ch09

Chapter 9: Government, Health, and Chapter 9: Government, Health, and Medical CareMedical Care

Health EconomicsHealth Economics

IntroductionIntroduction

Causes and consequences of government intervention in health care.

Types of government intervention. Case studies

– Cigarette taxes.– Price ceilings on health care services.– Hospital antitrust litigation.

Why Government Intervention?Why Government Intervention? Perfectly competitive markets lead to

efficient outcomes. Why?

Recall that the demand curve for any given product has a negative slope.– If consumers are visiting the doctor 2 times

per year when the price of a visit is $100, the price must fall below $100 in order to encourage consumers to see the doctor more often.

Why Government Intervention?Why Government Intervention? Thus, the demand curve reflects the

consumer’s marginal benefit from consumption.– The marginal utility from the third visit to

the doctor is lower than the marginal benefit from the second visit.

Similarly, we can define a demand curve for society’s preferences as a whole, which reflects the marginal social benefit of medical services.

Why Government Intervention?Why Government Intervention?

Quantity of medical services

Price

MSB

Why Government Intervention?Why Government Intervention? Recall that the supply curve for any

given product slopes upwards.– If a pharmacy is being paid $30 per

prescription to fill 300 prescriptions per day, it must be paid more than $30 per unit to fill 400 orders per day.

This reflects the fact that the marginal costs of production usually rise as output increases.

Why Government Intervention?Why Government Intervention? At the societal level, the marginal social

costs of providing services will also rise as output increases.– e.g. The marginal cost of achieving an

infant mortality rate of 20 per 100,000 live births may be fairly low, but the marginal cost of reducing the rate to 5 per 100,000 will be much higher.

Why Government Intervention?Why Government Intervention?

Quantity of medical services

Price

MSC

Why Government Intervention?Why Government Intervention? Equilibrium is reached where

MSB=MSC

Quantity

Price

MSB

MSC

P0

Q0

Why Government Intervention?Why Government Intervention? In equilibrium, all services are

exchanged at the price P0.

– But for all services less than Q0 (e.g. the 1st and 2nd physician visit), the marginal social benefit exceeds P0.

– The difference between marginal social benefit and the equilibrium price is called consumer surplus.

Why Government Intervention?Why Government Intervention?

Quantity

Price

MSB

MSC

P0

Q0

Consumer Surplus

Why Government Intervention?Why Government Intervention? For all services less than Q0, the

marginal social cost is lower than P0.– The difference between marginal social

cost and the equilibrium price is called producer surplus.

Why Government Intervention?Why Government Intervention?

Quantity

Price

MSB

MSC

P0

Q0

Producer Surplus

Why Government Intervention?Why Government Intervention? Perfect competition is considered efficient,

because it maximizes social welfare = consumer surplus + producer surplus.

Quantity

Price

D

SConsumer Surplus

Producer Surplus

Criteria for perfect Criteria for perfect competition competition

All firms and consumers are price takers.

Consumers and firms have perfect information.

All firms produce an identical product. Firms can freely enter an exit an

industry.

Market imperfections may lead to inefficient Market imperfections may lead to inefficient or inequitable distribution of resources.or inequitable distribution of resources.

Imperfect consumer information Monopoly Externalities

Government intervenes to restore efficiency and/or equity. “Public interest theory.”

An opposing theory: The amount and types An opposing theory: The amount and types of government intervention are determined of government intervention are determined by supply and demand.by supply and demand.

Vote-maximizing politicians “supply” legislation.

Wealth maximizing special interest groups are the buyers.

Successful politicians stay in office by satisfying special interest groups.

““Special interest group theory”Special interest group theory”

Examples:Examples:

Extended patent protection for brand name drugs.

Rejection of national health insurance in favor of private insurance companies.

Special interest group theory claims that special Special interest group theory claims that special interest groups gain at the expense of the general interest groups gain at the expense of the general public. public.

Consumers are diverse, fragmented, more costly for them to organize.

Inefficient, inequitable resource allocation by government.

Which theory do you believe? C-B analysis is needed to identify winners

and losers.

Types of Government InterventionTypes of Government Intervention

Provide public goods.

Correct for externalities

Impose regulations. Enforce antitrust laws. Sponsor redistribution

programs. Operate public

enterprises.

Fund medical research.

Tax cigarettes, pollution.

FDA Bar hospital mergers. Medicare and Medicaid.

VA hospitals

Public GoodsPublic Goods >1 individual simultaneously receives

benefits from the good. i.e., no rivalry in consumption.

Costly to exclude nonpayers from consumption of the good.

Private firms unwilling to produce and sell public goods.

Are most medical services public goods?

ExternalitiesExternalities

Definition: An unpriced byproduct of production or consumption that adversely affects another party not directly involved in the market transaction.

Cigarette smoking Pollution Medical treatment for cyclists who don’t

wear helmets Drunk drivers

Demand-side externality: Marginal Social Benefit Marginal

Private Benefit

Supply-side externality: Marginal Social Cost Marginal Private

Cost

Cigarette smoking is an example of a Cigarette smoking is an example of a (negative) demand-side externality.(negative) demand-side externality.

Smokers impose work-related costs on nonsmokers.

Health insurance, pensions, sick leave, disability, group life insurance financed collectively by smokers and nonsmokers. But smokers, die earlier, pay less taxes,

premiums.

Smokers also impose health care Smokers also impose health care costs on nonsmokers.costs on nonsmokers.

Smokers usually incur higher health care costs. But nonsmokers die prematurely from

passive smoking, smoking-related fires.

The total external costs of cigarette smoking are estimated to be 15¢ per pack. (Manning et al., 1991)

Keep in mind:Keep in mind:

The problem which calls for government intervention is external costs, not internal costs.

The full extent of external costs must be measured using a lifetime approach.

Manning et al.’s methodsManning et al.’s methods

Numerator takes into account life expectancy for smokers and the costs (savings due to early death) incurred each year.

smokedpacksostscexternalLifetime

#15 4

External Cost ComponentsExternal Cost Components

Covered medical costs. Covered work loss and disability. Group life insurance. Widow’s social security bonus. Covered nursing home costs. Pensions. Taxes on earnings. Fires.

At Q0 MSC0 > MSB0

Cigarettes are being over-consumed.

Cigarette Packs

$ per

pack

D=MPBMSB

S=MPC=MSC

Q0

MSC0

MSB0

Q1

Government can use taxes and subsidies to Government can use taxes and subsidies to alter economic incentives, correct for alter economic incentives, correct for externalities.externalities. Charge a tax on cigarettes that reduces

consumption to the socially optimal level Q1.

Levy a per-unit tax T on cigarette makers equal to vertical distance between MPB and MSB at Q1.

Cigarette packs

$ per pack

D=MPB

MSB

MPC0=MSC

MPC0+ T

Q0Q1

P0

P2

P1

With tax:With tax:

Market price of cigarettes = P1

Cigarette manufacturers receive P2 per pack.

Tax burden Consumer pays P1 - P0

Seller pays P0 - P2

The relative tax burden on consumers vs. The relative tax burden on consumers vs. producers depends on price elasticities for producers depends on price elasticities for supply and demand.supply and demand.

If demand for cigarettes is inelastic, consumers bear a larger?/smaller? Share of the tax burden.

Further issuesFurther issues

The current tax per pack exceeds external costs. Is this “OK”?

Should smokers or cigarette companies be responsible for the external costs of smoking?

“Thank you for smoking.” Is this moral??

RegulationsRegulations

Government can attempt to control price, quantity, or quality of health care products.

Example: Price Ceilings in The Canadian Health Care System.– Consumers are fully insured by the

government.– The government fixes the price the

physician receives for each visit.

RegulationsRegulations Because consumers are fully insured,

they will demand the number of visits as if the price per visit = 0.

Assume that the government sets a reimbursement rate for physician visits equal to PC.

Physician visits

Price

D

S

QDQS

PC

With full insurance, consumers want QD visits.

But the government has fixed the price of visits at PC.– Only QS visits will be provided.

Shortage of physician visits = QD - QS.

ConsequencesConsequences

1)Physicians may treat patients on 1st-come, 1st-served basis, regardless of severity/urgency.

2)Patients will have to queue for care/not receive care.

3)Unethical doctors may take bribes from patients trying to jump the queue.

Lesson: There is no free lunch under cost Lesson: There is no free lunch under cost containment. Price ceilings can lead to:containment. Price ceilings can lead to:

1) Shortages.2) Longer waiting lines.3) Nonprice rationing.4) Poorer health outcomes.

Types of Government InterventionTypes of Government Intervention

Provide public goods.

Correct for externalities

Impose regulations. Enforce antitrust laws. Sponsor redistribution

programs. Operate public

enterprises.

Fund medical research.

Tax cigarettes, pollution.

FDA Bar hospital mergers. Medicare and Medicaid.

VA hospitals

Antitrust: Sherman Antitrust ActAntitrust: Sherman Antitrust Act

Section 1: Every contract, combination in the form

of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states or with foreign nations, is hereby declared illegal.

Section 2: Every person who shall monopolize, or

conspire with any other person or persons to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be guilty of a misdemeanor.

The Act prohibits anticompetitive business The Act prohibits anticompetitive business practices that promote inefficiency and practices that promote inefficiency and inequity in the marketplace, such as:inequity in the marketplace, such as: Price fixing - when business rivals enter

a collusive agreement to refrain from price competition; fix the price of a good or service. Hospitals in a given city cannot jointly

establish the price of various hospital services.

Boycott - agreement among competitors not to deal with a supplier or a customer. Physicians in an area can’t collectively

agree to deny services to a particular managed care organization.

Market allocation - when competitors agree to compete with one another in specific market area. Hospitals in the same city can’t collectively

set geographic service boundaries.

Price fixing, boycotting, and market allocations are illegal per se. The plaintiff must only prove these actions

took place for the defendant to be in violation of the Act.

In contrast, rule of reason doctrine is used to evaluate horizontal mergers under the Act. While horizontal mergers may force price

above the competitive level, they may also create benefits which could be passed on to the customer.

Potential benefits of mergersPotential benefits of mergers Economies of scale in production. Organizational economies.

– less administrative staff Better access to technological

innovations. The potential anti- and pro-competitive

effects must be weighed by the courts in determining the social desirability of a merger.

AntitrustAntitrust in the health care industry in the health care industry

Is the health care industry subject to as much anti-competitive behavior as other industries?

Will mergers in health care help/harm consumer welfare? Benefits of non-profit organizations Consolidation on the consumer side to

counteract consolidation on the provider side.

The Government’s ViewThe Government’s View Prior to the mid-1970s, antitrust was not

widely applied in the health care field, because members of the medical profession claimed they were exempt.

1975, Goldfarb v. Virginia State Bar (Supreme Court)

“The nature of an occupation, standing alone, does not provide sanctuary from the Sherman Act…nor is the public service aspect of professional practice controlling in determining whether section 1 includes professions.”

1982 - Arizona v. Maricopa Medical Society

Physicians formed a medical society which agreed on maximum reimbursement fees they could be paid by insurance companies that agree to send patients.

Plaintiff:“…periodic upward revisions of the maximum-fee

schedules have the effect of stabilizing and enhancing the level of actual charges by physicians.”

Defendant:“…the schedules impose a meaningful limit on

physicians’ charges…the advance agreement by doctors to accept the maxima enables the insurance carriers to calculate more efficiently the risks they underwrite and therefore serves as an effective cost-containment mechanism…”

Decision:“…The per se rule is violated here by a restraint

that tends to provide the same economic rewards to all practitioners regardless of their skill, experience, training, or willingness to employ innovative and difficult procedures in individual cases. Such a restraint may also discourage entry into the market and may deter experimentation and new developments by new entrepreneurs.”

Antitrust and Hospital MergersAntitrust and Hospital Mergers

Traditional Dept. of Justice Analysis Define the product, and challenge mergers

that lead to very high market concentration. 50% market share by the proposed

merged entity.

The DOJ tends to challenge mergers in rural areas and small cities.

1997: DOJ challenged merger of 2 teaching 1997: DOJ challenged merger of 2 teaching hospitals in metropolitan New York.hospitals in metropolitan New York.

Long Island Jewish, North Shore Manhasset.

New Argument: Unilateral Effects Analysis. A merger would give the hospitals the

ability to raise the price charged to managed care networks.

Managed care networks need a prestigious teaching hospital as an “anchor.”

Court’s Decision: The DOJ argument Court’s Decision: The DOJ argument was not credible.was not credible.

1) LI Jewish and N Shore had many competitors in the area. 85% of their care was primary or

secondary. Tertiary care was available in several

teaching hospitals nearby.

2) The market had several other buyers in addition to managed care. Fee-for-service patients. Self-pay patients. Physicians who control admissions. Medicare and Medicaid. Employers. Government payers.

3) Managed care executives gave conflicting testimony on the effects of the merger.

Is unilateral effects analysis flawed, or did the DOJ just “goof” in preparing their argument?

RedistributionRedistribution

The government often taxes one group and uses the revenues to subsidize another. Why?

Interdependent utility functions. Donors get utility from increasing the

welfare of recipients. Why is the government involved?

“free rider” problem.

Two notions of equity in redistribution Two notions of equity in redistribution programsprograms

Vertical equity “Unequals should be treated unequally.” People who earn more should pay higher

taxes. Horizontal equity

“Equals should be treated equally.” Two persons with the same income level

should pay the same in net taxes.

Vertical equity in practiceVertical equity in practice

How much more in taxes should higher income people pay?

Suppose high income households pay $4,000 in taxes on average, and low income households pay $2,000. Is this equitable?

If the high income household makes $100,000, they pay a 4% tax.

If the low income household makes $10,000, they pay a 20% tax.

The notion of equity in taxation depends not just on total tax revenues, but on income levels and tax rates as well.

In practice, vertical equity is achieved when the net tax system is sufficiently progressive. Taxes as a fraction of income rise with

income. Federal income tax system.

Other forms of redistributionOther forms of redistribution Proportional.

The fraction of income going to taxes is constant as income rises.

The Medicare tax is a fixed % of payroll income.

Regressive. The fraction of income going to taxes falls

as income rises. Sales tax

Implementing redistributionImplementing redistribution Supply-side subsidies

Government funding aimed at reducing the costs of producing a consumer good or service.

Subsidy to a public hospital. Tuition for nurses or doctors.

Potentially violates notion of vertical equity if all persons have equal access to the

subsidized product.

Demand-side subsidies - government funding for consumers.

In-kind: vouchers or reimbursements for specific services. Food stamps, Medicare, Medicaid

Cash: government-provided income that people can use at their own discretion. AFDC, Supplemental Security Income

Keep in mind: It is difficult to guarantee horizontal equity with multiple programs in operation.

Back to the StartBack to the Start

Does government intervention correct for market imperfections, or is it ruled by special interest groups?

A Final CaveatA Final Caveat Market failure is a necessary, but not

sufficient condition for government intervention.

It may cost the government $10m to correct a problem in the marketplace, which imposes $8m in damages.

While markets may fail and impose societal costs, the costs of government intervention may be greater.