female OB/GYNs are higher than those of male OB/GYNs. What is the best explanation for this? a. Female OB/GYNs have more human capital than male OB/GYNs. b. Female OB/GYNs are smarter than male OB/GYNs. c. The demand for female OB/GYNs is greater than the demand for male OB/GYNs. d. The demand for female OB/GYNs is less than the demand for male OB/GYNs. e. More males are in OB/GYN residency programs than females. 16. Input demand is called derived demand because a. demand for an input is derived from demand for the product or service it produces. b. demand for an input is derived from its availability in the input market. c. demand for the output produced is also derived from consumer demand. d. input demand actually determines how much output is produced. 17. An important element in estimating the present value of an investment is the calculation of the discount factor. The discount factor may be expressed as _______, where r is the discount rate and n is the number of years the investment is held. a. (1 + r)n b. (1 + n)r c. 1/(1 + r)n d. 1/(1 + n)r 18. Empirical studies that suggest differences in utilization rates between fee-for-service and managed care plans a. are unreliable due to statistical biases. b. conclude that financial incentives are not the reason for differences in the amount of care physician provide.

c. show no differences in health status among patient groups. d. are unable to differentiate between the impacts due to financial incentives and those due to clinical rules.

Structured Discussion 1. Resolved: The medical school admission process is too selective. Everyone who graduates from an accredited undergraduate institution and successfully completes the courses required for admission should be allowed to attend medical school. 2. Resolved: The U.S. specialty mix is all wrong—there are far too many specialists and not enough generalists. The United States should adopt a national policy to reduce the number of medical specialists immediately. 3. Resolved: All this talk about financial incentives affecting quality of care is overblown. Physicians make so much money that ethical constraints are strong enough to outweigh any financial considerations. In other words, physicians are not affected by financial incentives. [return to top]

Appendix 10A: Medical Malpractice This appendix explains the purpose and the functions of the medical malpractice law. The impact on providers, patients, and third-party payers is addressed. It compares and contrasts the U.S medical malpractice law to other developed countries. The impact of the tort law on the health care spending is also discussed.

Appendix Outline 1. The purpose and function of tort law 2. International differences

Appendix Objectives • • •

Understand the purpose and function of the medical malpractice law. Compare and contrast the U.S medical malpractice law to other developed countries. Evaluate the impact of the tort system on U.S health care spending.

[return to top]

Table of Contents Purpose and Perspective of the Chapter..................................................................................... 2 Cengage Supplements .................................................................................................................. 2 Chapter Objectives ........................................................................................................................ 2 Complete List of Chapter Activities and Assessments ............................................................................... 2 Key Terms ....................................................................................................................................... 3 What's New in This Chapter .......................................................................................................... 4 Chapter 11: The Hospital Services Market .................................................................................. 4 Chapter Outline ............................................................................................................................. 4 Teaching Suggestions .................................................................................................................... 7 Suggested Approaches to End-of-Chapter Questions ................................................................ 7 Additional Questions for Discussion and Evaluation ................................................................. 8 Multiple Choice ......................................................................................................................................... 8 Structured Discussion: ............................................................................................................................. 10

Purpose and Perspective of the Chapter The purpose of this chapter is to provide students with a basic understanding of how hospitals work and how hospital services function as a market. The chapter begins with a brief overview of the hospital services market and then gives a brief history of American hospitals. It examines the institutional setting in the United States, the role of the not-forprofit hospital, and the dominant organizational form. Several popular theories of hospital behavior are summarized. Recent developments in the industry, in particular the trend toward multihospital systems, are also examined. Importantly, the chapter also describes cost shifting and price transparency.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Summarize the development of the hospital industry in the United States and its key features affecting hospital care. 2. Apply the basic model of cost shifting. 3. Evaluate the structure of the hospital sector. 4. Explain the importance of the not-for-profit sector in health care delivery and finance. 5. Explain the role of regulation in promoting concentration and limiting competition.

Complete List of Chapter Activities and Assessments Chapter Objective 11-1 Summarize the development of the hospital industry in the United States and its key features affecting hospital care.

Activity/Assessment Additional Discussion Questions #1 & 3 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 12 PPT Slide 13 PPT Slide 37

Duration 5–10 mins 5–10 mins 5 mins 10–15 mins

Chapter Objective 11-2 Apply the basic model of cost shifting.

11-3 Evaluate the structure of the hospital sector.

11-4 Explain the importance of the not-forprofit sector in health care delivery and finance. 11-5 Explain the role of regulation in promoting concentration and limiting competition.

Activity/Assessment

Duration

Additional Discussion Questions #2 & 5 Knowledge Check 2 Activity Knowledge Check 2 Answer Self-Assessment Additional Discussion Questions #1 & 3 Knowledge Check 3 Activity

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 25 PPT Slide 26 PPT Slide 37 Instructor’s Manual PPT Slide 29

Knowledge Check 3 Answer Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment Additional Discussion Question #4

PPT Slide 30 PPT Slide 35 PPT Slide 36 PPT Slide 37 Instructor’s Manual

5 mins 5–10 mins 5 mins 10–15 mins 5–10 mins

Self-Assessment

PPT Slide 37

10–15 mins

5–10 mins 5–10 mins 5 mins 10–15 mins 5–10 mins 5–10 mins

Key Terms Economies of scale: A situation in a production process where long-run average costs decline as output expands. Ambulatory surgery center (ASC): Medical care facilities offered outside the hospital setting that provide same-day surgical care, including diagnostic imaging and preventive care procedures. Ramsey pricing: A linear pricing scheme where prices to different customers are computed based on individual price elasticity of demand. Customers with a high willingness to pay are charged higher prices. Cost-plus pricing: A pricing scheme in which a percentage profit is added to the average cost.

Chargemaster: A compilation of hospital specific charges for all items that the hospital can bill to patients, insurance plans, and other payers. The list includes all procedures, services, drugs, and tests that are performed at the facility Ambulatory payment classification (APC): A congressionally mandated scheme to classify outpatient services into clinically similar procedures. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • • •

An updated and reorganized discussion of cost shifting both within hospitals and through hospital networks Updated analysis and considerations for the future direction of the hospital services market Additional section dedicated to the growing issue of price transparency to reduce health care costs New case studies demonstrating how applied economic methods can be used to evaluate real world problems

Chapter 11: The Hospital Services Market This chapter examines the market for hospital services. After a brief discussion of the history of hospitals and an examination of the institutional setting in the United States, the role of the not-for-profit hospital, the dominant organizational form, is addressed. Several popular theories of hospital behavior are summarized. Recent developments in the industry, in particular the trend toward multihospital systems and cost shifting, are also examined.

Chapter Outline I.

A Brief History of American Hospitals: In the 18th century, the germ theory of disease led to new technology and medical procedures. Following health insurance in the 1930s and the Hill-Burton Act of 1946, technology and medical procedures were expanded, health care expenditures were minimized by reducing costly services and by basing reimbursement based on diagnosis rather services, and then integrated systems and Medicare expansion programs were introduced (PPT Slides 5, 6, 32, & 59). a. Types of U.S. healthcare institutes are community hospitals (short-stay hospitals with general and specialty services), physician-owned hospitals (specialty hospitals with two-thirds of their Medicare patients treated in no more than two DRG categories; the main issue is the ability of hospitals to provide free care for the uninsured), and teaching hospitals (affiliated with medical schools). While Medicare and Medicaid paying a large percentage of

bill, the government reimburses in terms of subsidies and cross-subsidies and provides uncompensated care to the uninsured (PPT Slides 7–11). b. Cost shifting is a practice assuming that providers are able to offer free care to some patients who pass the excess costs on to insured patients. A study examining a negative correlation between the payment-to-cost ratios paid by privately insured and Medicare and Medicaid patients shows univariate approach, unlike price differentiation highlighting the result of differences in bargaining power between providers and payers. Many economists are skeptical about the cost-shift theory because providers do not fully use their market power to bargain and use unexploited revenues only when government lowers Medicare payment rates (PPT Slides 12–23, 41, 42, 46–53, & 59). II. Structure of the Hospital Sector: Competition in most markets improves economic welfare, which arises due to lower prices, improved efficiency, and higher quality. a. In the 1980s, certain studies show that hospital markets did not seem to be competitive as patient groups had no price sensitivity at all but others show that competition did result in a medical arms race that improved the quality of care and increased costs. In the 1990s, as competition continued to escalate, quality continued to improve and costs began to fall (PPT Slide 28). b. To counter the increased spending, federal strategy focused its costcontainment efforts on the supply side, devising a prospective payment mechanism for the hospital sector based on DRG reimbursement. DRG categories based on principal diagnosis, age of the patient, presence of comorbidity conditions, use of surgical procedures, and discharge status of the patient (PPT Slides 45, 53–58, & 59). c. By 1983, the government abandoned the cost-plus pricing model of Medicare and Medicaid in favor of a fixed payment per case determined by the principal diagnosis at the time of admission. Private insurance started paying negotiated prices based on discounts from billed charges, and this differential pricing charges those payers with the most purchasing power the lowest prices and forces the uninsured to pay the inflated prices stipulated by the chargemaster. III. The Role of Not-for-Profits in the Hospital Sector: Using the neoclassical model with profit-maximizing decision makers may seem inappropriate in an industry dominated by not-for-profit institutions (favored by the financial challenges of the Great Depression and the government policy, though some state legislatures made it illegal). With their tax-exempt status, not-for-profit hospitals were able to accept tax-deductible, charitable contributions, and many also received construction subsidies from the federal government under the Hill-Burton Act. a The institutional constraints facing for-profit and not-for-profit hospitals are substantially different. A not-for-profit hospital does not have shareholders, equity capital does not come from the sale of stock but from donations,

surplus funds are restricted and hospitals may not use them to provide ex post incentives to managers, hospital administrators may not receive dividends or other distributions of residual earnings, and no individual owner receives the proceeds in the event of in the event of liquidation or sale of assets (PPT Slide 31). b Evidence does not provide a good explanation why virtually providers work in the not-for-profit sector, and some explanations are as follows: patients purchase their medical care from providers who do not suffer from the profit motive; profit-maximizing hospitals will not undertake any activity in which the marginal revenue is less than the marginal cost; not-for-profit provides the most benefits for physicians; there is little difference in the provision of hospital care attributable to ownership status, while holding size, quality, and teaching status constant—but the exception is the performance of public, not-for-profit hospitals being higher than private hospitals. Half of the studies found no significant differences in operating behavior between notfor-profit and for-profit hospitals. c The only practical difference between the profit-maximizing model and the utility-maximizing model is the way residual earnings are distributed. Maximizing utility of not-for-profit firms through a break-even constraint has the following assumptions: to be in charge of the largest or the highestquality hospital possible given the resources available; quality maximization is merely a variant of profit-maximizing (and cost-minimizing) behavior: adding quality in most cases serves to increase costs and shift demand; over investing in quality produces a product higher quality than consumers are willing to buy. Physicians have a stake in combination of inputs, are more concerned about their own productivity than hospital efficiency, maximize their own incomes but maximize time spent with excess hospital capacity, interested in investing in additional services to increase hospital capacity, and wants the hospital to price complementary services (PPT Slides 43 & 44). IV. The Trend toward Multihospital Systems: Merger activity had increased over the decade, leading to increase in multihospital systems. The largest for-profit hospital system in the country is the HCA with 184 hospitals and 2,000 care centers (PPT Slides 33 & 34). a Horizontal integration allows businesses to take advantage of economies of scale, reduce administrative costs, and improve customer access to information. With increase in the size of operation, firms experience economies of scale when long-run average costs fall leading to the ability to secure discounts through bulk purchasing and the ability to take advantage of specialization and division of labor. b As hospital reimbursement shifted from retrospective to prospective payment beginning in the mid-1980s, the efficiencies of the multihospital system have become more evident. Identification with an established chain

of respected hospitals improves customer access to information, in turn increasing demand and allowing higher margins over cost. V. Summary and conclusions: A cost-plus environment will not reward efficiency, and the economic models predict that competition on the payment side will eliminate the inefficiencies and the ability to subsidize medical education and charity care for the uninsured. Increased hospital competition in the 1980s promoted quality enhancement, leading to a medical arms race, while further competition in the 1990s continued to see quality improvements and, at the same time, increased cost efficiencies (PPT Slide 38). [return to top]

Teaching Suggestions • • •

• •

Begin the discussion by summarizing the importance of the not-for-profit organizational form in medical care delivery and finance. Emphasize the major differences between for-profit and not-for-profit. Make sure you distinguish between private and public not-for-profit hospitals, especially in their commitment to medical education, research, and the provision of indigent care. An extremely hot topic in today’s hospital market is the well-publicized not-for-profit to for-profit conversions, especially those involving Columbia/HCA. Several good analytical discussions are included in this chapter—price discrimination in medicine and the theory of cost shifting.

[return to top]

Suggested Approaches to End-of-Chapter Questions 1. Major criticisms include they are disproportionately affected by the profit motive, they are not concerned with medical research or education, and they do not provide charity care. These criticisms may or may not be valid. In fact, there is little difference between private for-profit hospitals and private not-for-profit hospitals in their commitment to medical research and education and their provision of charity care. As far as the profit motive, even not-for-profit hospitals must generate a surplus. The major difference is how they use the surplus. 2. In theory, the for-profit hospital will not undertake activities unless the marginal benefit exceeds the marginal cost. They both seek to generate a surplus of revenue over cost. The differences would be in how they use their surplus. 3. There is really little difference between quality of care and access for the poor between the private not-for-profit hospital and the private for-profit hospital. There is a difference between the provision of charity care and the commitment to medical research and education between the public not-for-profit hospital and the other two types.

4. The behavior is not eliminated; it may be moderated. There is still a need to generate a surplus. Law restricts the use of the surplus. But a competitive environment will mean a convergence of behavior. 5. Cost-plus pricing is what it sounds like. The price charged includes a percentage mark-up over cost. Profit or surplus is guaranteed. With a fixed percentage mark-up, the incentive is for higher costs. They result in larger profits, since profit (surplus) is a percentage of cost. 6. A horizontal merger is when two firms (for example, two hospitals) in the same industry merge. A vertical merger is when firms at different stages of a production process merge; for example, when a hospital merges with an acute care nursing home. [return to top]

Additional Questions for Discussion and Evaluation 1. Many argue that hospitals are already too competitive in that competition in a notfor-profit environment turns into a “medical arms race.” How has the not-for-profit structure of the hospital industry affected competition? How has duplication of services affected the provision of hospital care? 2. Using the theory of cost shifting, describe what happens to the fees paid by private patients when Congress lowers the amount Medicare pays for services to the elderly. 3. How does competition manifest itself in the not-for-profit sector? Explain. 4. What are the arguments for and against conversion of not-for-profit hospitals to forprofit? What is the evidence? 5. What is cost shifting? How does cost shifting manifest itself in the hospital sector? How has the increase in competition in the hospital sector affected the ability to shift costs?

Multiple Choice 1.

This study was the catalyst for the early twentieth-century reform of medical education in the United States. What was it? a. Coolidge Commission b. Hill–Burton Committee c. Mangrum Report d. Flexner Report e. Kaiser Foundation Study In the nineteenth century, hospitals had notorious reputations—they were questionable places to visit, risky places to stay. What advances changed all this? a. Development of the germ theory of disease b. Advances in medical technology c. Availability of health insurance to pay the bills d. All of the above

The dominant factor affecting medical care delivery and finance in the 1960s was a. the Hill–Burton Act. b. prospective payment for hospitals. c. the creation of Medicare and Medicaid. d. the explosive growth of managed care. e. the passage of ERISA. The dominant factor affecting medical care delivery and finance in the 1980s was a. the Hill–Burton Act. b. prospective payment for hospitals. c. The creation of Medicare and Medicaid. d. the explosive growth of managed care. e. ERISA. The dominant factor affecting medical care delivery and finance in the 1990s was a. the Hill–Burton Act. b. prospective payment for hospitals. c. creation of Medicare and Medicaid. d. the explosive growth of managed care. e. ERISA. Which of the following statements is true concerning the trend in hospital care between in-patient and out-patient services since the mid-1980s? a. Both have been declining. b. Out-patient services have been static, while in-patient services have been declining. c. Out-patient services have increased substantially because admissions are down. d. Both have been growing. e. There has been no noticeable trend in either in-patient or outpatient services. In order to be a successful price discriminator, a provider must have a degree of market power (depicted by a downward-sloping demand curve) and meet what other condition(s)? a. Prospective customers must be categorized according to willingness-to-pay. b. Opportunities for resale of the good or service must be limited. c. Customers cannot know that multiple prices are being charged. d. The provider must have excess capacity to accommodate the extra business. e. Both a and b. Congressional studies report that Medicare payments fall 11 percent below the cost of treating patients, while private insurance patients pay 29 percent more than cost. This phenomenon is called a. price discrimination. b. the Medigap. c. Cost shifting. d. cost-plus pricing. e. revenue enhancing.

The predominate organizational form for U.S. hospitals is not-for-profit. Why? a. The profit motive corrupts human behavior. b. For-profit hospitals do not provide charity care. c. Private not-for-profit hospitals engage in most of the medical research. d. The not-for-profit form provides the most benefits to physicians. e. All of the above. 10. Using the physician-control model to explain hospital behavior leads to which of the following conclusions? a. Other medical inputs tend to be over used to maximize physicians’ productivity. b. The use of operating rooms will be maximized with little excess capacity. c. Physicians will strive to use the nursing staff efficiently. d. All investment decisions will be based on optimal resource use. e. All of the above are conclusions of the physician-control model. 11. The merger of two community hospitals located in the same geographic market is called a. vertical integration. b. horizontal integration. c. a leveraged buyout. d. a conglomerate merger. e. a real shame, since one of the hospitals will likely close. 12. Economies of scale exist when a. long-run average costs decline as output increases. b. long-run average costs are constant. c. long-run average costs increase as output increases. d. short-run average costs decline. e. short-run average costs increase. 13. Horizontal integration allows firms to do all of the following except a. take advantage of cost savings due to economies of scale. b. reduce administrative costs. c. create brand identity. d. fully integrate with primary care clinics and acute care nursing facilities. 14. Consolidation activity in the hospital industry a. has slowed due to government regulations. b. has created a large number of nationwide for-profit hospital chains. c. has occurred almost exclusively at the local level. d. occurs for same reasons that cause consolidation in other industries.

Structured Discussion: 1. Resolved: To promote public welfare, all not-for-profit to for-profit hospital conversions should be prohibited by law.

Table of Contents Purpose and Perspective of the Chapter..................................................................................... 2 Cengage Supplements .................................................................................................................. 2 Chapter Objectives ........................................................................................................................ 2 Complete List of Chapter Activities and Assessments ............................................................... 2 Key Terms ....................................................................................................................................... 3 What's New in This Chapter .......................................................................................................... 3 Chapter 12: Pharmaceuticals........................................................................................................ 3 Chapter Outline ............................................................................................................................. 4 Teaching Suggestions .................................................................................................................... 6 Suggested Approaches to End-of-Chapter Questions ................................................................ 6 Additional Questions for Discussion and Evaluation ................................................................. 7 Multiple Choice ......................................................................................................................................... 7 Structured Discussion: ............................................................................................................................... 8

Purpose and Perspective of the Chapter The purpose of this chapter is to provide students with a basic understanding of the pharmaceutical industry. The chapter begins with a brief overview of the industry’s structure and then addresses the great importance of research and development. The role of government, specifically the FDA, in overseeing the pharmaceutical sector is outlined next, before moving on to the various pricing issues observed in the market. A final section addresses the future of pharmaceuticals, explaining some of the associated cross-country issues and considerations for international trade.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Summarize the significance of research and development for new drugs. 2. Explain the role of government in the pharmaceutical market. 3. Explain some of the basic issues concerning the pricing practices in the pharmaceutical market. 4. Apply international trade theory to the market for pharmaceuticals.

Complete List of Chapter Activities and Assessments Chapter Objective 12-1 Summarize the significance of research and development for new drugs.

Activity/Assessment

Additional Discussion Question #1 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment 12-2 Explain the Additional Discussion role of Questions #2–5 government in the Knowledge Check 2 Activity pharmaceutical Knowledge Check 2 Answer market. Self-Assessment 12-3 Explain some Knowledge Check 3 Activity of the basic issues concerning the Knowledge Check 3 Answer pricing practices Self-Assessment in the pharmaceutical market.

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 15 PPT Slide 16 PPT Slide 41 Instructor’s Manual PPT Slide 22 PPT Slide 23 PPT Slide 41 PPT Slide 31

Duration

PPT Slide 32

5 mins

PPT Slide 41

10–15 mins

5–10 mins 5–10 mins 5 mins 10–15 mins 5–10 mins 5–10 mins 5 mins 10–15 mins 5–10 mins

Chapter Objective 12-4 Apply international trade theory to the market for pharmaceuticals.

Activity/Assessment Additional Discussion Question #4 Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 39 PPT Slide 40 PPT Slide 41

Duration 5–10 mins 5–10 mins 5 mins 10–15 mins

Key Terms Food and Drug Administration (FDA): A public health agency charged with protecting American consumers by enforcing federal public health laws. Food, medicine, medical devices, and cosmetics are under the jurisdiction of the FDA. Return on sales: A financial measure of a firm’s ability to generate after-tax profit out of its total sales. Calculated by dividing after-tax profit by total sales. Public good: A good that is nonrival in distribution and nonexclusive in consumption. Patent: An exclusive right to supply a good for a specific time period, usually 20 years. It serves as a barrier to entry, virtually eliminating all competition for the life of the patent. Spending cap: A limit on total spending for a given time period. Parallel trading: The act of purchasing a product in a market where the price is low and reselling it in a market where the price is high without the permission of the intellectual property owner. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • • •

New case studies demonstrating how applied microeconomic methods can be used to evaluate real-world problems A reorganized discussion of the various pricing issues in the pharmaceutical sector Updated analysis and considerations for the future direction of the pharmaceutical industry Additional section dedicated to the gains yielded through the international trade of pharmaceuticals

Chapter 12: Pharmaceuticals Pharmaceutical spending is a growing concern for patients and policy makers in the U.S. system. This chapter examines the growing importance of pharmaceuticals in both the individual and national health care budget. Until recently, Medicare did not provide significant coverage for outpatient drug spending, creating a climate of concern over the financial impact of drug spending on the nation’s elderly. Since the passage of the Medicare

Modernization Act, the focus has shifted to the rising costs of Medicare. Why are pharmaceutical drugs so expensive? We review the structure of the industry, the R&D costs to produce a new drug, the pricing of drugs, and where the money earned is spent.

Chapter Outline I.

II.

The Structure of the Industry: More stringent drug-price regulation can curb overall health care spending, and the effects of the expansion of the Medicare outpatient prescription drug program will be offset by increased generic competition (as drug patent protection is lost and cost sharing increases as copays increase). Government and private philanthropy taken a direct role in funding basic research through the National Institutes of Health (NIH) and grants to the university (PPT Slide 4). a. The pharmaceutical industry relies heavily on R&D to discover new chemical compounds that save lives and improve the quality of life and to gain profits (as the patent protection grants monopoly rights to the firm). The R&D process of drug discovery has two stages: the preclinical phase-involving discovery research to develop new concepts in treating disease-and the screening phase (for pharmacological activity and toxicity), and the FDA approval has the three phases of human testing: 1) Phase 1 testing for drug safety, 2) Phase 2 evaluation, and 3) Phase 3 testing for effectiveness (PPT Slides 5–10, & 12–14). b. In 1836, Congress authorized the U.S. Patent Office to determine if proposed inventions qualified for patent protection and to insure adequate rewards. For U.S. domestic policy, the most important change was increasing the patent term, from 17 years from the date of grant to 20 years from the date of application. The flaws of the patent system are as follows: patents do not transfer to the holder the social surplus; inventions were quickly stolen; the patent system fails to account for beneficial externalities that result from the patent; patents create monopoly rents and copycat inventions (PPT Slides 11 & 17–21). Pharmaceutical Pricing Issues: The discovery of medicines to cure or significantly alter the progression of chronic and degenerative diseases represents the single best prescription for increasing profitability in the industry, so innovation is the key to survive increased competition and government oversight. Publication of the average wholesale price (for determining how much pharmacies paid for drugs) stopped in 2008, while PBMs and other payers had to come up (PPT Slide 24). a. The special treatment of intellectual property through the patent system distorts drug prices, limits treatment options for those who not have the means to pay, and causes American consumers to pay too much for their medications. The awarding of a patent provides the innovator with monopoly power—the ability to limit availability of the product and set prices above the marginal cost of production (PPT Slides 25 & 26).

III.

IV.

b. The monopoly response for a prescription drug insurance plan with a copayment provision is to raise the drug price in proportion to the inverse of the copay. Some limitations of the patent system include monopolists effectively exercise market power, restricting output below its social optimum, and charging high prices, resulting in consumer surplus to educate them about the benefits of drugs (PPT Slides 27 & 28). c. Many pharmaceutical firms, especially those specializing in copycat drugs, spend twice as much on administration and marketing than they do on R&D (at wholesale prices three to six times higher than their costs of production; these unusually high gross profit margins allow the drug companies to funnel large sums of money into advertising and promotion). The fastest growing segment is advertising directed at the end consumers—so-called direct-to-consumer advertising (DTCA)—is an effective strategy (PPT Slides 29 & 30). Future Directions for the Industry: U.S. Government Accountability Office (GAO) introduces price controls on drugs resulting in lower prices in the United States than Canada, utilizes a biased methodology that by design is predisposed to finding higher prices in the U.S. market and an unrepresentative sample of drugs, where only one of many possible dosage forms, strengths, and package sizes was included in the pricing survey, and ignores generics (today, a generic competitor will receive approximately half of the new prescription volume in less than two months after its introduction). Opponents of price controls; which will limit innovation, lower quality, and availability, and result in reduced well-being; claim that they have been uniformly disastrous, resulting in market distortions, shortages, poor quality, and black markets (PPT Slide 33). a. The cost of R&D is a quasi-fixed cost and will not change no matter how many consumers or how many countries receive access to the drug. The challenge is determining how much each country will contribute to the innovator for use of the patented drug. The most direct way to cover global joint costs is to allow the patent holder to charge different prices in different countries. b. Voluntary trade normally increases economic welfare, enabling consumers in importing countries to benefit from more of the product available at lower prices. Parallel trading is a practice in which intermediaries in low-price countries purchase cheaper pharmaceuticals, repackage them for export, and sell them in countries that have higher prices, where the price differences across the developed world are differences in regulatory control over pharmaceutical pricing but not due to differences in production efficiencies in the respective countries (PPT Slide 34–38). Summary and conclusions: The close causality between the availability of medical technology and the ability to pay for it. To control expenditures, it is essential preserve the financial incentives that foster and promote scientific inquiry at its basic level and also reward the applied research that creates marketable products

that enhance the quality of medical care for millions around the world (PPT Slide 42). [return to top] Issues in Medical Care Delivery

Back-of-the-Envelope

•

Pharma’s Search for a New Research Strategy

•

A Simple Estimate of the Cost of R&D

• •

Orphan Drugs

•

The Economics of Regulating Drug Prices

• •

Gene-Based Research

Biotechnology: What Is a Fair Price?

Applied Micro Methods

•

Can the Use of Statins Reduce the Risk of Heart Attack?

•

The Cost of Obesity

Why Are Pharmaceutical Drug Prices So High?

Teaching Suggestions •

•

Understanding patents and the role they play in creating monopoly pricing may be the most important point addressed in this chapter. Emphasize the competing policy goals of encouraging innovation and making products available at affordable prices. The role of insurance in pricing pharmaceuticals is critically important. Understanding the inverse relationship between the copay on drugs and their price goes a long way to answering the question of why drug prices are so high. The pharmaceutical market lends itself nicely to a discussion of the differences in pricing and availability of drugs across nations. The observation that U.S. prices are higher is a complicated issue. National income, the popularity of generic substitutes and the access to new drugs can explain a lot of the differential between U.S. prices and those of the rest of the world.

[return to top]

Suggested Approaches to End-of-Chapter Questions 1. Insurance coverage for inpatient pharmaceuticals is fairly good. However, outpatient coverage is typically subject to high copays. The result is that individuals, especially those with chronic conditions, pay substantial out-of-pocket sums for prescription drugs. 2. The substantial investment in research and development, the long development period, and the small number of successful drugs create an environment where winners must generate substantial returns to compensate the firm for losers. A discussion of the patent process and an analysis of drug-price regulation in a monopoly market should follow.

3. I have recently had several students write research papers on this question. The results run the spectrum from everyone should have access to only the patient and physician should know. You can make a strong case either way. If insurance companies and employers know, we run the risk of genetic discrimination. If only patients and providers know, we run the risk of adverse selection. Setting up highrisk pools or requiring community-rated premiums are ways to deal with the outcomes. [return to top]

Additional Questions for Discussion and Evaluation 1. A genetic test may be judged from several different perspectives—scientific, ethical, economic. How are these perspectives different? Why is it important to understand the differences? 2. Explain how generic competition affects the market for a name-brand drug. Use a graph in your explanation. 3. How can regulation of pharmaceutical drug prices improve social welfare? 4. What is an orphan drug? Why do firms producing orphan drugs receive special patent treatment? 5. What is the effect of health insurance on the rate of innovation in health care? Is the rate of innovation inefficiently high? 6. Pharmaceutical companies are under attack over high drug prices. Most Americans believe that they should be allowed to re-import drugs from Canada. Are pharmaceutical prices too high? If so, what is the primary cause of high prices? Should U.S. consumers be permitted to re-import lower-priced drugs from Canada? Why or why not? Should Medicare, the federal health care insurance program, be permitted to negotiate with the industry over pharmaceutical prices? Why or why not?

Multiple Choice 1.

What is the most important factor leading to rising health care costs in the United States since 1980? a. The increased use of expensive medical technology b. The aging U.S. population c. The increased cost of malpractice insurance for providers d. Rising incomes for physicians e. The rising cost of pharmaceutical drugs Rent-seeking behavior results in a. increased economic activity by promoting efficiency. b. lower economic activity by diverting resource to less-productive uses. c. a more equitable distribution of income and wealth. d. lower prices throughout the economy. e. greater income and wealth in the private sector.

Of the new drugs introduced in the United States between 1940 and 1990, what percentage were discovered by U.S. firms? a. 15 percent b. 30 percent c. 45 percent d. 60 percent e. 75 percent Pharmaceutical companies receive patents as an exclusive right to produce a drug. This results in a. normal profits on the patented drug. b. monopoly status in the production of the drug. c. lower prices for patients requiring the drug. d. orphan drug status. e. fewer new chemical compounds discovered. The regulatory agency with oversight responsibility for the pharmaceutical industry is the a. IRS. b. FDA. c. SEC. d. ITC. e. ATT. One of the primary reasons that costly technology is being introduced into the health care system is that a. research scientists have successfully mapped the human genome. b. high cost is synonymous with better outcomes. c. third-party insurance finances most of the cost of care. d. all of the above. The fastest-growing segment of pharmaceutical marketing is: a. marketing to physicians. b. marketing to nurse practitioners. c. marketing to the consumer. d. none of the above.

Structured Discussion: 1. Resolved: The United States should control pharmaceutical prices more strictly through a network of price and spending controls. 2. Resolved: The primary reason for the increase in the share of health care spending relative to GDP over the past 30 years is technological change in medicine. 3. Resolved: Parallel trading in pharmaceuticals should be legalized so U.S.

citizens can purchase cheap drugs from Canada.

Table of Contents Purpose and Perspective of the Chapter..................................................................................... 2 Cengage Supplements .................................................................................................................. 2 Chapter Objectives ........................................................................................................................ 2 Complete List of Chapter Activities and Assessments ............................................................... 2 Key Terms ....................................................................................................................................... 2 What's New in This Chapter .......................................................................................................... 3 Chapter 13: Medicare .................................................................................................................... 3 Chapter Outline ............................................................................................................................. 3 Teaching Suggestions .................................................................................................................... 5 Suggested Approaches to End-of-Chapter Questions ................................................................ 6 Additional Questions for Discussion and Evaluation ................................................................. 6 Multiple Choice ......................................................................................................................................... 7 Structured Discussion: ............................................................................................................................... 8 Appendix 13A: Changing Demographics: The Aging of America ............................................... 9 Appendix Objectives...................................................................................................................... 9 Appendix Outline ........................................................................................................................... 9

Purpose and Perspective of the Chapter The purpose of this chapter is to introduce students to the Medicare program. It begins with a brief summary of the primary institutional features of the program, including information on who is covered and how it is funded. The text next turns to the important role of private insurance, such as the use of Medicare Administrative Contractors and private plans. Finally, the chapter helps develop students’ understanding of Medicare through a critical analysis of the future of the program, which focuses on its sustainability and options for reform.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Explain the basic structure of the Medicare program. 2. Summarize the important role of private insurance in Medicare delivery. 3. Evaluate the future of Medicare.

Complete List of Chapter Activities and Assessments Chapter Objective 13-1 Explain the basic structure of the Medicare program. 13-2 Recognize the important role of private insurance in Medicare delivery. 13-3 Evaluate the future of Medicare.

Activity/Assessment

Duration

Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment

Source (i.e., PPT slide) PPT Slide 16 PPT Slide 17 PPT Slide 35

Additional Discussion Questions #2 & 5 Knowledge Check 2 Activity Knowledge Check 2 Answer Self-Assessment Additional Discussion Questions #1, 3, & 4 Knowledge Check 3 Activity

Instructor’s Manual PPT Slide 23 PPT Slide 24 PPT Slide 35 Instructor’s Manual PPT Slide 33

5–10 mins

Knowledge Check 3 Answer

PPT Slide 34

5 mins

Self-Assessment

PPT Slide 35

10–15 mins

5–10 mins 5 mins 10–15 mins

5–10 mins 5 mins 10–15 mins 5–10 mins 5–10 mins

Key Terms Universal coverage: A guarantee that all citizens will have health insurance coverage regardless of income or health status. Coverage usually requires mandatory participation.

Balance billing: Billing a patient for the difference between the physician’s usual charge for a service and the maximum charge allowed by the patient’s health plan. Assignment: A Medicare policy providing physicians with a guaranteed payment of 80 percent of the allowable fee. By accepting assignment, physicians agree to accept the allowable fee as full payment and forgo the practice of balanced billing. Participating physician: A physician who agrees to accept Medicare assignment. Actuarially fair premium: An insurance premium based on the actuarial probability that an event will occur. Medigap insurance: A supplemental insurance policy sold to Medicare-eligible individuals to pay the deductibles and coinsurance that are not covered by Medicare. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • • •

New section focusing on the role of private insurance in Medicare, including the use of Medicare Administrative Contractors and the popularity of private plans A case study analyzing the accomplishments of Medicare through applied microeconomic methods An additional text to evaluate the sustainability of the Medicare program An updated appendix with recent data to analyze the effects of the aging American population

Chapter 13: Medicare This chapter discusses the development of the government’s role in the provision of medical care to vulnerable populations. Government has been instrumental in providing medical care to over 100 million people under two major programs: Medicare and Medicaid. The institutional features of these programs are developed, including eligibility, benefit structure, and financing. Any major overhaul of the present medical care delivery system will have to carefully consider the impact on these programs.

Chapter Outline I.

Medical Care for the Older Americans: The Hill–Burton Act provided free care to those who did not have the means to pay, Kerr-Mills provided access to low-income seniors, and Medicare guaranteed older Americans access to health care regardless of their financial circumstances. Serving 19.1 million in 1966, Medicare enrollment reached over 60 million Americans in 2019 and is expected to grow to over 76 million by 2029 as the baby boom generation reaches eligibility age (PPT Slide 4). a. Administered by the Centers for Medicare and Medicaid Services (CMS), Medicare provides benefits through four major programs: Part A is medical

II.

III.

hospital insurance (the contribution of Medicare progressively reduces over every six months), Part B is supplemental medical insurance, Part C is Medicare Advantage, and Part D is outpatient prescription drug insurance. Working Americans pay the payroll tax along with the Social Security tax (those making more than $200,000 and couples filing joint returns pay an additional tax), and Medicare benefits are Part A: underwriting medical care spending for large groups and Part B: lifetime benefits exceeding the premiums and taxes by six times the amount paid into the system (PPT Slides 5–7 & 9–15). b. For short hospital stays, Medicare pays virtually all the bill beyond the deductible, while for longer hospital stays, individuals are subjected to larger percentages of the total bill—meaning they are at the risk of a catastrophic financial loss. Supplemental insurance Medigap policies have the same problem as Medicare itself: cover the up-front costs and provide for some non-covered expenses but do not protect against catastrophic financial risk (PPT Slide 8). The Role of Private Insurance: The private insurance market is evident throughout the entire Medicare program, whether participants receive medical coverage through the traditional FFS option or by joining privately administered Medicare Advantage plans (many features of the plan are available through employers). Medicare Administrative Contractors (MACs) process all claims for those participating in the traditional FFS option. a. MAC contractors administer all aspects of the claims process including enrollment in the program, processing claims, payment of providers, and dispute resolution. MACs enrolled almost 37.5 million participants in 2020, processed more than a billion claims, and paid out over $400 billion for services delivered by over 1 million providers (PPT Slide 18). b. A comparison of Medicare with private insurance is as follows: 1) Even if administrative costs between the two programs were identical, Medicare administration would appear to be more efficient because of larger claim size; 2) the claim of the lower administrative costs for Medicare is doubtful stems from the fact that taxes finance a significant portion of program costs (PPT Slides 19–22). The Future of Medicare: The Social Security Act, as amended in 1964, established the Medicare Board of Trustees to manage the hospital insurance trust fund and oversee the long-term solvency of the program. Annually, the board submits to Congress a detailed analysis summarizing its current financial condition and prospects for the future. a. The pay-as-you-go funding structure of Medicare has no permanent funding for recipients to save and invest for their own spending as older generations rely on the next generation of workers to pay. Evidence shows that the hospital insurance trust fund will become insolvent in 2026 that it will be able to pay 90 percent of the promised benefits after 2026 (as Medicare is unable

IV.

to borrow money to cover the annual deficits so the payroll tax should be raised), and a study shows that further reductions in Medicare payments to physicians would jeopardize access to mainstream physicians’ services (PPT Slides 25 & 26). b. The ACA made few changes to Medicare, but the biggest change was a cut of more than $740 billion from Medicare spending over the next decade and redirecting it to pay for the Medicaid expansion (e.g., the IPAB board set low prices that few providers would be willing to offer them) and the exchange subsidies. The reforms to be taken for considering the fact that Medicare is unsustainable in its current form are as follows: 1) establishing a comprehensive plan for hospitals, physicians, and prescription drugs; 2) completely restructuring Medicare from defined benefit to defined contribution; 3) incorporating a competitive bidding process—a reverse auction where the second lowest premium becomes the benchmark—to establish a benchmark premium that sets the subsidy level (PPT Slides 27– 32). Summary and Conclusions: The 2020 Medicare Trustees Report estimates that the Medicare Trust Fund depletion will occur in 2026. Policymakers have still not addressed the long-term demographic problem facing the system—the aging baby boom generation—and the fact that Medicare seems insulated from the market forces that serve as a moderating influence on the rest of the health care sector, so a reform plan should address the structural deficiencies of the system (PPT Slide 36).

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Teaching Suggestions •

•

By the time you get to this chapter, you have probably already mentioned Medicare and Medicaid more than once. As the introductory chapter to the policy discussion, it serves as a good springboard to the use of government-run programs to enhance access to specific well-defined groups. I spend very little time on the institutional features. Instead, my focus is on the economics of the two programs. Specifically, I focus on the impact of assignment on the availability of medical care to the elderly and nonelderly and the effect of Medicare on the overall cost of medical care. Medicare politics is an increasingly important discussion topic. At this writing, the Centers for Medicare and Medicaid Services (CMS) has issued final regulations revising Medicare Advantage plans and Part D drug benefit plans, requiring that providers report and return any Medicare overpayment. Further changes are on the horizon. Check the website for updates.

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Suggested Approaches to End-of-Chapter Questions 1. Increased cost sharing will reduce quantity demanded. Whether the reductions come in the form of “needed medical services” is open to empirical debate. 2. Rather than prepare three sample memos, let’s focus on what to expect from your students. This question allows them to really begin to integrate their economics with an important policy issue. The commission currently studying Medicare reform will likely be looking at these three approaches as part of the Medicare reform to ensure its future solvency. Students recommending a freeze in fees and mandatory assignment should address the economic issues presented in “The Impact of Medicare Assignment on Medical Practice” beginning on page 391. Those suggesting encouraging elders to join managed care organizations should address the issues dealing with fixed-budget systems. Those suggesting medical savings accounts (MSAs) will have read about them elsewhere. The formal discussion of MSAs does not appear until Chapter 16. 3. This question is better suited for class discussion than written homework. It is these types of questions where the legalists and the moralists will get into interesting discussions. 4. For the most part, Medigap policy still does not provide adequate catastrophic coverage. Instead, it covers deductibles and copayments, resulting in an increased use of medical care. The purpose of deductibles and copayments to address moral hazard is compromised by the availability of Medigap insurance. 5. These terms are defined in the glossary. [return to top]

Additional Questions for Discussion and Evaluation 1. What are the alternatives available to policymakers interested in ensuring the solvency of the Medicare program? 2. In their April 14, 2009, Wall Street Journal article (Is Government Health Insurance Cheap?), Kerry N. Weems and Benjamin E. Sasse examine the administrative performance of Medicare. They claim that superficially, Medicare has lower administrative costs than do private plans and then offer a list of four categories of administrative costs that would make the comparison between public plans and private plans more meaningful. a. Outline the reasons presented in the article as to why Medicare has lower administrative costs than private insurance plans. b. What additional information would make the comparison between Medicare and private insurance more meaningful? c. Should the federal government offer a health insurance plan to all citizens? 3. What change should be made to ensure the future solvency of Medicare?

4. What lessons can we learn from government-sponsored programs such as Medicare, Medicaid, and the VA System about the problems facing fixed-budget health care systems? 5. Describe the basic features of the new outpatient prescription drug coverage recently added to Medicare.

Multiple Choice 1.

Medicare and Medicaid were enacted by the Johnson administration in 1965 as amendments to which federal law already in existence? a. Welfare Act of 1960 b. Social Security Act c. Employee Retirement and Income Security Act d. Managed Care Act e. Equal Rights Act The only disease-specific group eligible for Medicare are those suffering from a. AIDS. b. end-stage renal disease. c. advanced coronary artery disease. d. metastasized cancer. e. diabetes. One of the most serious weaknesses in the Medicare system is that a. patients are not able to choose their own physicians. b. the definition of an episode of illness is too restrictive. c. it provides poor insurance coverage for unusually long hospital stays. d. patients must pay a deductible every time they enter the hospital. e. Part B is voluntary. The Medicare pay-as-you-go system is jeopardized by a. an overly generous fee schedule that pays physicians more than private insurance for most procedures. b. the changing demographics of the U.S. population, with an increasing percentage of individuals over the age of 65. c. a reliance on the premiums paid by the elderly themselves to fund the majority of the total cost of the system. d. allowing physicians to balance bill their patients. e. the rising costs of long-term care. For Part A coverage of Medicare, the patient pays a deductible approximately equal to the cost of the first day in the hospital; Medicare pays a. for days 2–30. b. for days 2–60. c. for days 2–90. d. for the remainder of the hospital stay, however long it may be.

Participation in Part B of Medicare is a. applicable to supplemental hospital payments. b. applicable to nursing home stays c. voluntary. d. involuntary. e. none of the above. Possibly, the most serious flaw in the Medicare system is the fact that a. the deductible is too high for most older Americans to afford. b. it provides no real protection against catastrophic losses resulting from unusually long hospital stays. c. the definition of an episode of illness can lead to patients paying the deductible more than once during the calendar year. d. coverage for outpatient drugs is poor. e. elders are required to pay monthly premiums to participate in Part B. Physicians who accept assignment on their Medicare patients a. bill patients for 80 percent of the allowable fee. b. agree to forego balance billing. c. accept the allowable fee for all services. d. agree to charge private insurance patients the same fees as Medicare patients. e. both b and c. The most important source of funding for Medicare is a. the federal income tax. b. premiums paid by elders and deducted from their monthly Social Security checks. c. a 2.9 percent payroll tax paid by all workers, regardless of their age. d. proceeds from the Medicare Trust Fund. e. a tax on the health insurance premiums paid by all group plans.

Structured Discussion: 1. Resolved: Differential access to medical care across socioeconomic groups is the primary reason for differential health status among these groups. [return to top]

Appendix 13A: Changing Demographics: The Aging of America This appendix presents a note of caution on the unquestioned acceptance of projections of future health care spending. A number of predictions of future health care spending are presented. The use of extrapolation and the importance of the underlying assumptions are also discussed.

Appendix Objectives 1. 2. 3. 4.

Understand the change in the U.S. demographic characteristic Understand the cost of medical care for the elderly Understand the challenges associated with the treatment of chronic diseases Evaluation of the cost of long-term care

Appendix Outline a. b. c. d. e. f. g.

The aging population Medical care costs for the elderly The challenge of treating chronic diseases The cost of long-term care Comments on aging Questions and problems References

Table of Contents Purpose and Perspective of the Chapter..................................................................................... 2 Cengage Supplements .................................................................................................................. 2 Chapter Objectives ........................................................................................................................ 2 Complete List of Chapter Activities and Assessments ............................................................... 2 Key Terms ....................................................................................................................................... 3 What's New in This Chapter .......................................................................................................... 3 Chapter 14: Medicaid .................................................................................................................... 3 Chapter Outline ............................................................................................................................. 3 Teaching Suggestions .................................................................................................................... 6 Suggested Approaches to End-of-Chapter Questions ................................................................ 6 Additional Questions for Discussion and Evaluation ................................................................. 7 Multiple Choice ......................................................................................................................................... 7 Structured Discussion: ............................................................................................................................... 8 Appendix 14A: A Note on “Projections” ....................................................................................... 9 Appendix Objectives...................................................................................................................... 9

Purpose and Perspective of the Chapter The purpose of this chapter is to provide students with a basic understanding of Medicaid and how this government-run program affects the low-income and middle-income populations in the United States. The chapter begins by outlining the basic institutional features of the program and how Medicaid is used for primary safety net coverage for the low-income population. The chapter discusses how Medicaid was vastly expanded under the Affordable Care Act (ACA) and reviews the State Children’s Health Insurance Program (SCHIP) and the economic consequences of Medicaid. It also addresses the changes in eligibility resulting from the passage of the ACA, the impact of Medicaid on its participants, and the future of the program.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. 2. 3. 4.

Explain the basic structure of the Medicaid program. Summarize the expansion of Medicaid under the Affordable Care Act (ACA). Analyze the impact of Medicaid on enrollees. Evaluate the future of Medicaid.

Complete List of Chapter Activities and Assessments Chapter Objective 14-1 Explain the basic structure of the Medicaid program. 14-2 Summarize the expansion of Medicaid under the Affordable Care Act (ACA). 14-3 Analyze the impact of Medicaid on enrollees. 14-4 Evaluate the future of Medicaid.

Activity/Assessment

Duration

Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment

Source (i.e., PPT slide) PPT Slide 17 PPT Slide 18 PPT Slide 39

Additional Discussion Question #1 Knowledge Check 2 Activity Knowledge Check 2 Answer Self-Assessment

Instructor’s Manual PPT Slide 24 PPT Slide 25 PPT Slide 39

5–10 mins 5–10 mins 5 mins 10–15 mins

Additional Discussion Question #2 Knowledge Check 3 Activity Knowledge Check 3 Answer Self-Assessment Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment

Instructor’s Manual PPT Slide 32 PPT Slide 33 PPT Slide 39 PPT Slide 34 PPT Slide 35 PPT Slide 39

5–10 mins 5–10 mins 5 mins 10–15 mins 5–10 mins 5 mins 10–15 mins

5–10 mins 5 mins 10–15 mins

Key Terms Disproportionate share: A payment adjustment under Medicare and Medicaid that pays hospitals that serve a large number of indigent patients. In-kind transfer: Welfare subsidies provided in the form of vouchers for specific goods and services, such as food stamps and Medicaid. Universal access: A guarantee that all citizens who desire health insurance will have access to health insurance regardless of income or health status. Those who cannot afford insurance are usually subsidized, and participation is voluntary. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • • •

An updated discussion of Medicaid and its implications for both the low-income and middle-income populations in the United States A more in-depth analysis of the expansion of Medicaid under the Affordable Care Act Updated analysis and considerations for the future direction of Medicaid New case studies demonstrating how applied economic methods can be used to evaluate real-world problems

Chapter 14: Medicaid This chapter examines the primary safety net coverage for the low-income population in the United States, Medicaid. It discusses the basic institutional features of the program, including the State Children’s Health Insurance Program (SCHIP), its economic consequences, the changes in eligibility resulting from the passage of the ACA, the impact of Medicaid on its participants, and the future of the program.

Chapter Outline I.

Medicaid: Medical Care for Vulnerable Population Groups: Medicaid, passed in 1965 and being part of the same legislative package with the federal Medicare program, served approximately 4 million low-income Americans in 1966, increasing to over 76 million by 2020. Medicaid spending amounted to $0.9 billion in 1966 and grew to over $670 billion by 2020. a. Medicaid is an open-ended entitlement program, administered by the states (need not take full responsibility for effectively managing it and benefits eligible in one state cannot be applicable in another under similar circumstances) and financed jointly with state and federal funds. Changes in the program include coverage for children aged 5 to 18 with their family incomes less than 133 or 100 percent of the FPL (e.g., the State Children’s

II.

Health Insurance Program or SCHIP), childless adults, and pregnant women and subsidy for employers (PPT Slides 4–10). b. Three factors for increase in Medicaid spending are 1) program expansions mandated by the federal government that have led to dramatic increases in enrollment, 2) the overall increase in medical care costs, and 3) increases reimbursement rates to hospitals and other providers. New services offered by the expansion of the program include coverage of nurse practitioners (constituting 20 percent of the total outlays), community health centers, treatment of a condition during diagnosis, and the challenges are states showing unwillingness to participate in the expansion due to added cost, program cutbacks jeopardizing federal funding, and tax increases jeopardizing political careers (PPT Slides 11–16). c. Medicaid expansion was ignored due to the following reasons: the number of low-income enrollees decreased because of the 2012 Supreme Court ruling that made the expansion optional for the states; it is uncertain that federal spending will continue or not; high adult take-up rate in the current program, indicating a large number of non-participants; interstate migration is not a common way to qualify for Medicaid coverage; access is reasonable in parts of the country but relatively poor overall; Medicaid’s value to its recipients is less than the overall cost. As Medicaid fails to produce physical health outcomes compared to no insurance at all, many states are exploring different alternatives for covering the low-income population (PPT Slides 19– 23). Medicaid’s Impact on Enrollees: As with any other entitlement program, researchers are interested in its impact on the behavior and well-being of its participants. Research has examined the economic impact of the Medicaid program to determine its effect on health outcomes, enrollment in private insurance, labor supply, family structure, and savings. a. Medicaid eligibility expansions among pregnant women improved prenatal care utilization and reduced the proportion of low-birth-weight deliveries and improved birth outcomes. A research study shows that shortage of physicians willing to serve the Medicaid population is due to low reimbursement rates and can be improved by higher fees, and evidence shows that patients with Medicaid coverage have worse outcomes than virtually all other patients (PPT Slides 26 & 27). b. As the value of free, public insurance coverage increases, holders of costly, private insurance are likely to drop private coverage and enroll in Medicaid. The decision to drop private insurance coverage is often encouraged by employers who decrease their own share of the private insurance premium, creating an incentive for employees to drop private coverage “voluntarily” (PPT Slide 28). c. In-kind transfer programs, such as Medicaid, reduce the supply of labor: people are hesitant to accept jobs if there is no free, public health insurance.

III.

IV.

With the current policy environment, several states have declined to extend eligibility to the sole remaining uncovered category: low income, working age, and nondisabled adults without dependents (PPT Slide 29). d. Research shows that the Medicaid program as traditionally structured created a bias favoring single-parent families. There a significant increase in fertility among eligible women because of lower cost of childbearing and generous child coverage lowering the discounted present value of raising a child (PPT Slide 30). e. Medicaid expansions have an impact on individual savings decisions diminishing the need for precautionary savings. Evidence supporting this principle shows the following findings: The wealth holdings of Medicaid families are lower because of the asset test; there is transfer of assets by older people to qualify for Medicaid financing for nursing home care; eligibility standards create incentives and disincentives; Basing eligibility standards on marital status promotes family breakups; Using disability for categorical eligibility encourages dependence; Illegitimate births are encouraged by tying eligibility to pregnancy and the presence of children in single-parent families; the single greatest disruption is the minimum asset requirement for eligibility, forcing many older females into poverty to qualify for long-term care assistance (PPT Slide 31). The Future of Medicaid: Expansion is not reform, and Medicaid needs to be reformed. The administrative efficiency of Medicaid can be improved by basing the grant on the number of state residents under the FPL; in other words, states could contribute to health savings accounts for participants by adding a cost-sharing requirement based on income and ability to pay (PPT Slide 34–36). Summary and Conclusions: The reform challenge faced with Medicaid begins with agreeing upon a clear understanding of the program’s primary mission: whether it is a medical program to provide good health care to the poor or a social program to eliminate the financial risk related to provision of health care services; whether its success is measured by relative improvement in the health of its participants or by the redistributive impact the program has on some measure of income. Inefficient use of resources is wasteful and focuses on supporting health care special interests but not individuals. Within the next decade, the United States will be spending over one trillion dollars on Medicaid annually (PPT Slide 40).

[return to top] Issues in Medical Care Delivery

•

Medicaid Expansion Will Stimulate the Economy and Create Jobs, or Not

Applied Micro Methods

•

Is Medicaid Worse Than No Insurance At All?

•

Did Medicaid Expansion Lead to Increased Emergency Department Use?

Teaching Suggestions • • •

Spend very little time on the institutional feature of the Medicaid program. Instead, focus on the economics and the impact of the Medicaid program. Discuss the Medicaid expansion under the Affordable Care Act and its impact on beneficiaries. Introduce students to the proposed alternatives to the current Medicaid financing structure.

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Suggested Approaches to End-of-Chapter Questions 1. The advantages of DRG include the following: • Early evidence indicated reduction in Medicare hospital expenditures. • In 1990, the savings amounted to approximately $18 billion. • In 1982 and 1985, the average length of stay for Medicare patients fell 15 percent. • It resulted in an overall improvement in efficiency. Critics have argued that the DRG payment system has caused patient dumping by hospitals, and that hospitals release their Medicare patients more quickly. 2. Prior to DRG, Medicare reimbursed hospital on a cost-plus basis. This payment system led to growing inefficiencies and increased spending. In 1992, Medicare started the resource-based relative-value payment system. This payment system is determined based on the resource costs needed to provide care (physician work, practice expense, and professional liability insurance). This system is to incentivize physicians to be more efficient. 3. A price control can lead to a shortage because by lowering price, the demand for health care services will increase, which can result in longer waiting times. Under a global budget, a spending cap is set for providers and they are required to deliver care to patients within that budget. This method can incentivize efficiency and help control spending growth. 4. This question was discussed in Chapter 4, page 118. The author argued that “One of the main reasons why medical markets are not efficient is that consumers do not spend their own money.” In traditional markets, individuals spending their own money provide the discipline that culminates in the efficient provision of goods and services. Because of the third-party payment (low out-of-pocket costs to patients), patients have no incentive to search for lower-cost providers. 5. Review Chapter 4, pages 104–105. Figures 4.11 and 4.12 can be used to explain the changes that occur. The effect of a price ceiling depends on the competitive nature of the market. • Under a perfectly competitive market, when the price ceiling is below the equilibrium price, it will lead to an increase of the demand of health care (due to

•

the lower price), which can result in shortages, longer waiting times, and a reduction in the quality of care. Under a monopoly market, a price ceiling works well if the level of the price ceiling is reasonably set.

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Additional Questions for Discussion and Evaluation • •

What changes in Medicaid financing are currently being proposed? Some policymakers are currently proposing new Medicaid financing systems. Discuss their basic features and their impact on low-income families.

Multiple Choice 1. Medicare and Medicaid were enacted by the Johnson administration in 1965 as amendments to which federal law already in existence? a. Welfare Act of 1960 b. Social Security Act c. Employee Retirement and Income Security Act d. Managed Care Act e. Equal Rights Act 2. Which of the following statements is true about the Medicaid program? a. Eligibility standards are uniform across states. b. The program is totally funded by federal tax revenues. c. Everyone in the poverty-level population is eligible for benefits. d. About 20 percent of total outlays are for nursing home and home health care for the elderly. e. All of the above are true. 3. The most significant expansion of Medicaid since its inception occurred in 1997 and is referred to as a. SCHIP. b. SHIP. c. TANF. d. AFDC. 4. Empirical research indicates that the expansion of Medicaid has led to a number of unintended consequences, including a. an increase in the incidence of low-birth weight babies among participants. b. fewer pregnant women seeking prenatal care. c. an increase in the birthrate among the eligible population. d. all of the above. 5. Currently, about 60 percent of all Americans younger than 65 living below the poverty level receive assistance through Medicaid. a. True b. False

6. Which of the following statements is not true about the Medicaid expansion under the ACA? a. Families with income less than 138 percent of the federal poverty level are covered. b. The federal government covered 100 percent of the total cost of the expansion from 2014–2016. c. In June 2012, the U.S. Supreme Court ruling made the expansion mandatory for the states. d. Beyond 2016, the federal will pay 90 percent of the expansion cost, with the states paying the other 10 percent. 7. Federal law establishes the Medicaid eligibility threshold for pregnant women with children at a minimum of 133 percent of the poverty level for all states. a. True b. False 8. In 2015, the Medicaid overall spending was higher than expected by: a. 49 percent b. 50 percent c. 60 percent d. 62 percent 9. The evidence seems to indicate that Medicaid coverage is associated with better health outcomes when compared to individuals with other forms of insurance. a. True b. False

Structured Discussion: 1. Resolved: Differential access to medical care across socioeconomic groups is the primary reason for differential health status among these groups. [return to top]

Appendix 14A: A Note on “Projections” This appendix presents a note of caution on the unquestioned acceptance of projections of future health care spending. A number of predictions of future health care spending are presented. The use of extrapolation and the importance of the underlying assumptions are also discussed.

Appendix Objectives 1. Recognize the economic basis of health care spending projections and forecasts. 2. Understand the importance and implication of assumptions in generating projections and forecasts.

Table of Contents Purpose and Perspective of the Chapter..................................................................................... 2 Cengage Supplements .................................................................................................................. 2 Chapter Objectives ........................................................................................................................ 2 Complete List of Chapter Activities and Assessments ............................................................... 2 Key Terms ....................................................................................................................................... 3 What's New in This Chapter .......................................................................................................... 4 Chapter 15: Health Systems in High-Income Countries ............................................................. 4 Chapter Outline ............................................................................................................................. 4 Teaching Suggestions .................................................................................................................... 6 Suggested Approaches to End-of-Chapter Questions ................................................................ 7 Additional Questions for Discussion and Evaluation ................................................................. 8 Multiple Choice ......................................................................................................................................... 8 Structured Discussion: ............................................................................................................................. 10

Purpose and Perspective of the Chapter The purpose of this chapter is to acquaint students with the design and function of medical care systems worldwide. It examines six major countries—Canada, France, Germany, Japan, Switzerland, and the United Kingdom—and compares them to the U.S. health care system. It will give students a perspective of the systems of health care delivery in various countries. Each one of these countries, including the United States, struggles with a common problem: controlling the growth in medical care spending. Important topics discussed include cost-containment strategies, health system classification and expenditures, and whether they can be applied to the United States.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Explain the World Health Report (2000) and the factors used to compare the health systems of different countries. 2. Explain the challenges involved in making cross-country comparisons. 3. Analyze the challenges associated with limiting spending growth. 4. Evaluate the United States’ system relative to those of other nations in the developed world. 5. Analyze the advantages and disadvantages of different health care systems.

Complete List of Chapter Activities and Assessments Chapter Objective

Activity/Assessment

Duration

Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment

Source (i.e., PPT slide) PPT Slide 9 PPT Slide 10 PPT Slide 60

15-1 Explain the World Health Report (2000) and the factors used to compare the health systems of different countries. 15-2 Explain the challenges involved in making crosscountry comparisons.

Additional Discussion Questions #2 & 3 Knowledge Check 2 Activity Knowledge Check 2 Answer Self-Assessment

Instructor’s Manual PPT Slide 18 PPT Slide 19 PPT Slide 60

5–10 mins

5–10 mins 5 mins 10–15 mins

Chapter Objective

Activity/Assessment

15-3 Analyze the challenges associated with limiting spending growth. 15-4 Evaluate the United States’ system relative to those of other nations in the developed world. 15-5 Analyze the advantages and disadvantages of different health care systems.

Duration

Additional Discussion Question # Knowledge Check 3 Activity Knowledge Check 3 Answer Self-Assessment Additional Discussion Questions #1, 4, & 5 Knowledge Check 4 Activity Knowledge Check 4 Answer

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 26 PPT Slide 27 PPT Slide 60 Instructor’s Manual PPT Slide 37 PPT Slide 38

Knowledge Check 5 Activity Knowledge Check 5 Answer Self-Assessment

PPT Slide 58 PPT Slide 59 PPT Slide 60

5–10 mins 5 mins 10–15 mins

5–10 mins 5–10 mins 5 mins 10–15 mins 5–10 mins 5–10 mins 5 mins

Key Terms Global budget: A limit on the amount of money available to a health care system during a specified time. All medically necessary care must be provided to all eligible patients within the limits of a fixed budget. Cost containment: Strategies used to control the total spending on health care services. Sickness fund: A quasi-governmental group that serves as an insurance company by collecting premiums and paying providers within the national health care system of France and Germany. Laissez faire: A French term meaning literally “allow [them] to do.” It depicts a situation in which individuals and firms are allowed to pursue their own self-interests without government restraint. Single-payer system: Usually associated with Canada and the U.K., a system of financing medical care in which payment comes from a single source, typically the government. Individual mandate: A legal requirement that individuals carry their own insurance protection. [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • •

• •

A more in-depth discussion about the difficulties in making cross-country comparisons. An updated and reorganized discussion of health system classifications, focusing less on Canada’s national health insurance but rather on the Bismarck Model of national health insurance. Additional commentary and discussion about how and whether the health care systems in other countries can be applied to the United States. New case studies demonstrating how applied economic methods can be used to evaluate real-world problems.

Chapter 15: Health Systems in High-Income Countries This chapter presents a discussion of the health care delivery systems in the six major countries that are often compared to the U.S. system—Canada, France, Germany, Japan, Switzerland, and the United Kingdom. No attempt is made to glamorize or debase any system of health care delivery. Each one of these countries, including the United States, struggles with a common problem: controlling the growth in medical care spending. These problems are carefully documented, not for the purpose of ranking the delivery systems, but to show that reform in the United States must take on a uniquely American character— one that will work within the institutional framework that is the backbone of U.S. society.

Chapter Outline I.

International Comparisons: Tread Lightly: Examining international differences in the organization and performance of health systems can provide insight for improvements in the way we approach health care delivery and finance. Practitioners constantly search for best practices in providing services, while policymakers search for health care systems that provide the best outcomes at the right level of spending (PPT Slides 5–8). a. Factors affecting health status studied in cross-nation comparisons include living conditions and lifestyle issues, and important measures are life expectancy and mortality (one type is infant mortality rate; the role of genetics and environmental factors plays a vital role): differences in obesity and the health consequences are responsible for over one-half of the gap in life expectancy (diabetes alone is a major contributor to the gap) between the United States and Canada. Cost is of less consequence to the employersponsored or Medicare insured, but access can be a challenge for the Medicaid insured or the uninsured (PPT Slides 11–17 & 28–36). b. Medical care spending in the United States is the highest both in per capita terms and as a percentage of GDP, but over the past decades, it was not number one (consistently ranked in the top half of the comparison group).

The causes of the high spending should be analyzed before recommending policies to address the problem (PPT Slides 20–22). c. Two strategies to control cost and spending: provide incentives for people to use less medical care or increase regulation to control access and spending (a combination of approaches includes mandatory fee schedules, global budgets—can be established without fee schedules and rationing, and resource rationing—strict control over utilization of services). The limitations of controls are as follows: quality of care does not improve; they actually increase costs, because the distortions stifle the innovative activities that would lower costs; they never really address the root cause of increased spending, limited cost-conscious behavior on the part of buyers and sellers (PPT Slides 23–25). II. Health System Classification: The main identifying characteristic of the Beveridge model is government ownership of most hospitals and clinics with clinicians serving as government employees. Regardless of financing mechanism used, taxes, premiums, or some combination of the two, our focus will be on who ultimately takes on the role of payer: Single payer has its roots primarily in the Beveridge approach, national health insurance (NHI) is predominantly the Bismarck approach, and consumer directed is a variant of the NHI model with more patient choice. a. Bismarck model (the Sickness Insurance Act of 1883 established the German NHI model followed by Japan and France models): Three principles of the German model are social solidarity (access to social benefits), subsidiarity (decentralized system in the smallest unit), and corporatism (embodying the boards of sickness funds); the features include highly effective competitive fringe, copayments being low by U.S. standards, ambulatory care physicians paid on a fee-for-service, cost-containment measures resulting in a dramatic decrease in the physicians’ salaries relative to the average wage, no limits to volume of services, and budget-capping mechanism that directly challenges the independence of physicians. The features of the Japan model include a fee-for-service, reimbursement with a diagnosis-procedure combination, a point-fee system, and a system protecting patient volume without expensive treatment options. The features of the France model include controls over prices and budgets, no deductibles, and prospective global budgeting covering public hospitals and private covering nonprofit hospitals (PPT Slides 39–42). b. Beveridge model (the all-government, single-payer system where the single payer is billed according to a fee schedule through negotiations between providers and the payer): The British National Health Service (NHS) oversees approximately 200 clinical commissioning groups (CCG) providing free of charge services; the limitations include takes the pressure off the national system, slowing improvements; creates a two-tiered system, undermining the perception of equality; it is paternalistic as is evident in the method of resource allocation. Canadian NHS delivers high-quality medical care at

about one-half of the per capita spending; Key features are setting physician fees unilaterally and controlling overall spending through regionalization of high-tech services; the main limitation is waiting for diagnostic procedures being even longer (PPT Slides 43–46, 56, & 57). c. Consumer-directed approach (Switzerland and the Netherlands): The features of the Switzerland model are as follows: only individual basis so no group and family plans; a prospective risk-adjustment mechanism that subsidizes funds that have disproportionately higher costs due to adverse selection; a DRG-based system determines hospital payments (not per patient); two managed plans are plan similar to staff model and plan based on a GP network; competition is based on premiums and not benefits offered. The features of the Netherlands model are as follows: established in line with European standards; 30 percent of the population receive subsidies to purchase insurance; three segments of GP services: a capitated payment for basic services, dedicated funds for chronic care treatment, and a bonus pool; a 2011 agreement established controls using a combination of global budgeting and growth caps (PPT Slides 47–55). III. Summary and Conclusions: Cross-country comparisons of health care systems health care system, the metrics used to measure access and outcomes, and the unique differences in the values and expectations of the different populations. Some key points to control medical spending for any delivery system are as follows: Universal access is possible without strictly relying on a single-payer system or public sector approach; people who cannot insurance can still access to essential services within a system of subsidized premiums; universal access in a governmentrun system does not guarantee public satisfaction; competition in the private sector enables compensating for excess demand (PPT Slide 61). [return to top] Issues in Medical Care Delivery

• •

Who Has the Best Health Care System?

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In Search of the Perfect Belly Button

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A Matter of Life and Death

Medical Care Spending and International Competitiveness

Back-of-the-Envelope

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The Economics of a Safety Valve

•

Promoting Equality

Negotiating Fee Schedules: Bilateral Monopoly in Canada

Physician Supply under the National Health System

Teaching Suggestions •

Many students are surprised when they learn about the demographic differences among the six developed countries discussed in this chapter. The comparisons across countries give them a better appreciation for the challenges facing policymakers.

•

After presenting the international comparisons, pick your favorite country. I almost always compare the U.S. and Canadian systems and then poll the students about which of the other systems they would like to formally discuss. Economics majors are particularly interested in the Back-of-the-Envelope discussions in this chapter. Use them as springboards for discussing specific systems: bilateral monopoly as a way of introducing Canada, promoting equality in the NHS to discuss the British system, and the economics of the safety valve for just about any system. Because I use the Swiss system as a model of reform, I spend a great deal of time explaining its features. You can learn more about the Swiss approach in my book Health Care for Us All: Getting More for Our Investment, coauthored with Earl Grinols and published by Cambridge University Press.

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Suggested Approaches to End-of-Chapter Questions 1. Health care spending is higher in the United States than abroad because 1) per capita incomes are higher in the United States, 2) there are fewer price restrictions, 3) running the system means high administrative costs, 4) there are inefficiencies in providing care to those without good access to care, 5) there is excess capacity especially in terms of expensive procedures, 6) there are more generous tort remedies for malpractice, and 7) there are other confounding factors discussed in Chapter 11. 2. More spending does not necessarily mean market failure. It could be that because income is higher in the United States, spending is higher. 3. Students will summarize the discussion on one of the countries and comment on what would and would not work. 4. Critics of using the German system as a model for reform in the United States argue that moving to a similar plan would likely raise spending significantly. The typical U.S. firm spends less than 10 percent on health insurance benefits. Mandating such coverage would likely raise the percentage of GDP spent on health care in this country. 5. Collective ownership means that investment decisions are subject to political influence. Budget needs may dictate spending priorities rather than medical needs. Collective ownership seems to work reasonably well in providing primary and preventive care. Its success in providing costly diagnostic, surgical, and specialty care is not as clear. 6. Trace the historical development of the Canadian system from its inception in the post–World War II period. Most Canadians are satisfied with the system; however, many are not. Those who are wait-listed may prefer paying a bit more to have quicker access to expensive procedures. 7. “Medical Care Spending and International Competitiveness” beginning on page 440 provides a good discussion of this question. [return to top]

Additional Questions for Discussion and Evaluation 1. As part of the nineteenth-century reforms that were part of the Meiji Restoration, Japan adopted a health care delivery system that was similar to that of Germany’s. Describe the similarities and differences between the Japanese and German systems. 2. The European Union’s efforts to create a single market have a long way to go. Nowhere is that more obvious than in the medical care sector. EU policymakers are concerned that patients crossing borders to access medical care will imperil national health care systems. But every successful government-run system has one thing in common: they each have a safety valve. a. What is a safety valve in medical care? Provide examples of the safety valves available in many developed countries. b. Why do some analysts consider it important that every system have a safety valve? c. Using your best graphing skills, show how the model of a safety valve works. d. What is medical tourism, and how does it function as a safety valve? 3. Compare the availability of medical technology across the countries discussed in this chapter. Does more technology mean better health care? Does it always translate into better health outcomes? What is the data telling us? 4. What can the United States learn from the organization and delivery of health care from the countries discussed in this chapter? What can they learn from the United States? 5. Some argue that the reformed British National Health Service, discussed in the chapter beginning on page 455, looks a lot like managed care in the United States. How have the recent changes, including general practioner fundholders and hospital trusts, changed the incentive structure of the NHS?

Multiple Choice 1.

The British National Health System has been “reformed” how many times? a. Twice b. Three times c. Four times d. Five or six times e. Never One major challenge of the Canadian National Health Insurance system is a. there is more access to medical technology in Canada. b. the population density differences in the country. c. the monopsony power of the Canadian provincial health plans in negotiating fees with physicians’ associations. d. the fact that there is no large inner-city population in Canada to drive up costs. e. all of the above.

The Japanese health care system most closely resembles the health care system of _______, from which it was copied. a. the United States b. France c. Great Britain d. Germany e. Canada Which of the following countries has the longest life expectancy for both men and women? a. Japan b. Germany c. Canada d. Great Britain e. United States. We all know that the United States has the highest per capita health care spending in the world. Which country has the second highest? a. Japan b. Germany c. Switzerland d. Great Britain e. France Which of the following is not a practice of Japanese physicians? a. Performing an unusually large number of surgeries b. Seeing a large number of patients daily c. Dispensing medicine to their patients d. Accepting gifts of appreciation from their patients for special service e. Discharging patients from the hospital after relatively short average stays One lesson that American policymakers can learn from the health care systems of other counties is a. people must be willing to accept long waiting lists for expensive services. b. a government-run system ensures equal access across socioeconomic groups. c. the importance of having a safety valve. d. the mix between general practitioners and specialists is of little importance. e. private insurance cannot complement government insurance. Which of the following statements is true about the Canadian health care system? a. Many Canadians travel to the United States in order to receive expensive treatments. b. Canadians have the option of purchasing private health insurance if they can afford it. c. Canadian physicians are salaried employees of the provincial health plans. d. Canadian hospitals have significant excess capacity that is used to treat patients from foreign countries.

Canadian physicians are allowed to “balance bill” patients for certain high-cost procedures. 9. When medical fee schedules are negotiated by two monopolists—one representing patients and one representing providers—the equilibrium medical fees will a. be greater than fees determined in a competitive market. b. be less than fees determined in a competitive market. c. be greater than fees determined by provider groups alone. d. be less than fees determined by patient groups alone. e. depend on the relative bargaining strengths of the two groups negotiating the fee schedule. 10. The French respect individual freedoms even as they accept collective action to reach important national goals of social solidarity and equality. What has been the major cost of a government-run system in France? a. The long waiting lists of expensive medical services b. High out-of-pocket spending, with over 90 percent of the population purchasing supplementary private insurance c. An erosion of the incomes of physicians relative to those of the average wage and salary worker d. An erosion of physician autonomy in making treatment decisions e. Both b and c 11. The biggest challenge faced by the German health care system in the 1990s was a. eliminating the long waiting lists for expensive medical services. b. integrating East and West Germany into a single system. c. controlling overall health care spending as a percentage of GDP. d. how to control rising physicians’ incomes in the name of social solidarity. e. how to provide high-income Germans with an effective safety valve so they would continue to support the system with their taxes.

Structured Discussion: 1. Resolved: The United States should adopt a single-payer Canadian-style system of health care delivery. 2. Resolved: The U.S. system of health care delivery is better than any system Europe has to offer.

Purpose and Perspective of the Chapter The purpose of this chapter is to provide students with an understanding of where the United States stands in terms of medical care reform. The chapter begins with a discussion of the prevailing beliefs and pressure behind reform movements. It then turns to analyze the different health care systems being used by other developed nations to give students a perspective of the various policy options. Next, the text discusses the market-oriented approach as well as current and future avenues for reform.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Explain the prevailing beliefs and pressure for medical care reform in the United States. 2. Evaluate the different policy options for health care system reform. 3. Explain the healthcare access and quality (HAQ) index as a means of comparing medical care systems. 4. Analyze the feasibility of the market-oriented approach to reform. 5. Summarize current and future avenues of reform for the U.S. health care system.

Complete List of Chapter Activities and Assessments Chapter Objective

Activity/Assessment

16-1 Explain the prevailing beliefs and pressure for medical care reform in the United States.

Additional Discussion Questions #8 & 9 Knowledge Check 1 Activity Knowledge Check 1 Answer Self-Assessment Additional Discussion Question #10 Knowledge Check 2 Activity Knowledge Check 2 Answer Self-Assessment

16-2 Evaluate the different policy options for health care system reform.

Source (i.e., PPT slide) Instructor’s Manual PPT Slide 10 PPT Slide 11 PPT Slide 61 Instructor’s Manual PPT Slide 17 PPT Slide 18 PPT Slide 61

Duration 5–10 mins 5–10 mins 5 mins 5–10 mins 5–10 mins 5–10 mins 5 mins 5–10 mins

Chapter Objective

Activity/Assessment

16-3 Explain the healthcare access and quality (HAQ) index as a means of comparing medical care systems. 16-4 Analyze the feasibility of the market-oriented approach to reform. 16-5 Summarize current and future avenues of reform for the United States health care system.

Duration

Knowledge Check 3 Activity

Source (i.e., PPT slide) PPT Slide 24

Knowledge Check 3 Answer

PPT Slide 25

5 mins

Self-Assessment

PPT Slide 61

5–10 mins

Additional Discussion Questions #1 & 3–5 Knowledge Check 4 Activity Knowledge Check 4 Answer Self-Assessment Additional Discussion Questions #2, 6, & 7 Knowledge Check 5 Activity Knowledge Check 5 Answer Self-Assessment

Instructor’s Manual PPT Slide 31 PPT Slide 32 PPT Slide 61 Instructor’s Manual PPT Slide 59 PPT Slide 60 PPT Slide 61

5–10 mins

5–10 mins 5 mins 5–10 mins 5–10 mins 5–10 mins 5–10 mins 5–10 mins

Key Terms National health insurance: A government-run health insurance system covering the entire population for a well-defined medical benefits package. Usually administered by a government or quasi-government agency and financed through some form of taxation. Play-or-pay: A health care reform feature whereby employers “play” by providing health care coverage to their employees or pay a payroll tax to fund government-provided insurance. Health savings account: A tax-advantage savings account designed to provide its owner with funds to cover out-of-pocket medical expenses, including deductibles, copayments, and coinsurance that remain uncovered by health insurance plans. Managed competition: A health care reform plan first popularized by economist Alain Enthoven, whereby individuals are given a choice among competing health plans. Health alliances: Called by various names, including health insurance purchasing cooperatives (HIPC), these provide a way for small employers to act collectively to purchase health insurance. Often geographically based and not-for-profit, the alliance contracts with insurers and/or providers for medical coverage for its members. Shirk: An action taken to avoid responsibility. Integrator: An entity responsible for consolidating the resources required to achieve the triple aim.

Pay-for-performance: An alternative payment model where the provider is rewarded for reaching certain performance goals, including patient satisfaction and preventive care coverage. Iron triangle: Describes three competing priorities in health care: cost, quality, and access. Baumol’s cost disease: Situation where lagging productivity in one sector (i.e., services) leads to higher prices in that sector as resources are shifted from sectors with high rates of productivity growth (i.e., manufacturing). [return to top]

What's New in This Chapter The following elements are improvements in this chapter from the previous edition: • • • •

Reorganized discussion of the beliefs and pressure behind contemporary calls for reform New analysis of policy options and the alternative medical care systems of other developed countries Revamped exploration of the market-oriented approach, including a review of the essentials for a properly functioning market Updated evaluation of current and future reform of the U.S. health care system

Chapter 16: Medical Care Reform in the United States This chapter explores the nature of the medical care reform movement in the United States: the pressures behind the movement, the goals of reform, and the alternative strategies competing for acceptance. One potentially controversial discussion is the one on the right to medical care. While some may be uncomfortable with addressing the “rights” issue, it is nonetheless an essential element in the future of health care delivery in the United States.

Chapter Outline I.

The Conditions for Reform: The debate over reform of the medical sector is not new. Every congressional session since 1916 generated at least one piece of federal legislation proposing to modify the system in some way, but the issues remain the same—access, quality, and affordability—the triple aim. a. Treating health care resources as public property may introduce the free rider problem and need to regulate use through administrative rules (In other words, health care as a right should consider a freedom-preserving and a resource-extracting right). A national policy must be able to establish reasonable priorities devise acceptable means to allocate resources sensibly (as there are justifiable limits on the use of certain medical options) (PPT Slides 65–67).

II.

b. In establishing spending priorities, health and medical care have a considerable advantage over other goals. For collective financing, a basic benefits package (it is a battle of specific interest groups) that is less generous than the standard insurance plan may be considered, even though a multi-tiered medical care system may not satisfy everyone’s notion of the social ideal (PPT Slides 6–9 & 70–83). Policy Options: Future Directions: Expansion of insurance coverage to all Americans can be achieved through three popular options: (1) expand existing government programs such as Medicare using a single-payer system, (2) mandate coverage through a government-run national health insurance (NHI) program, and (3) expand choice with the use of market incentives targeting where consumers make purchasing decisions (PPT Slide 12). a. Administered and financed by the government or a quasi-governmental agency, the single-payer option is a system that bills the single payer according to a predetermined fee schedule. Some of its advantages are its administrative simplicity: provider to payer, coverage of all regardless of employment status or financial circumstances, and the most equitable and efficient way to strike a balance between cost, access, and quality (PPT Slide 13). b. The NHI systems of many developed nations share the organizational elements of social health insurance, and in spite of taking many forms, either tax-based or employment-based, the underlying objective is to provide universal coverage for a well-defined population (participation is mandatory with individual contributions based on income and not health status). Financing based on ability to pay is a means of promoting the goal of universal coverage (PPT Slide 14). c. Health insurance exchanges feature choice of plan, individual mandates supported by generous subsidies (government-run solutions rise tax burden though eliminating premiums, making individuals less concerned about rising expenditures), and requirements that employers provide insurance to their employees in a play-or-pay environment. Markets typically result in the duplication of services caused by a system populated by multiple insurers, which will naturally increase the administrative burden of the system but will expand consumer choice and improve consumer welfare (PPT Slide 15). d. The healthcare access and quality (HAQ) index an index of mortality rates from causes that should not be fatal when access to high-quality medical care is present (the HAQ gap—the difference between the actual and potential HAQ—would narrow significantly by changing the way of delivering care). Results of a research study show that 25 percent deaths in the United States are due to amenable causes; the solution is the market-oriented approach (consumer-directed) resulting in a system that comes closer to its potential than single payer (PPT Slides 16 & 19–23).

III.

IV.

The Market-Oriented Approach: The failures of the system prior to the passage of the ACA are the government’s failure to promote competition and choice as a means of addressing the problems of access and cost (limited access for the uninsured and high costs), whereas the main distortion stems from two related features of employer-sponsored insurance: ESI is purchased by the employer using the employees’ money and exempting ESI from taxation desensitizes employees to the actual cost of health insurance. The core idea of the market approach is that individual decisions are better than collective decisions (e.g., the market-based approach would provide more power to the individual, whereas the approach under the ACA gives more power to the government) (PPT Slides 26 & 68). a. To function properly, buyers must understand the nature of the available goods and know all relevant prices in order to value their options (e.g., in an open exchange, the free flow of information is essential for competition to result in the efficient allocation of resources and promote economic welfare). If other objectives enter the mix, markets may not function to their full potential, and two strategies incorporated in the design of health care markets are managed competition and the consumer directed approach (PPT Slide 27). b. The “point-of-sale” approach is the basis of the original model of managed competition. Under managed competition, in employer-provided insurance, employees choose among plans that compete based along the lines of network coverage, benefits offered, premiums charged, and cost sharing required (but they cannot choose for other plans) (PPT Slides 28 & 30). c. The primary difference between the managed competition and the consumer choice option is the emphasis on spending consumer's own money on routine care; the other difference is that the former offers the best alternative for bringing competitive forces to bear in this market, while the latter views competition at the point of purchasing medical care as the appropriate choice (PPT Slide 29). Where Do We Go from Here? Prior to the ACA becoming law, Scott Brown (the U.S. Senate denied Democrat's filibuster-proof majority) was elected to fill their vacant Senate seat and then the Senate version of the bill was passed. The reform process was not complete even with signed legislation, but the ACA passed in 2010 initiating a 10-year process intended to expand health insurance coverage to millions of uninsured Americans (PPT Slides 64 & 69). a. Focused on a combination of Medicaid expansion and mandatory insurance, the three legs—insurance reform, mandates, and subsidies—form the core of the ACA legislation, with key provisions such as additional insurance market regulations including guaranteed issue and guaranteed renewability with no benefit exclusions due to preexisting conditions (PPT Slides 33 & 34). b. The Medicaid expansion was responsible for the majority of the coverage gains. However, the ACA reforms were not the overwhelming success that supporters claim, as evident from the following points: Someone making less

than 250 percent of the FPL pays less premium and receives generous support to cover their out-of-pocket spending, while an unsubsidized purchaser pays very high premium; the rollout of the insurance exchanges for small groups and individual markets faced problems with the website and information security, which led to a decline in the public perception and drops of insurance plans; premiums are higher for young, healthy individuals enrolled into risk pools of older, sick people; shortages in certain specialties along with low reimbursement rates to physicians have made it difficult for the newly insured to find regular sources of care (PPT Slides 35–58). c. The core problems and solutions are as follows: too many uninsured— everyone in the pool would have to opt out of ESI in favor of individual coverage, simplify the premium subsidies and make them uniform across all plans, replace the mandates as originally set up with penalties similar to those already incorporated into Medicare, and offer no penalty for nonparticipation but higher premiums when finally decided to purchase; addressing adverse selection, and for young purchasers subsidizing the older buyer, work out a different funding source for the subsidy, stabilize the exchanges by reducing uncertainty, and attract them so there are low premiums; closing the Medicaid coverage gap—Congress could make more than the states’ eligibility threshold but less than 100 percent of the FPL; and encourage competition—expand access to affordable health insurance provides coverage for catastrophic events and patients must have money to spend on care. For payment reforms, maintain the current exchanges for those keeping their ACA compliant plans and allow private exchanges that offer actuarially fair premiums; and transform FFS by linking it to the cost of delivery and restricting the use of price discrimination. Summary and Conclusions: For now, the ACA is the law of the land, despite its shortcomings: preexisting condition exclusions will remain illegal and there will be no lifetime maximums or annual limitations. The number of people who gain (or lose) coverage and whether the new plan is able to “bend the cost curve” will be the ultimate measures of success: shifting cost, paying providers less, passing cost onto business and the states, expanding subsidies, and rationing benefits are not reducing costs (PPT Slide 62).

[return to top] Issues in Medical Care Delivery

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Obamacare 1.0: The Massachusetts Plan Managed Competition in Practice: The Federal Employees Health Benefit Plan Lessons from ClintonCare

Teaching Suggestions •

•

Many people do not feel comfortable discussing “rights” in the context of access to medical care. I believe that it is an important discussion with real substance. The fact that most politicians avoid the issue reinforces my beliefs. While you will not reach agreement on the issue, it is important to get students thinking about the rights issue. Make sure that students who believe that we have a right to medical care have a clear understanding of what they mean by a “right.” Reiterate the goals of a health care system: Who’s covered, what’s covered, who pays, and how much? Students tend to be a bit simplistic in their approach to change. Make sure they are aware of the overriding implications of a system change. Most state legislatures have initiated some type of change in their system of delivery or financing in recent years. Your students will probably appreciate a brief summary of some of the changes that your state legislature has enacted recently. In the fast-changing world of health care reform, it is difficult to know which policy alternatives to feature. While the old standbys are discussed, look online for updates on the current state of the legislative process.

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Suggested Approaches to End-of-Chapter Questions 1. Federal authorities have much more power in determining the future direction of health care reform. One of the biggest hurdles for state government is ERISA, which preempts state governments from mandating employers to cover their workers and limits the states’ ability to regulate self-insured plans. State governments are closer to their citizens and likely more responsive to local needs than the federal government. State experiments seem wise. 2. Probably both. 3. The major key elements of the Affordable Care Act (ACA) are discussed beginning on page 473. 4. Students should have enough background in health care economics and reform to come up with their own plan at this stage in the course. 5. Halfway measures may doom us to the worst of both worlds. The political will to stay a particular course reduces uncertainty and improves outcomes. 6. Spending large sums to extend life under all circumstances is a prescription for maintaining a high level of spending. Uniformly applied standards for end-of-life care could save some money. Whether it would make a significant difference is not clear. 7. This question addresses the issue of the provision of a safety valve. Are we willing to accept a multi-tiered system? Those who realistically look at the situation in most countries conclude that no system exists where resources are uniformly distributed.

Those with more money will always be able to get more medical care and more fancy cars. 8. The elderly and indigent have a legal right to medical care created by federal entitlement programs, including Medicare and Medicaid. If you define rights according to the natural rights philosophy, if you don’t pay for it, you have no right to it. Hawaii has gone one step further by mandating coverage (thanks to an ERISA exemption) and Oregon has set limits on Medicaid spending based on cost effectiveness. [return to top]

Additional Questions for Discussion and Evaluation 1. In the spring 1995 issue of Health Affairs, Mark Pauly and John Goodman discuss their proposal for using medical savings accounts and tax credits as part of an incremental approach to health care reform. Deborah Chollet comments and the authors respond in the summer 1995 issue. Examine the main arguments Pauly and Goodman use in support of MSAs. What are Chollet’s main arguments against MSAs? 2. The summer 1995 issue of Health Affairs presents two views on Singapore’s experience with medical savings accounts, one by William C. Hsiao and the other by Thomas A. Massaro and Yu-Ning Wong. Examine these two different perspectives and comment on whether MSAs could work in the United States. 3. President Clinton’s health care reform plan used price controls as one of its basic means of controlling spending. The controls included fee schedules in the fee-forservice sector, limits on the absolute level of health insurance premiums and their allowable year-to-year increases, and prospective budgets for regional health alliances. Review the case for and against price controls in medical care. Under what circumstances will they work? Do these circumstances exist in medical markets? 4. A slightly different perspective on the fairness issue requires that we look at the dynamics of a multi-tiered system. Are current recipients of the collectively provided plan likely to remain at the basic benefits level, or is there mobility within the system? [Answer: As individual circumstances change—job changers, job movers, job losers, new hires—it is reasonable to expect that individuals will have their eligibility for the collectively provided plan affected. From our discussion of the dynamics of the uninsured population, remember that while 15 percent of the U.S. population are uninsured at any one time, only about four percent are chronically uninsured. Thus, it is highly likely that participation in the collectively provided basic benefit plan will be a temporary phenomenon for most recipients, just like being uninsured is temporary for most people now.] 5. Suppose a law is passed mandating that every employer provide health and disability insurance for employees suffering a heart attack. Who would benefit from such a law? Who would be hurt? Who would pay for this employee benefit? (If you

suffered from a heart condition or had a family history of heart disease, would you advertise this fact to prospective employers?) 6. States have traditionally served as incubators for new ideas and approaches to health care delivery. Former governor Mitt Romney along with a Democratcontrolled Massachusetts legislature rolled out a state reform plan in 2006 that served as a blueprint for the Affordable Care Act. a. Describe the main features of the Massachusetts plan. b. What are the economic implications of the approach? Has it worked as planned to increase access? To control spending? c. What can we learn from the Massachusetts experiment that will help us formulate a national strategy? 7. Public support for a patient's bill of rights is significant because the benefits can be easily identified. Health plans are less likely to say no to treatments, but costs are not as easily identified—the increase in premiums, deductibles, and copayments, or the employers who drop employer-sponsored health insurance. Do you agree or disagree? Explain. 8. Outline the arguments that favor implementation of a universal healthcare program? Who should pay for the coverage? 9. Do state mandates for coverage of—for example, in vitro fertilization and hearing aids—have a cost? If so, what is the opportunity cost? Discuss the trade-off between the amount of coverage and the number of people covered. 10. Should the states be in the business of mandating insurance coverage? Do these regulations make consumers better or worse off?

Structured Discussion: 1. Resolved: The United States should immediately enact some health plan that covers the entire population. 2. Resolved: The United States should seek universal coverage through a broad-based tax with subsidies for the poor and the sick. 3. Resolved: The United States should seek universal coverage through employer mandates with subsidies for the poor and the sick.

Purpose and Perspective of the Chapter The purpose of this chapter is to summarize the 10 key economic principles that have been at the center of this text’s discussion of health economics. By reviewing these essential concepts, the chapter aims to reinforce students’ understanding of basic economic theory, which can be usefully applied in their future careers, particularly those who will engage in public policy.

Cengage Supplements Supplements, including PowerPoints, an Instructor Manual, and a Cognero Test Bank, can be found at www.cengage.com.

Chapter Objectives The following objectives are addressed in this chapter: 1. Analyze the economic lessons relating to health care delivery and finance. 2. Explain how economics provides few solutions to medical care problems and can only offer alternative approaches to addressing the problems. [return to top]

What’s New in This Chapter The following elements are improvements in this chapter from the previous edition: •

Reorganized and updated summary of the 10 key economic concepts used to guide this text in its discussion of health economics

Chapter 17: Lessons for Public Policy This chapter is organized according to the 10 key economic concepts that have served as guiding principles for our study of health economics. Some of the lessons are obvious, some not quite so obvious. There will be disagreement, as the propositions are not all based on positive analysis. The very nature of public policy discussions means that some are laced with normative implications.

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Scarcity and Choice: Economics recognizes the problem of limited resources and unlimited wants and desires. Without enough resources to satisfy all the desires of all the people, allocating those resources (have alternative uses that are also beneficial) among competing objectives becomes essential. Opportunity Cost: Opportunity cost is defined as the cost of any decision or action measured in terms of the value placed on the opportunity forgone (e.g., time and resources used to satisfy one set of desires cannot be used to satisfy another set). Some assumptions in implementing the cost are as follows: 1) Practitioners have

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knowledge of the fundamentals of economics to mitigate the issues regarding costs and benefits that affect medical care delivery and policy; 2) Long-run savings and understanding what other beneficial use of the same resources is foregone are determinants of wise resource use; 3) Resources taken from Medicare and used to fund the expansion of Medicaid cannot be used simultaneously to extend the solvency; 4) Universal coverage is expensive and state-financed programs will crowd out private programs, making coverage costlier. Marginal Analysis: The economic way of thinking about the optimal resource allocation may be classified as marginal decision making. This is manifested in several ways: There is transfer of the benefits of productivity gains for greater use of superior goods if productivity grows in most sectors; If MC is very low, resources are of no value; Balancing incremental benefits and incremental costs can optimize resource allocation (spending more on one resource makes spending less on another one); Only marginal changes (not overall) in utilization and spending are analyzed; Wise resource use is by comparing one with the next best option; Other factors, besides medical care spending, improve health status; The relationship between health care spending and death proximity is due primarily to the relationship between age and mortality; Risk-averse people will insure against lowprobability, high-cost events; A one-size-fits-all benefits package is expensive and pressures to expand coverage are enormous. Self-Interest: People respond to incentives and practice economizing behavior only when they individually benefit from it. This pursuit of self-interest leads to the following courses of action: It dominates decision making; Practicing economizing behavior is influenced by cost-conscious behavior: whether people spend their own money (tend to spend wisely) or other people's money (show little concern for how it is spent); The patient/buyer must actively involve in cost containment if achieved without artificial controls (mandatory fee schedules, fixed budgets, and resource rationing); Good health is not always the primary goal in life for most people; The best way to control overall spending is to require more personal responsibility in financing medical care consumption; Economic incentives matter in determining the demand for medical care; Evidence that insurance affects medical decisions supports the notion that physicians respond to economic incentives; The differences between the for-profit and the not-for-profit organizational form may be classified as differences in property rights; Consumers perceiving that they will benefit from additional information will demand information, and it will be provided. Markets and Pricing: The market accomplishes its tasks through a system of prices, Smith’s “invisible hand.” The price mechanism balances a firm’s output decisions with consumer desires in the following ways: Providing all care for a fixed fee changes the nature of the physician–patient relationship; With Medicare and Medicaid paying a large amount, government reimbursement rules determine the financial stability; As efficiencies are eliminated, so too is the ability to subsidize for the uninsured, increasing the pressure on public policymakers to improve the social safety net; Transportation and Internet eliminates the boundaries of the medical

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marketplace; Policymakers must be ready to respond to the inevitable cost pressures that have the potential to undermine any early access; Expanding insurance coverage beyond a delivery system’s ability to provide care results in shortages and a call to ration care. Supply and Demand: Supply and demand determine pricing and output decisions. Goods and services are allocated by equating the consumers’ willingness to pay and the suppliers’ willingness to provide: The quantity of care increases with decrease in cost to the individual; Price controls create shortages; The favorable tax treatment for employer-based health insurance distorts the composition of employee compensation; Information costs are a central factor in economic decision making; Managed care can control utilization when patient choice is restricted; Problems in the system emphasize cost containment over quality and access (e.g., the desire for expensive treatment is sacrificed to the demand to control spending); When the physician faces a zero price for other medical inputs, too many other inputs will be used relative to physician inputs, resulting in inefficiencies; When government attempts to provide “free” care, shortages develop in the form of long waits, and the quality of specialized care deteriorates; After the initial cost efficiencies are realized, the lower prices associated with the mandatory fee schedules lead to fixed budgets and eventually to limits on services. Competition: Competition forces resource owners to use their resources to promote the highest possible satisfaction of society (those can do so are rewarded, while those are inefficient are penalized). The effects of competition on resource owners are as follows: Competition guards against undue concentration because substitutes are readily available; Competition in markets forces suppliers to improve efficiency resulting in lower prices for consumers; Competition forces providers to charge prices reflecting their costs; Competition on the demand side of the market serves to reduce inefficiencies; The nature of competition dominated by nonprofit providers does not promote cost efficiency but instead promotes quality enhancement; The nature of competition in a market dominated by nonprofit providers does not promote cost efficiency but instead promotes quality enhancement Efficiency: Economic efficiency measures how well resources are being used to promote social welfare. Some approaches of economic efficiency to the efficient use of scarce resources are as follows: the ethical use of resources is as important as their efficient use; Specialization leads to cost savings through a more efficient allocation of resources; Given the wide range of managed care arrangements, the overall effectiveness of the new forms of controlling costs should be studied; Physician ownership improves hospital efficiency by allowing physicians to benefit from the shared savings; Efficiency is not rewarded in a cost-plus environment: With the increasing use of managed care and prospective payment, only recently have hospitals been given an incentive to be efficient; The fiscal realities of expanding coverage to the uninsured may eventually require a scaling back of the basic

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benefits package to one that covers much less than the standard policy that those with private insurance expect. Market Failure: Free markets sometimes fail to promote the efficient use of resources by producing either more or less than the optimal level of output. Sources of market failure include natural monopolies, externalities in production and consumption, and public goods; Policymakers have used market failure to justify the provision of social insurance as a safety net Comparative Advantage: Because the private insurance market cannot provide adequate insurance for those with preexisting conditions, it becomes a collective responsibility if this group is to have access to medical care; Cream skimming is the result of regulation in the insurance industry, not competition; it increasingly difficult to subsidize care for those with preexisting conditions, including older adults, the indigent, and the uninsured, providing justification for collective action through government to ensure access for these groups; Hospital markets may not fit the competitive model very well, because so many structural characteristics of perfect competition are violated; Tax-financed government spending often crowds out private spending. Final Reflections: Economics does not promise answers, only a systematic way to study the alternatives. Let health economics be the beginning of a lifetime of inquiry into health care issues.

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Teaching Suggestions •

If you’re like me, it is going to be difficult to find class time to discuss this chapter. It is presented as a summary of the lessons that I have learned from my study of health economics. You will most likely not agree with all of them. They are meant solely to stimulate thought and discussion. Accept them in that spirit.