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1) A person has end stage renal disease and has life of 3 years left with utility of 0

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A person has end stage renal disease and has life of 3 years left with utility of 0.8. Therapy A cost $100,000 during the first year but extends the life expectancy by 2 years with utility of 0.7 for the first year, but 0.9 for the other 4 years. Another therapy B costs $300,000 during the first year, but extends the life expectancy by 4 years with utility of 0.6 in the first year, but 0.9 in other 6 years. Don't consider discounting.

1. Find incremental cost-effectiveness ratio $/QALY of Therapy A vs baseline ? 2. Find incremental cost-effectiveness ratio of Therapy A vs Therapy B vs baseline. 3. If you are a doctor which treatment would you recommend ? Suppose you're an executive of HMO , what will you recommend ? Why ?

2)

• Some years ago a second children’s hospital opened in Virginia despite market analysts suggesting that the population of state only needs one children’s hospital .
  • If you were the Mayor (or Governor or Health Commissioner) trying to decide whether to support the opening of a second children’s hospital, what tools might you use to determine whether it was a good idea?
  • If you were going to conduct a cost-effectiveness or cost-benefit analysis of this decision, describe how you might attempt to do this. What costs would you include? What outcomes would you include?
  • Why would the health care system that opened the second children’s hospital choose to do so? Try to use predominantly economic arguments.
  • From the perspective of a purchaser of children’s hospital services (please consider both a patient’s perspective and an insurance company’s perspective), is it a good or bad thing to have a second children’s hospital? Please argue both sides and consider issues such as prices and quality.

The Economics of Health and Health Care 8th Edition Folland, Goodman, and Stano’s bestselling The Economics of Health and Health Care text offers the market-leading overview of all aspects of Health Economics, teaching through core economic themes, rather than concepts unique to the health care economy. The Eighth Edition of this key textbook has been revised and updated throughout, and re?ects changes since the implementation of the Affordable Care Act (ACA). In addition to its revised treatment of health insurance, the text also introduces the key literature on social capital as it applies to individual and public health, as well as looking at public health initiatives relating to population health and economic equity, and comparing numerous policies across Western countries, China, and the developing world. It provides up-to-date discussions on current issues, as well as a comprehensive bibliography with over 1,100 references. Extra material and teaching resources are now also available through the brand new companion website, which provides full sets of discussion questions, exercises, presentation slides, and a test bank. This book demonstrates the multiplicity of ways in which economists analyze the health care system, and is suitable for courses in Health Economics, Health Policy/ Systems, or Public Health, taken by health services students or practitioners. Sherman Folland is Professor of Economics (emeritus) at Oakland University in Rochester, Michigan, USA. He received his PhD from The University of Iowa in 1975 and has taught at Penn State University and Oakland University. He has written over 50 articles and edited several books. Allen C. Goodman is Professor of Economics at Wayne State University in Detroit, Michigan, USA. He received his PhD from Yale University and has taught at Lawrence University, The Johns Hopkins University, and Wayne State University. He has written over 100 articles and three books in health and housing economics. Miron Stano is Professor of Economics and Management at Oakland University in Rochester, Michigan, USA. He received his PhD from Cornell University in 1971 and has taught at Wayne State University and Oakland University. He has written over 70 articles and has also served as an expert witness in antitrust cases involving the health care professions. The Economics of Health and Health Care 8th Edition Sherman Folland, Allen C. Goodman, and Miron Stano Contents Preface Acknowledgments 1 23 27 Introduction 29 What Is Health Economics? Box 1.1 Technological Change and Health Care Costs— Why Rising Health Care Costs Affect All Nations The Relevance of Health Economics The Size and Scope of the Health Economy Health Care’s Share of GDP in the United States Health Care Spending in Other Countries Importance of the Health Economy in Personal Spending Importance of Labor and Capital in the Health Economy Time—The Ultimate Resource The Importance Attached to Economic Problems of Health Care Delivery In?ation Access Quality The Economic Side to Other Health Issues Economic Methods and Examples of Analysis Features of Economic Analysis Scarcity of Resources Rational Decision Making Marginal Analysis Use of Models Two Notable Contributors to Health Economics Does Economics Apply to Health and Health Care? An Example: Does Price Matter? Is Health Care Different? Presence and Extent of Uncertainty Prominence of Insurance Problems of Information 30 31 32 32 32 33 33 35 37 37 38 39 39 39 39 40 40 40 40 40 41 41 42 43 43 43 45 5 Contents 2 3 6 Large Role of Nonpro?t Firms Restrictions on Competition Role of Equity and Need Government Subsidies and Public Provision Conclusions Postscript Summary Discussion Questions Exercises 46 46 46 47 47 48 49 49 50 Microeconomic Tools for Health Economics 55 Scarcity and the Production Possibilities Frontier Box 2.1 There’s Scarcity and Then There’s Real Scarcity Practice with Supply and Demand The Demand Curve and Demand Shifters The Supply Curve and Supply Shifters Equilibrium Comparative Statics Functions and Curves Linear Functions Demand Functions Derived Demand Consumer Theory: Ideas behind the Demand Curve Utility Indifference Curves Budget Constraints Consumer Equilibrium Individual and Market Demands Elasticities Production and Market Supply The Production Function Production Functions Isocost Curves Cost Minimization or Output Maximization Marginal and Average Cost Curves The Firm Supply Curve under Perfect Competition Monopoly and Other Market Structures Box 2.2 Is Competition Better than Monopoly? Conclusions Summary Discussion Questions Exercises 56 58 60 60 61 62 62 63 63 64 65 65 66 67 68 68 70 71 73 73 74 77 77 78 79 82 84 85 85 86 86 Statistical Tools for Health Economics 89 Hypothesis Testing 90 Contents 4 Difference of Means The Variance of a Distribution Standard Error of the Mean Hypotheses and Inferences Box 3.1 Do Cell Phones Cause Cancer?—Positive Reports but Inconsistent Data Regression Analysis Ordinary Least Squares (OLS) Regressions A Simple Regression Estimating Elasticities Multiple Regression Analysis Interpreting Regression Coef?cients Box 3.2 Hormone Replacement Therapy—Rigorous Statistics Reveal Surprising Results Dummy Variables Statistical Inference in the Sciences and Social Sciences Conclusions Summary Discussion Questions Exercises 91 92 93 94 101 102 103 104 104 104 105 Economic Ef?ciency and Cost-Bene?t Analysis 109 Economic Ef?ciency Cost-Bene?t Analysis: Background Measuring Bene?ts and Costs Risk Equity versus Equality of Marginal Costs per Life Saved Box 4.1 When Is Preventative Medicine a Good Investment? Marginal Analysis in CBA Box 4.2 Cookstoves, Global Warming, Health in Developing Countries, and CBA Discounting Box 4.3 Discounting and Global Warming Risk Adjustment and CBA Distributional Adjustments In?ation Valuing Human Life Willingness to Pay and Willingness to Accept Contingent Valuation How Valuable Is the Last Year of Life? Cost-Bene?t Analyses of Heart Care Treatment Cost-Effectiveness Analysis Advantages of CEA Cost-Utility Analysis, QALYs, and DALYs 110 113 113 95 96 96 97 98 99 100 115 116 117 118 118 120 121 121 121 121 122 122 122 124 125 126 126 7 Contents 5 8 QALYs Revisited: Praise and Criticism Are QALYs Consistent with Standard Welfare Economics? Extra-Welfarism What People Think The Ageism Critique How Are QALYs Used for Evaluation Conclusions Summary Discussion Questions Exercises Appendix—Discounting 128 128 128 129 129 130 130 131 131 132 134 Production of Health 137 The Production Function of Health The Historical Role of Medicine and Health Care The Rising Population and the Role of Medicine What Caused the Mortality Rate Declines? Was It Medicine? Box 5.1 Tuberculosis and The Magic Mountain Box 5.2 The Importance of Clean Water What Lessons Are Learned from the Medical Historian? The Production Function of Health in the Modern Day Preliminary Issues The Contribution of Health Care to Population Health: The Modern Era Is Health Care Worth It? Box 5.3 Sulfa: A Drug That Really Made a Difference On the Effect of Social Health Insurance Prenatal Care The World’s Pharmacies Do Other Measures of Health Care Affect Health? On the Importance of Lifestyle and Environment Cigarettes, Exercise, and a Good Night’s Sleep The Family as Producer of Health Social Capital and Health Environmental Pollution Income and Health The Role of Schooling Two Theories about the Role of Schooling Empirical Studies on the Role of Schooling in Health Conclusions Summary Discussion Questions Exercises 138 140 140 142 143 146 146 147 147 148 149 149 150 151 153 153 153 154 155 155 156 156 156 157 157 158 158 159 159 Contents 6 7 The Production, Cost, and Technology of Health Care 161 Production and the Possibilities for Substitution Substitution What Degree of Substitution Is Possible? Elasticity of Substitution Box 6.1 Health Care Professionals: Expanding the Possibilities Estimates for Hospital Care Costs in Theory and Practice Deriving the Cost Function Cost Minimization Economies of Scale and Scope Why Would Economies of Scale and Scope Be Important? Empirical Cost-Function Studies Dif?culties Faced by All Hospital Cost Studies Modern Results Summary: Empirical Cost Studies and Economies of Scale Technical and Allocative Inef?ciency Technical Inef?ciency Allocative Inef?ciency Frontier Analysis The Uses of Hospital Ef?ciency Studies For-Pro?t versus Nonpro?t Hospitals Ef?ciency and Hospital Quality Are Hospital Frontier Ef?ciency Studies Reliable? Box 6.2 Should We Close Inef?cient Hospitals? Performance-Based Budgeting Technological Changes and Costs Technological Change: Cost Increasing or Decreasing? Health Care Price Increases When Technological Change Occurs Box 6.3 Aspirin, the Wonder Drug at a Bargain Diffusion of New Health Care Technologies Who Adopts and Why? Other Factors That May Affect Adoption Rates Diffusion of Technology and Managed Care Conclusions Summary Discussion Questions Exercises 162 162 164 164 165 166 167 167 168 169 169 171 171 173 173 173 173 174 175 177 178 178 178 179 179 179 180 180 181 183 183 183 184 185 185 186 186 Demand for Health Capital 189 The Demand for Health The Consumer as Health Producer 190 190 9 Contents 8 10 Time Spent Producing Health Box 7.1 Exercise Technology—FitBits or Smartphones? Labor–Leisure Trade-Offs Trading Leisure for Wages Preferences between Leisure and Income The Investment/Consumption Aspects of Health Production of Healthy Days Production of Health and Home Goods Investment over Time The Cost of Capital The Demand for Health Capital Marginal Ef?ciency of Investment and Rate of Return The Decreasing MEI Changes in Equilibrium: Age, Wage, and Education Age Wage Rate Education Empirical Analyses Using Grossman’s Model Box 7.2 Rational Addiction Obesity—The Deterioration of Health Capital An Economic Treatment of Obesity Economic Effects Why Has Obesity Increased? Conclusions Summary Discussion Questions Exercises 191 191 192 193 194 195 195 196 197 197 197 198 198 199 199 200 201 201 202 203 206 207 208 209 210 210 211 Demand and Supply of Health Insurance 213 What Is Insurance? Insurance versus Social Insurance Insurance Terminology Risk and Insurance Expected Value Marginal Utility of Wealth and Risk Aversion Purchasing Insurance The Demand for Insurance How Much Insurance? Changes in Premiums Changes in Expected Loss Changes in Wealth The Supply of Insurance Competition and Normal Pro?ts The Case of Moral Hazard 214 215 215 216 216 217 218 219 219 221 222 223 223 224 225 Contents Demand for Care and Moral Hazard Box 8.1 Another Type of Moral Hazard—Health Insurance and Insecticide-Treated Bed Nets in Ghana Effects of Coinsurance and Deductibles Health Insurance and the Ef?cient Allocation of Resources The Impact of Coinsurance Box 8.2 Got Insurance? You Still May Pay a Steep Price for Prescriptions The Demand for Insurance and the Price of Care The Welfare Loss of Excess Health Insurance Income Transfer Effects of Insurance Conclusions Summary Discussion Questions Exercises 9 226 228 228 229 229 231 233 233 236 239 239 240 240 Consumer Choice and Demand 243 Applying the Standard Budget Constraint Model Box 9.1 What Happens to Costs When Patients Participate in Medical Decision Making? The Consumer’s Equilibrium Demand Shifters Health Status and Demand Two Additional Demand Shifters—Time and Coinsurance The Role of Time The Role of Coinsurance Issues in Measuring Health Care Demand Individual and Market Demand Functions Measurement and De?nitions Differences in the Study Populations Data Sources Experimental and Nonexperimental Data Box 9.2 Oregon’s Health Insurance Experiment Empirical Measurements of Demand Elasticities Price Elasticities Individual Income Elasticities Income Elasticities across Countries Insurance Elasticities Impacts of Insurance on Aggregate Expenditures Other Variables Affecting Demand Ethnicity and Gender Box 9.3 Disparities in Health Care: A National Priority Urban versus Rural 245 245 246 247 249 250 250 252 254 255 255 255 256 256 256 257 257 259 259 260 262 262 262 263 264 11 Contents 10 11 12 Education Age, Health Status, and Uncertainty Conclusions Box 9.4 How Much Will That Hospitalization Cost Me? Summary Discussion Questions Exercises 264 264 265 266 266 267 268 Asymmetric Information and Agency 271 Overview of Information Issues Asymmetric Information On the Extent of Information Problems in the Health Sector Asymmetric Information in the Used-Car Market: The Lemons Principle Application of the Lemons Principle: Health Insurance Inef?ciencies of Adverse Selection The Affordable Care Act and Adverse Selection Experience Rating and Adverse Selection The Agency Relationship Agency and Health Care Box 10.1 What Happens When the Patient Is a Medical Expert? Consumer Information, Prices, and Quality Consumer Information and Prices Consumer Information and Quality Other Quality Indicators Box 10.2 Quality Rankings and Health Care Outcomes Conclusions Summary Discussion Questions Exercises 272 273 273 280 282 282 283 284 285 286 287 288 289 The Organization of Health Insurance Markets 291 Loading Costs and the Behavior of Insurance Firms Impacts of Loading Costs Insurance for Heart Attacks and Hangnails Loading Costs and the Uninsured Employer Provision of Health Insurance: Who Pays? Box 11.1 Employers Shift More Health Care Costs to Employees—How You Feel Depends on Where You Sit Spousal Coverage: Who Pays? How the Tax System In?uences Health Insurance Demand Who Pays the Compensating Differentials?—Empirical Tests Other Impacts of Employer Provision of Health Insurance 292 292 294 294 295 274 276 277 278 279 280 280 297 297 299 301 302 Contents 12 Box 11.2 For Many with Pre-Existing Conditions, Obamacare’s Flaws are Only a Small Price to Pay Employer-Based Health Insurance and Labor Supply Health Insurance and Retirement Health Insurance and Mobility The Market for Insurance The Market for Private Insurance Insurance Practices Health Insurance Markets Since the 1980s The Uninsured: An Analytical Framework Box 11.3 Counting the Uninsured Box 11.4 Why Being Insured Matters The Working Uninsured The Impacts of Mandated Coverage Impacts of the Affordable Care Act on the Uninsured Elements of the ACA Evidence on the Impact of the ACA on the Uninsured Conclusions Summary Discussion Questions Exercises 303 304 304 305 306 306 308 309 309 310 311 311 312 314 314 314 316 317 317 318 Managed Care 321 What Is the Organizational Structure? What Are the Economic Characteristics? The Emergence of Managed Care Plans Employer-Sponsored Managed Care Medicaid and Medicare Managed Care Plans Managed Care Contracts with Physicians Managed Care Contracts with Hospitals Development and Growth of Managed Care—Why Did It Take So Long? Federal Policy and the Growth of Managed Care The Economics of Managed Care Modeling Managed Care Modeling Individual HMOs How Much Care? What Types of Care? Framework for Prediction Where Managed Care Differs from FFS—Dumping, Creaming, and Skimping Equilibrium and Adverse Selection in a Market with HMOs How Does Managed Care Differ?—Empirical Results Methodological Issues—Selection Bias and Quality of Care 323 324 325 326 328 328 329 330 330 331 331 332 332 333 334 334 335 337 337 13 Contents 13 14 Comparative Utilization and Costs The RAND Study—A Randomized Experiment More Recent Evidence Box 12.1 What Do HMOs Actually Do? Growth in Spending Competitive Effects Theoretical Issues Managed Care Competition in Hospital Markets Managed Care Competition in Insurance Markets Managed Care and Technological Change The Managed Care Backlash Box 12.2 Pay-for-Performance Accountable Care Organizations (ACOs) Managed Care and the Affordable Care Act Conclusions Summary Discussion Questions Exercises 338 338 339 340 341 342 342 344 345 345 346 348 349 350 351 351 353 353 Nonpro?t Firms 357 An Introduction to Nonpro?ts Why Nonpro?ts Exist and Why They Are Prevalent in Health Care Nonpro?ts as Providers of Unmet Demands for Public Goods The Public Good–Private Good Aspect of Donations Relevance to Health Care Markets Nonpro?ts as a Response to Contract Failure Applications of Contract Failure to Health Care Financial Matters and the Nonpro?t Summary of the Reasons for the Prevalence of Nonpro?ts Models of Nonpro?t Hospital Behavior The Quality–Quantity Nonpro?t Theory The Pro?t-Deviating Nonpro?t Hospital The Hospital as a Physicians’ Cooperative Maximizing Net Revenue per Physician A Comparison of the Quantity–Quality and the Physicians’ Cooperative Theories Competition from Home Care and Outpatient Care The Evidence: Do Nonpro?t Hospitals Differ from For-Pro?t Hospitals? Summary of Models of Hospital Behavior What Causes Conversion of Nonpro?ts into For-Pro?ts? The Relative Ef?ciency of Nonpro?ts versus For-Pro?ts Are Nonpro?t Health Care Firms Less Technically or Allocatively Ef?cient?—Hospital and Nursing Home Studies 358 358 359 360 361 362 362 363 363 363 363 365 367 367 368 370 371 372 372 373 373 Contents 14 15 Box 13.1 Why Are Registered Nurses’ Wages Higher in Nonpro?t Nursing Homes? Conclusions Summary Discussion Questions Exercises 374 374 374 375 376 Hospitals and Long-Term Care 377 Background and Overview of Hospitals History Organization Regulation and Accreditation Hospital Utilization and Costs Competition and Costs Box 14.1 Game Theory and the Medical Arms Race (MAR) Closures, Mergers, and Restructuring Box 14.2 Hospitals and Airlines: What Are the Lessons? Quality of Care Nursing Homes Background and Costs Quality of Care Excess Demand Financing Long-Term Care Hospice, Home Health, and Informal Care Conclusions Summary Discussion Questions Exercises 378 379 380 381 381 383 383 387 388 389 390 390 391 392 394 395 396 397 398 398 The Physician’s Practice 401 Physician Agency and Supplier-Induced Demand (SID) Modeling Supplier-Induced Demand The Supply and Demand Model Do Physicians Respond to Pro?t Incentives? The Target Income Hypothesis Box 15.1 SID and Target Income: A Physician’s Perspective The McGuire and Pauly Model What Do the Data Say about Supplier-Induced Demand? Box 15.2 Supplier-Induced Pregnancies A Marketplace Approach Conclusion on SID Small Area Variations (SAV) Contributions to These Variations Education, Feedback, and Surveillance 402 402 403 403 405 405 406 409 409 410 411 411 412 413 15 Contents 16 16 The Demand Side The Supply Side Issues that Affect Both SID and SAV Malpractice Paying for Outcomes Box 15.3 Clinical Decision Making and Patient Preferences Conclusions Summary Discussion Questions Exercises 413 414 414 414 415 415 416 417 417 418 Health Care Labor Markets and Professional Training 419 The Demand for and Supply of Health Care Labor Production Functions and Isoquants Marginal Productivity of Labor Factor Substitution and Labor Demand The Supply of Labor Factor Productivity and Substitution among Factors Measurement of Physician Productivity The Ef?cient Utilization of Physician Assistants: Substitution among Inputs Health Care Labor Supply and the Meaning of Shortages Box 16.1 Recent Productivity Studies Availability of Physicians Economic De?nitions of Shortages of Health Professionals Box 16.2 Dealing with Shortages of Primary Care Physicians The Role of Monopsony Power: Shortages of Registered Nurses Medical Education Issues and the Question of Control Sources of Medical School Revenues Teaching Hospitals, Medical Schools, and Joint Production Foreign Medical School Graduates The Control of Medical Education Control over Entry Licensure and Monopoly Rents Licensure and Quality Other Physician Labor Issues Specialization Private Practice or Employed Physician Income by Gender—The Increasing Role of Women Box 16.3 The $16,819 Unexplained Gender Income Gap Conclusions Summary Discussion Questions Exercises 420 420 421 423 424 424 425 425 426 426 427 428 428 431 433 434 434 435 436 436 438 440 441 441 442 443 444 444 445 446 446 Contents 17 18 The Pharmaceutical Industry 449 Box 17.1 Patents and Media Attention Structure and Regulation Box 17.2 Martin Shkreli and Valeant Pharmaceuticals Competition Barriers to Entry Box 17.3 Direct-to-Consumer (DTC) Advertising Regulation The Production of Health and Substitutability Least-Cost Production Insurance and Substitutability Technological Change Drug Pricing and Pro?ts Monopoly Pricing Price Discrimination Monopsony Pricing and Price Controls Competition and Generic Entry Research and Development (R&D) and Innovation Investment Decisions R&D Spending Firm Size and Innovation Prices, Price Regulation, and Innovation Cost Containment Copayments Generic Substitutes Drug Formularies Reference Pricing New Drugs and Health Care Spending The ACA and the Pharmaceutical Industry Conclusions Summary Discussion Questions Exercises 450 452 452 453 454 455 456 457 459 459 461 462 462 463 464 465 465 466 467 468 468 469 469 471 471 472 472 473 474 474 475 475 Equity, Ef?ciency, and Need 479 Ef?ciency and Competitive Markets The Concept of Pareto Ef?ciency (Optimality) Trading along the Budget Line The Competitive Equilibrium The First Fundamental Theorem of Welfare Economics Redistribution of the Endowment Price Discrimination Trade-Offs between Equity and Ef?ciency Deviations from the Competitive Model in the Health Care Sector 480 481 482 482 483 484 485 485 486 17 Contents 19 18 The Assumptions under Perfect Competition Promoting Competition in the Health Care Sector The Theorem of the Second Best An Economic Ef?ciency Rationale for Social Health Insurance Need and Need-Based Distributions Health Care Needs and the Social Welfare Function Box 18.1 The Extra-Welfarist Critique Box 18.2 The “Fair Innings” Proposal Norman Daniels’s Concept of Health Care Need Economic Criticisms of Need-Based Distributions Horizontal Equity and Need Income Inequality Schooling and Income Inequality Theories of Social Justice Utilitarianism Rawls and Justice as Fairness Liberalism, Classical, and Modern Conclusions Summary Discussion Questions Exercises 486 487 487 488 490 491 493 495 495 496 497 499 500 501 501 502 503 504 505 505 506 Government Intervention in Health Care Markets 507 Economic Rationale for Government Intervention Monopoly Power Public Goods Externalities Other Rationales for Government Intervention Forms of Government Intervention Commodity Taxes and Subsidies Public Provision Box 19.1 Is There a Case for a Sugar-Sweetened Soda or “Junk Food” Tax? Transfer Programs Regulation Government Involvement in Health Care Markets Box 19.2 What Is HIPAA? Support of Hospitals Department of Veterans Affairs and Department of Defense Food and Drug Administration Mandated Health Insurance Bene?ts Tax Policy Public Health Other Government Programs Health Sector Regulation and the Prospective Payment System 508 508 510 512 512 513 513 515 515 517 517 518 518 519 519 520 520 520 521 521 522 Contents 20 21 Description of PPS The Theory of Yardstick Competition and DRGs Government Failure Who Does the Regulator Represent? Conclusions Summary Discussion Questions Exercises 524 526 529 529 531 532 532 533 Social Insurance 537 Social Insurance Policies and Social Programs Program Features Box 20.1 Increased Longevity Favors the Rich in Social Security Historical Roots of Social Insurance European Beginnings Early Experience in the United States The Establishment of Medicare and Medicaid The Affordable Care Act (ACA) of 2010 Medicare and Medicaid in the United States Medicare Part C—Medicare Managed Care Part D—Prescription Drug Insurance Medicaid Medicaid Eligibility Box 20.2 Oregon Medicaid’s Doctor-Assisted Suicide— 18 Years Later The Medicaid–Medicare Relationship Medicare and Medicaid: Con?icting Incentives for Long-Term Care Children’s Health Insurance Program—CHIP Public Insurance and Health The Effects of Medicare and Medicaid Costs and In?ation Health Status Medicare: Recent Changes and Future Prospects Conclusions Summary Discussion Questions Exercises 538 539 540 541 541 542 542 543 544 544 545 546 550 551 Comparative Health Care Systems 569 Contemporary Health Care Systems A Typology of Contemporary Health Care Systems The United Kingdom—The National Health Service The National Health Service 570 570 576 576 553 554 555 556 556 559 559 563 564 565 566 567 567 19 Contents 22 20 A Model of Rationed Health Care and Private Markets Box 21.1 “Jump the Queue for Cataract Operations by Paying Yourself” Box 21.2 How Your Health Visitor Can Help China—An Emerging System The Canadian Health Care System Background Physician Fees and Quantity Why Are Fees and Hospital Costs Lower in Canada? Administrative Costs A Comparison Different Systems: The Public’s Evaluation Box 21.3 “Someone Else Needed It Before I Did” Differences in Health Care Spending across Countries A Model of Health Expenditure Shares Conclusions Summary Discussion Questions Exercises 577 578 578 580 584 584 586 587 587 588 592 592 593 593 596 596 597 598 Health System Reform 601 Goals of Reform Basic Issues in Reform The Costs of Universal Coverage Ensuring Access to Care Employer versus Individual Mandates Separation of Health Insurance from Employment Single-Payer versus Multiple Insurers Quality of Care Box 22.1 Preventive Care and Cost-Effectiveness Analyses The Affordable Care Act (ACA) of 2010 The “Three-Legged Stool” The ACA—Basics Economic Analysis of the ACA Competitive Strategies in the Post-ACA Era Development of Alternative Delivery Systems Consumer-Directed Health Plans and Health Savings Accounts Other Market Reforms Graphical Representation of the Competitive Approach ACA Outcomes after Six Years Health Care Access Box 22.2 Has the ACA Improved Access to Care? Health Care Costs The ACA and Quality Employment Effects 602 603 604 605 606 607 607 608 609 610 610 611 612 614 615 616 617 617 618 618 620 621 622 623 Contents 23 24 Adverse Selection under the ACA Meeting Reform Goals Creating a Safety Net Cost Containment Quality, High-Value Care Choice for Patients and Providers Ease in Administration Conclusions Summary Discussion Questions Exercises 625 625 626 626 626 626 626 626 627 628 629 The Health Economics of Bads 633 An Introduction to Bads Box 23.1 Who Smokes and Who Drinks? Cultures and Behaviors Models of Addiction Imperfectly Rational Addiction Models Myopic Addiction Models Rational Addiction Rationales for Public Intervention Other Interventions Advertising Restrictions on Cigarettes and Alcohol Box 23.2 Can Advertising Lead Patients Astray? The Case of Medical Quackery The Possible Effects of Brand Switching Increased Demand or Brand Switching? Advertising and Alcohol Consumption Excise Taxes and Consumption of Cigarettes and Alcohol The Consumption-Reducing Effects of Excise Taxes in Theory Excise Taxes and Cigarette Consumption in Practice Box 23.3 Mind If I Smoke? Excise Taxes and Alcohol Consumption Conclusions Summary Discussion Questions Exercises 634 642 643 644 645 645 645 646 647 649 651 651 652 653 The Economics of Social Capital and Health 655 What Is Social Capital? How Do People Choose Social Capital? The Individual Case Community Social Capital How Could Increments to Social Capital Improve Health? Empirical Tests of Social Capital and Health 656 656 656 658 658 659 634 637 637 638 638 640 641 641 21 Contents Pursuing Causality Natural Experiments Testing the Social Capital Effect for Causality Elements of Trust The Geography of Trust and of Social Capital Social Capital and Risky Choices Social Capital and Smoking Conclusions Summary Discussion Questions Exercises Glossary References Author Index Subject Index 22 662 662 662 663 664 665 666 667 667 668 668 669 680 728 731 Preface This is the eighth edition of a book conceived in 1990 and first published in 1993. The world of health economics has changed since 1990. Our first (1993) edition made but a single reference to “managed care.” Until the seventh edition, we spoke of the United States as the only country without a universal health insurance plan. This, of course, changed with the passage of the Affordable Care Act (ACA) in March 2010. New to the Eighth Edition Five years have passed since our last edition, an eternity in the health care world. Outside of updated tables, and features, we highlight the following. O O O O O The Affordable Care Act (ACA) withstood two legal challenges and changed the landscape of health care. By 2016, 20 million more Americans now have health insurance because of the ACA, and over 80 percent with a plan have government subsidies. The Congressional Budget Office estimates that were the ACA repealed, 24 million would have no health insurance. Although the Trump administration has pledged to “repeal and replace” Obamacare, preliminary (2017) analyses suggest that change will occur along the margins of the Act rather than wholesale repeal. A new Chapter 24 on Social Capital replaces our previous chapter on Epidemiology and Economics. Social capital is an exciting new development in the conceptualization and modeling of health care, health services, and population health. We have streamlined our material on regulation by combining the previous Chapters 19 and 20 into a new Chapter 19 entitled Government Intervention in Health Care Markets Chapter 20 (Social Insurance) continues with the most up-to-date evaluations of the Medicare Advantage, and the Medicare Part D drug benefit. It also updates research and policy work on the inherent conflicting incentives between the Medicare and Medicaid programs that jointly lead to inefficiencies in the provision of health services for the elderly and the poor. Chapter 21 continues our path-breaking comparative analyses across countries. We introduce a new classification of health care systems, supplanting the Gordon typology that we have used for over 20 years. We review our discussion of the the Chinese health economy which has moved away from the command system of the 1950s through the 1970s, toward a more incentive-based system, with its conflicting impacts. Chapter 21 also provides updated survey information on comparative satisfaction across eleven countries, looking in particular at differences in access and in costs. 23 Preface From the beginning, we have sought to assist instructors in conveying a clear, stepby-step understanding of health economics to their students. We have also believed it important for instructors to demonstrate what health economics researchers are doing in theory and in empirical work. The book synthesizes contemporary developments around a set of economic principles including maximization of consumer utility and economic profit, and it makes these principles accessible to undergraduate as well as to graduate students. Rather than focusing on institutions specific to the health care economy, we continue to emphasize core economics themes as basic as supply and demand, as venerable as technology or labor issues, and as modern as the economics of information. We continue to improve accessibility to the book for the wide range of health services students and practitioners. Students must have a working knowledge of the analytical tools of economics and econometrics to appreciate the field of health economics. Some students may be ready to plunge directly into Chapter 5, “The Production of Health,” upon completion of the introductory Chapter 1. However, Chapters 2 through 4 help students and their instructors to develop or to review needed analytical concepts before tackling the core subject matter. In Chapter 2, students with as little as one semester of microeconomics may review and study how economists analyze problems, using relevant health economics examples. Chapter 3 provides a review of core statistical tools that characterize modern economic and health services analyses. Chapter 4 completes the core economic concepts by reviewing the concept of economic efficiency, and showing how cost-benefit, cost-effectiveness, and cost-utility analyses fit into the general economic framework. Consistent with an emphasis on clear exposition, the book makes extensive use of graphs, tables, and charts. As in all previous editions, we require no calculus. Discussion questions and exercises help students master the basics and prompt them to think about the issues. We also include up-to-date applications of theory and policy developments as features, and occasional tidbits containing purely background information. We caution that some chapters, such as those on insurance and on regulation, although developed without advanced mathematics, are logically complex and will require considerable effort. No painless way is available to appreciate the scope of the contributions that scholars have made in recent years. More advanced students of the health care economy who seek further challenges can utilize a comprehensive references section, with over 1,100 sources, to enrich their (and our) work through referral to the original sources. Additional Sources The Internet now contains tables and charts that were once available only in book form and then only after several years. We have chosen to focus on those sites that we believe to be both long lasting and reliable. O O O O O 24 Bureau of the Census, for health insurance (www.census.gov/newsroom/press-releases/ 2016/cb16-158.html) Centers for Disease Control and Prevention (www.cdc.gov) Centers for Medicare and Medicaid Services, for research, statistics, data, and systems (www.cms.hhs.gov/home/rsds.asp) Kaiser Family Foundation (www.kff.org), specializing in studies of health insurance National Institutes of Health (www.nih.gov) Preface Organization for Economic Cooperation and Development, for international data (www. oecd.org) O Social Security Administration, for research and analysis (www.ssa.gov/policy/research_ subject.html) O Health-related material is increasingly accessible both in print and on the Internet. University-affiliated professionals and their students will discover that their libraries have extensive electronic access to a wide range of journals. Most health economists browse Health Affairs, an up-to-date policy journal. Health Economics, Journal of Health Economics, and American Journal of Health Economics have emerged as the leading technical journals that specialize in health economics. Users can see, from our comprehensive reference section, many other specialized journals, including health services and medical journals not often referenced by economists. In the popular press, the New York Times and the Wall Street Journal also provide excellent health economics coverage. The Handbook of Health Economics, a two-volume set published in 2000, with an additional volume in 2011, emerged as an invaluable source for specific topics, with more detail and more mathematic rigor than any text, including this one. The Elgar Companion to Health Economics, published in 2006 and updated in 2012, provides both useful updates and important new topics. They are not texts, however. Our book, with its graphical analysis, discussion questions, and problem sets, provides a valuable complement to both Handbook and Companion offerings. Alternative Course Designs The economics of health and health care encompasses an evolving literature with no single “correct” order for the course design. U.S. economists typically organize topics through markets, and include the roles of government much later. International health economists, and population and public health students and scholars, often assign the governmental sector far more importance; it is “public” health, after all. No matter how we construct it, a text is necessarily linear in that one chapter must follow another. Our text offers instructors considerable flexibility. We view the 24 chapters as six parts: I. II. III. IV. V. VI. Basic Economics Tools (Chapters 1–4) Supply and Demand (Chapters 5–9) Information and Insurance Markets (Chapters 10–13) Key Players in the Health Care Sector (Chapters 14–17) Social Insurance (Chapters 18–22) Special Topics (Chapters 23–24) The categories are not exclusive. Chapter 8, looking at the demand and supply of insurance, is as important to Part III on insurance as it is to Part II on demand and supply of goods. From front to back, we follow an “economics” model in which we first examine consumers and firms in a world without government and governmental policies. As a result, explicit discussions of government policies do not come until Chapter 19, although we examine regulation, licensing, and mandates in reference to other topics much earlier. Many economics instructors may wish to follow the chapters in the book’s order. 25 Preface Instructors with population health, public health, or policy interests may wish to “tool up” on some of the earlier analyses and then skip directly to Part V, which examines social insurance, health care regulation, and health care reform. After that, they may wish to browse selected topics. Some analyses build on one another within chapters, but we seek to minimize cross-referencing among chapters. Instructor Resources The Economics of Health and Health Care is connected to the Companion Website available at www.routledge.com/cw/folland. As a registered faculty member, you can download resource files. The following supplements are available to adopting instructors: O O Instructors’ Answers, Teaching Tips, and Study Material. PowerPoint Slides. The Publisher would like to thank Laura Storino for providing the PowerPoint Slides. The International Handbook on Teaching and Learning Economics (2012) has a section by Allen Goodman on the teaching of health economics, along with over 70 chapters on general course content, specific fields, pedagogic techniques, and the scholarship of the teaching enterprise. 26 Acknowledgments This book emerges from years of classroom and professional interaction, and we thank those students and colleagues who have discussed the economics of health and health care with us and who have challenged our ideas. Annie Todd suggested the endeavor back in 1989 and introduced us to each other, and Tom McGuire convinced us that we could succeed. We have been blessed with outstanding editors—Jill Leckta, Leah Jewell, Rod Banister, Gladys Soto, Marie McHale, Michael Dittamo, Chris Rogers, Susie Abraham, and Lindsey Sloan. We are delighted to work with Emily Kindleysides on this edition. We have received outstanding composition support from our publishers, with John Travis, Maureen Wilson, Kelly Warsak, Melissa Feimer, Clara Bartunek, Kerri Tomasso, and Nancy Freihofer managing previous editions. Laura Johnson has been our most capable manager for this eighth edition. We extend our gratitude to instructors at hundreds of universities in the United States and around the world, who have helped us pass the market test by adopting the book. Numerous professional colleagues generously offered their time and energy to read and critique various chapters. We thank: Carson Bays, East Carolina University James Burgess, Boston University Frank Chaloupka, University of Illinois–Chicago Hope Corman, Rider College Merton Finkler, Lawrence University Colleen Flood, University of Toronto Howard Forman, Yale University Andrew D. Foster, Brown University Gary Fournier, Florida State University H. E. Frech, III, University of California–Santa Barbara Martin Gaynor, Carnegie Mellon University John Goddeeris, Michigan State University Warren Greenberg, late of George Washington University Michael Grossman, City University of New York Jack Hadley, Center for Health Policy Studies James Hamilton, Wayne State University Janet Hankin, Wayne State University Govind Hariharan, Kennesaw State University Ronald Horwitz, Oakland University Harold Hotelling, late of Lawrence Technological University 27 Acknowledgments Kathy A. Kelly, University of Texas at Arlington Paul Langley, University of Colorado William Low, University of Northern British Columbia Timothy McBride, Washington University Tom McCarthy, National Economic Research Associates Catherine McLaughlin, University of Michigan Eric Nauenberg, University of Toronto Eleanor Nishiura, Wayne State University John Nyman, University of Minnesota Albert A. Okunade, University of Memphis Martin Pernick, University of Michigan Uwe E. Reinhardt, Princeton University Joann Richards, Oakland University John Rizzo, Stony Brook University T. Paul Schultz, Yale University Ya-chen Tina Shih, MEDTAP International, Inc. Kosali Simon, Indiana University Robert J. Sokol, Wayne State University John M. Tilford, University of Arkansas Scott Vander Linde, Calvin College Rob Verner, Kent State University Jian Wang, Peking University Kenneth Warner, University of Michigan Gerard Wedig, University of Pennsylvania Burton Weisbrod, Northwestern University William White, Cornell University Barbara Wolfe, University of Wisconsin–Madison Michael Woolley, University of Southern California We also thank the following colleagues who, with their classes, test-taught and test-learned parts of the text: Randall Ellis, Boston University Gail Jensen, Wayne State University Thomas McGuire, Harvard University Lee R. Mobley, Georgia State University Kathleen Possai, Wayne State University Richard Scheffler, University of California–Berkeley Nancy Wolff, Rutgers University In the 27 years since we began this project, our wives have patiently supported our efforts and our young daughters have grown into talented young professional women. All have watched and helped their husbands and fathers learn about health economics. For these gifts we remain eternally grateful. S. F. Rochester, Michigan A. C. G. Detroit, Michigan M. S. Rochester, Michigan 28 Chapter 1 Introduction In this chapter O O O O O O O What Is Health Economics? The Relevance of Health Economics Economic Methods and Examples of Analysis Two Notable Contributors to Health Economics Does Economics Apply to Health and Health Care? Is Health Care Different? Conclusions 29 Introduction Health care accounts for over one-sixth of the U.S. economy! Yet millions in the United States have no health insurance. The Obama reform legislation, the Affordable Care Act or ACA, passed in 2010 and still in progress, is designed to address this problem. Health, health care costs, and health insurance have dominated the economic and political landscape in the United States and many other countries. Health economists study these issues carefully, and in general, health economics applies the principles of scientific empiricism to issues of health and health care. Because our health is of vital concern to us, and because the health care sector has become the largest sector of the U.S. economy, we should not be surprised that health economics has emerged as a distinct specialty within economics. The scope of health economics and the emphasis of this text can be previewed by examining the Table of Contents. The production of health and health care, demand and supply of specific health services are prominent. Private health insurance markets critically define the U.S. workplace, so we examine these markets. Government, through its social programs and power to regulate, receives close attention. We also concentrate on issues such as information, quality of care, and equity of access. Finally, we look to the health care systems of other countries for information on their practices and for potential insights on the policy issues that dominate the political landscape. In this first chapter, we provide further background on health economics and health economists. We follow with a broad overview of the magnitude and importance of the health care sector and with an introduction to some major policy concerns. As our final goal, we seek to promote the theme that economics helps explain how health care markets function. We focus on methods used in economic analyses and address two recurring questions: Is health care different, and does economics apply? Despite stressing the distinctive features of health care services and markets, we answer both in the affirmative. With appropriate modifications to conventional analytical tools, economics is relevant and useful. As we shall see throughout the book, although there is continuing controversy on many major issues, health economists have provided insight and solutions to most problems of academic and policy interest. What Is Health Economics? Health economics is defined by who health economists are, and what they do! Morrisey and Cawley (2008) examined the field of health economics in 2005 and found that almost all (96 percent) held academic doctorate degrees. Nearly three-quarters of those with doctorates received their degrees in economics. The majority worked in university settings; most others worked for nonprofit organizations or in government, mainly the federal government. Health economists held their appointments in economics departments, schools of public health, and in schools of medicine. Many of the leading economics departments—e.g., MIT, Princeton, Berkeley, Harvard—now feature prominent health economists. Health economists draw on various sub-disciplines of training within economics, including labor economics, industrial organization, public finance, cost-benefit analyses, and most generally, microeconomics. Throughout this book, we describe many specific research studies. Consider, at this time, that the United States devotes by far the largest share of GDP to health care spending (over one-sixth), and its per capita health care spending (over $9,500) greatly exceeds that of any other country. Most health economists agree that these spending patterns reflect the rapid rate of adoption of new technology in the United States. The United States does not have a very impressive record in terms of broad health outcomes indicators such as life expectancy 30 Introduction and infant mortality. Critics of the U.S. health care system often wonder what Americans are getting for their money. Policymakers and health economists seek to determine whether spending on new technology is worth it. Arguably, there is no more important issue. Consider, for example, a new surgical procedure for a patient with acute myocardial infarction (heart attack). It is not enough to estimate the immediate cost impact of the new procedure and the expected benefit to the patient in terms of short-term survival. By impacting the patient’s health for many years, the new treatment will affect spending well into the future. David Cutler (2007) develops a framework to address these complex interrelationships in “The Lifetime Costs and Benefits of Medical Technology.” He analyzes revascularization, a set of surgical procedures such as coronary bypass and angioplasty that restore blood flow. He looks at a group of Medicare patients who have had heart attacks and he tracks them for up to 17 years. Chapter 4 devotes considerable attention to Cutler’s work, but here we highlight his conclusion that revascularization costs $33,000 for an extra year of life. Is this worth it? Most would agree that it is! Health care costs in general, and technology-related costs in particular, are relevant to all countries (Box 1.1 provides an international perspective). Health economics is still a relatively new discipline with an evolving scope and pedagogy, and neither it, nor we, will provide answers to all the health system questions that nations face. Despite this caveat, we cannot think of any field of study that is more relevant to unraveling the meaning of today’s headlines, or more pertinent to the lives of individuals. BOX 1.1 Technological Change and Health Care Costs—Why Rising Health Care Costs Affect All Nations In a March 2005 speech to the National Association of Business Economics, thenChair of the Council of Economic Advisers Harvey Rosen noted that over the last several decades, the health care quality—diagnostic techniques, surgical procedures, and therapies for a wide range of medical problems—has improved. Treatment of a heart attack today is simply not the same “commodity” as treatment of a heart attack in 1970. Although innovations like coronary bypass surgery and cardiac catheterization have raised expenditures per heart patient, they have actually reduced the prices of obtaining various health outcomes, such as surviving hospitalization due to a heart attack. Some improvements in medical technique were quite inexpensive. Prescribing aspirin for heart attack victims leads to a substantial improvement in their survival probabilities, but new medical technologies were often costly. For example, it cost about $2 million to acquire a PET (positron emission tomography) machine, which can detect changes in cells before they form a tumor large enough to be spotted by X-rays or MRI. Such costly improvements lead medical expenditures to grow. This technology-based theory also helps explain why countries as different as the United States, the United Kingdom, or Japan have all experienced increases in health care expenditures. Rosen argued that these societies have at least one thing in common—they all have access to the same expensive innovations in technology. The technology-based explanation puts any debate over cost containment in a new 31 Introduction light. Is it a bad thing if costs are rising mostly because of quality improvements? A key question in this context is whether people value these innovations at their incremental social cost. No one knows for sure, but economist Dana Goldman reiterates a provocative insight: “If you had the choice between buying 1960s medicine at 1960s prices or today’s medicine at today’s prices, which would you prefer?” A vote for today’s medicine is validation of the improvement and willingness to pay for improved quality! Source: Dana P. Goldman, “Pressure from Rising Health-Care Costs: How Can Consumers Get Relief?” www.rand.org/commentary/ 102305PE.html, accessed November 2016. The Relevance of Health Economics The study of health economics is important and interesting in three related ways: (1) the size of the contribution of the health sector to the overall economy, (2) the national policy concerns resulting from the importance many people attach to the economic problems they face in pursuing and maintaining their health, and (3) the many health issues that have a substantial economic element. The Size and Scope of the Health Economy The health economy merits attention for its sheer size, constituting a large share of GDP in the United States, as well as in other countries. It also represents a substantial capital investment and a large and growing share of the labor force. Health Care’s Share of GDP in the United States By the second decade of the twenty-first century, more than $1 out of every $6 spent on final goods and services in the U.S. economy went to the health sector. As recently as 1980, the share of GDP (the market value of final goods and services produced within the borders of a country in a year) devoted to health care was $1 in $11, and in 1960 it was just $1 in $20. Figure 1.1 tracks the health economy’s share of GDP from 1970 to 2024. The conclusion? The health care sector is a large and growing portion of our economy. In calculating the share of GDP spent on health care, we net out the effects of general inflation. Therefore, only three major possibilities exist to explain the substantially increased ratios shown in Figure 1.1: 1 People may be buying more health services. Patients may be consulting with health care providers more frequently, doctors may be ordering more tests, or they may be prescribing more drugs. 2 People may be buying higher-quality health services, including products and services that previously were not available. Laser surgery, organ transplants, measles vaccines, and new treatments for burn victims, unavailable in 1960, have raised the quality of care. Economic theory suggests that people are willing to pay more for better quality. 3 Health care inflation may be higher than the general inflation rate. Higher incomes and the increased prevalence of insurance, including large government programs such as Medicare and Medicaid, may have led to increased health care prices over time. 32 Introduction 25.0 Percent of GDP 20.0 15.0 10.0 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 5.0 Figure 1.1 U.S. Health Expenditure Shares, 1960–2024 Sources: Centers for Medicare and Medicaid Services: www.cms.gov/National HealthExpendData, accessed November 15, 2016; Proquest Statistical Abstract of the United States, 2016; NHE ?gures from 2016 and later are projected numbers. We seek to understand these phenomena and their contributions to total spending. The study of demand, insurance, production, technology, and labor supply, among other topics, will help meet this challenge. Health Care Spending in Other Countries Examining the health economies of other countries enhances our understanding of the U.S. health economy. Many countries have large health care sectors and face the same major issues. Table 1.1 shows how health care spending as a share of GDP grew rapidly in most countries between 1960 and 1980. A more mixed picture emerges after 1980. The health care share in the United States continued to grow in each period after 1980 shown in Table 1.1, but growth was more modest in most other countries. The data also indicate the relative size of the U.S. health economy compared to that of other countries. For example, health care’s share of GDP in the United States is nearly twice as large as the share in the United Kingdom—a country with national health insurance. Is care costlier in the United States? Is it higher quality care, or are we simply consuming more? Importance of the Health Economy in Personal Spending Because it accounts for such a large share of the domestic product, the size of the health economy is also reflected through other key indicators. Two of these are especially easy to 33 Introduction Table 1.1 Health Expenditures as Percent of GDP in Selected OECD Countries Country 1960 1970 Australia 1980 1990 2000 2010 2015 6.3 6.9 7.6 8.5 9.3 10.1 10.3 Austria 4.3 5.2 7.5 8.4 9.2 Belgium 3.9 6.3 7.2 8.6 7.9 9.9 10.4 Canada 5.4 6.9 7.0 8.9 8.3 10.7 10.2 Czech Republic Denmark 4.7 5.7 6.9 7.6 8.9 8.3 8.1 10.4 10.6 Finland 3.8 5.5 6.3 7.7 6.9 8.9 9.6 France 3.8 5.4 7.0 8.4 9.5 10.7 11.0 Germany 6.0 8.4 8.3 9.8 11.0 11.1 Greece 5.4 5.9 6.6 7.2 9.9 8.2 6.8 7.6 7.0 Hungary Iceland 3.0 4.7 6.3 7.8 9.0 8.8 8.8 Ireland 3.7 5.1 8.3 6.1 5.9 10.6 9.4 7.7 7.6 9.0 9.1 3.0 4.6 6.5 6.0 7.4 9.5 11.2 3.4 4.0 4.0 6.4 7.2 3.1 5.2 5.4 5.9 7.1 7.2 Italy Japan Korea Luxembourg Mexico 4.8 4.9 6.2 5.9 7.4 8.0 7.1 10.4 10.8 5.2 5.9 6.9 7.5 9.7 9.4 4.4 7.0 7.6 7.7 8.9 9.9 4.8 5.3 6.4 6.3 5.9 8.4 9.8 8.9 5.3 7.8 7.0 Netherlands New Zealand Norway 2.9 Poland Portugal 2.5 5.3 Slovak Republic Spain 1.5 3.5 5.3 6.5 6.8 9.0 9.0 6.8 8.9 8.2 7.4 8.5 11.1 4.9 5.4 7.3 8.2 9.3 10.5 11.5 3.3 3.6 4.7 5.3 5.2 United Kingdom 3.9 4.5 5.6 6.0 6.3 8.5 9.8 United States 5.1 7.0 8.7 11.9 12.5 16.4 16.9 Sweden Switzerland Turkey Note: OECD data for the United States may differ slightly from values reported by the Centers for Medicare and Medicaid Services. Source: Organization for Economic Cooperation and Development (OECD) Health Care Data, extracted June 2016. 34 Introduction relate to at the personal level: (1) share of income spent on medical care and (2) number of jobs in the health economy. Table 1.2 provides data on how U.S. consumers spend their disposable incomes. It shows that in 2015, consumers spent 18.3 percent of their budgets on health care, as opposed to 7.3 percent on food, and 15.6 percent on housing. These figures represent a major shift in spending patterns. As recently as 1960, food represented about 25 percent of spending, and medical care only 5 percent. Importance of Labor and Capital in the Health Economy Table 1.3 provides information on specific health care occupations and their growth since 1970. In 2013, there were over 1,045,910 physicians and almost 287,420 pharmacists. The Table 1.2 Total Consumption Expenditures (in $ Billions) by Type, 2015 2015 % of Total 12,283.7 100.0% Durable goods 1,355.2 11.0% Nondurable goods 2,656.9 21.6% Food and beverages 900.7 7.3% Clothing and footwear 379.5 3.1% Gasoline and other energy goods 303.7 2.5% Total personal consumption expenditures Other nondurable goods Services Housing 1,073.0 8.7% 8,271.6 67.3% 1,919.9 15.6% Household utilities 313.3 2.6% Transportation services 368.4 3.0% Recreation services 466.3 3.8% Food services and accommodations 808.8 6.6% Other services 2,147.2 17.5% Health care 2,247.7 18.3% Physicians 484.5 3.9% Dentists 117.8 1.0% Paramedical services Hospitals and nursing homes Health insurance 328.5 2.7% 1,138.2 9.3% 178.7 1.5% Source: U.S. Department of Commerce, Bureau of Economic Analysis, Table 2.4.5: Personal Consumption Expenditures by Type of Product [Billions of Dollars], last revised on August 3, 2016, accessed August 2016. www. bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&903=70. 35 36 203,302,031 226,542,199 142,780 (63) 1,272,900 (562) — 467,679 (206) 1980 Total Source: U.S. Department of Health and Human Services, Health United States, Various Years. 112,750 (55) U.S. Population 750,000 (369) Pharmacists Registered Nurses Vocational Nurses — 334,028 (164) Physicians Licensed Practical and Licensed 1970 Total Occupation 248,709,873 161,900 (65) 1,789,600 (720) — 615,421 (247) 1990 Total 281,421,906 212,660 (76) 2,189,670 (778) 679,470 (241) 813,770 (289) 2000 Total Table 1.3 Active Health Personnel and Number per 100,000 Population (in Parentheses) 316,799,000 287,420 (91) 2,661,890 (841) 705,200 (223) 1,045,910(330) 2013 Total Introduction nursing sector alone consisted of over 3 million people with over three-quarters of them trained as registered nurses. The considerable growth in health care personnel is evident. In 1970, there were 334,000 physicians, or 164 physicians per 100,000 people. By 2013, the number of physicians had increased by 171 percent to 1,045,910 or 330 per 100,000 population. The number of registered nurses had more than tripled by 2013, with their number per 100,000 population more than doubling from 369 to 841. Reflecting the increases in spending, the health care sector serves increasingly as a source of employment. Thus, cutbacks in spending on health care, if proposed and implemented, would typically mean cutbacks in employment opportunities. In addition to labor, a substantial amount of capital has been drawn to the U.S. health care system. The number of nursing home beds increased from about 1.3 million in 1976 to about 1.7 million in 2013. The number of short-term hospital beds (as distinguished from nursing homes) peaked in the late 1970s, at almost 1.5 million, but the total number has since leveled at approximately 915,000 by 2013. There are also considerable and growing amounts of other capital—such as diagnostic equipment—per bed. Time—The Ultimate Resource Data on health care expenses and labor and capital inputs reflect only some of the items used by people to produce health. Inputs that are not bought and sold in the marketplace are also important. These include people’s own contributions of time and effort in producing health care and entail real costs to society. For example, when people use their own time to produce better health for themselves, or for loved ones as caregivers, the cost to the individuals and society is the value of the leisure that they forego. Adults who are taking care of their elderly parents for two hours per day, seven days per week, provide care that might otherwise have to be purchased in the market for $15 per hour or more. In this simple illustration, the caregivers provide care worth over $10,500 per year. Though such examples are not necessarily the population norm, these time costs must be added to our measured health care costs. We have stressed inputs, but the contribution of health resources to the economy is ultimately a measure of the value of the output—health itself. We measure the values of improvements to our health in both consumption and production. We value health both for its own sake and for its contribution to the production of other goods. The intrinsic value of being healthy is ultimately the value we attach to life and limb, which people commonly describe as infinite in certain circumstances, and at least substantial in others. The value of health in the production of other goods is exemplified not just in reduced absenteeism rates but also in output per worker on the job. In both its consumption and production aspects, the output of the health sector makes a substantial contribution to the economy. The Importance Attached to Economic Problems of Health Care Delivery The health sector receives attention from policymakers because of its widely perceived problems. The substantial resources devoted to health care are reflected in a more meaningful way through the average level of the nation’s spending for health care. Table 1.4 provides various measures of health care spending and its growth since 1960. 37 Introduction Table 1.4 National Health Expenditures and Other Data for Selected Years Year NHE % Growth GDP NHE per NHE % CPI Hospital + Physician Related Services Previous Services Price Year Price Index Index ($billion) in NHE over ($billion) Capita GDP 1960 27.2 543 146 5.0 29.6 21.9 1970 74.6 13.2% 1,076 355 6.9 38.8 34.5 1980 255.3 15.3% 2,863 1,108 8.9 82.4 1990 69.2 76.5 721.4 11.9% 5,980 2,843 12.1 130.7 178.0 160.8 2000 1,369.7 7.2% 10,285 4,857 13.3 172.2 317.3 244.7 2005 2,024.5 6.7% 13,094 6,856 15.5 195.3 439.9 287.5 2010 2,595.7 4.0% 14,964 8,402 17.3 218.1 621.2 334.1 2011 2,696.6 3.9% 15,518 8,666 17.4 224.9 653.8 343.0 2012 2,799.0 3.8% 16,155 8,927 17.3 229.6 684.0 349.9 2013 2,879.9 2.9% 16,663 9,115 17.3 233.0 701.9 356.5 2014 3,031.3 5.3% 17,393 9,523 17.4 236.7 743.2 361.7 Sources: NHE and GDP data: Centers for Medicare and Medicaid Services, NHE Summary Including Share of GDP, CY 1960–2014, www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpend Data/NationalHealthAccountsHistorical.html, accessed August 2016. CPI (1960–2014) and price indices (2010–2014): Bureau of Labor Statistics, CPI Detailed Report—June 2016, Tables 24 and 25, www.bls.gov/cpi/cpid1606.pdf, accessed August 2016. Price indices (1960–2005): U.S. Department of Commerce, Statistical Abstract of the United States, 2012, Table 142— Consumer Price Indexes of Medical Care Prices 1980 to 2010, www2.census.gov/library/publications/2011/compendia/ statab/131ed/2012-statab.pdf, accessed August 2016. Table 1.4 shows how national health expenditures (NHE) grew from $27 billion in 1960 to $3,031 billion in 2014. From 1960, the U.S. population grew from 186 million to 318 million by 2014. Thus, NHE per capita rose from $146 in 1960 to $9,523 in 2014. However, the real increase is what matters most. Prices, as measured by the broad-based consumer price index (CPI), rose by 700 percent over the same period. After deflating by the CPI, we find that real expenditures per capita in 2014 were 8.16 times the 1960 level—still a hefty increase.1 In?ation Although we have deflated the spending values using the CPI, medical care prices have grown faster historically than prices overall. Table 1.4 also shows the pattern of health care inflation since 1960. Note that hospital and physician care prices have risen much faster than the CPI—a phenomenon that is typical of other health care services and commodities as well. Medical price inflation is a common problem for maintaining health programs, and it has spurred numerous cost-containment efforts by the government. Understanding and evaluating the effects of such measures are important tasks for the health economist. 38 Introduction Access For many, the rising costs significantly reduce accessibility to health care. Financial affordability influences demand for most goods and services, and there are many reasons why some people do not have health insurance. What is clear is that the number of uninsured has fallen in response to the Affordable Care Act of 2010. From 2010 to 2016, the uninsured number fell by 20 million people in the United States. The ACA is a form of national health insurance. Later in this book, we will examine several broad groups of plans, the national health insurance programs that exist in other countries, and the newly established ACA. Quality Increases in the quality of care contribute to spending increases. Often, the focus is on ensuring quality through professional licensure and certification and, especially for hospitals, through quality-assurance programs. At the same time, concerns arise about access to high-quality care, and they are not limited to those without insurance or with minimal insurance. Other observers, however, express concerns that the quality of care in the United States is often excessive, especially for some “high-tech” treatments. For such treatments, the resource costs may exceed the benefits to patients. The interplay among insurance, technology, and consumption is of major interest to economists. The Economic Side to Other Health Issues Production, costs, and insurance naturally involve economics, but many other health issues have economic components, even though they may seem to be purely medical concerns. A few examples illustrate this point. The choice of a health care treatment seems purely medical to many people, but physicians and other providers increasingly believe in evaluating and comparing alternative treatments on economic grounds. It is necessary to examine the costs of alternative techniques. Physicians are also increasingly sensitive to the economic side of the patient–physician relationship. The patient’s preferences are considered valid in determining the appropriateness of a given treatment. We also must explore the economic reasons behind people’s health choices. People take care of themselves well at some times and poorly at other times. People’s desired health status can be understood as a meaningful economic choice. Even addiction to a relatively benign substance such as caffeine or a harmful substance such as methamphetamine can be understood better when analyzed as a possibly rational economic choice. Other health issues clearly have an economic aspect: What role should the government play in health? What health care investments should a developing country make? Should cigarette advertising be banned? Questions like these are not solely economic, but they have an economic side. Economic Methods and Examples of Analysis We have already provided a formal definition of health economics as “the study of the allocation of resources to and within the health economy.” From another perspective, however, health economics is what economists actually do and how they apply economics to health. Economists in practice use certain characteristic approaches to their analyses of the world. 39 Introduction Features of Economic Analysis Many distinctive features of economics might be exhaustively identified, but we emphasize four: 1 2 3 4 Scarcity of societal resources. Assumption of rational decision making. Concept of marginal analysis. Use of economic models. Scarcity of Resources Economic analysis is based on the premise that individuals must give up some of one resource in order to get some of another. At the national level, this means that increasing shares of GDP going to health care ultimately imply decreasing shares available for other uses. The “opportunity cost” of (what we give up to get) health care may be substantial. While most people will recognize the money costs of goods and services, economists view time as the ultimate scarce resource. Individuals sell their time for wages, and many individuals will refuse overtime work even if offered more than their normal wage rate—because “it’s not worth it.” Similarly, many will pass up “free” health care because the travel and waiting time costs are too high. Rational Decision Making Economists typically approach problems of human economic behavior by assuming that the decision maker is a rational being. We define rationality as “making choices that best further one’s own ends given one’s resource constraints.” Some behaviors may appear irrational. However, when disputes over rationality arise, economists often attempt to point out, perhaps with some delight, that so-called irrational behavior often makes sense when the incentives facing the decision maker are properly understood. Marginal Analysis Mainstream economic analyses feature reasoning at the margin. To make an appropriate choice, decision makers must understand the cost as well as the benefit of the next, or marginal, unit. Marginal analysis often entails the mental experiment of trading off the incremental costs against the incremental benefits at the margin. A prime example involves the purchase of brand-name drugs. Patients’ decisions to buy brand-name drugs, particularly for elective treatments, may depend critically on whether they must pay $2 or $3 per pill, or, instead, a fraction of those amounts if prescription drug insurance is available. Use of Models Finally, economics characteristically develops models to depict its subject matter. The models may be described in words, graphs, or mathematics. This text features words and graphs. Any model can be pushed too far and must be tested against a sense of reality and ultimately against the facts. Nonetheless, they can be apt, and we can learn from them. Economic models are often abstract. Abstract models help to make sense of the world, in economics as in everyday life. A young child asking what the solar system is like will 40 Introduction undoubtedly be shown the familiar drawing of the Sun and planets in their orbits—an abstract model. The drawing is quickly grasped, yet no one supposes that the sky really looks like this. Two Notable Contributors to Health Economics If health care markets were very similar to other markets there would be no need for a field called health economics. What made this field arise and grow? The defining and distinctive characteristics of the health economy were seen in a seminal work by Kenneth Arrow published in 1963. His exceptional ability in mathematical economics earned him the Nobel Prize in 1972, but his clear thinking about health care markets provided a starting point for health economics. His paper, “Uncertainty and the Welfare Economics of Medical Care,” examined how the health care markets differed. In many endeavors we face win/loss gambles where risks are identified with known probabilities. Arrow pointed out that health outcomes are difficult to predict and may even be difficult to attribute to past behaviors and care. These facts make it complicated to develop markets for risk sharing, and needed insurance markets may fail to develop. To overcome this, partly, health care markets may rely on institutional norms and other institutions such as licensure. The superior knowledge of the physician is relied on as a matter of trust. We must also trust the physician not to base his medical decisions on his own options for profit. The societal norm developed that physicians must remain above such base concerns. We may say today “So what?” we know all this stuff don’t we? Yes, Arrow’s insights permeate the thinking of every health economist. But these and his related insights are true, and they make it impossible to see health care markets as just the same as markets for things like “widgets” or ketchup. In consequence this new field has grown and matured. Amy Finkelstein at MIT has become a preeminent student of health insurance markets, especially Medicare and Medicaid (but also long-term care insurance). Her work created novel theories of choice under risk, but she also conducted large-scale empirical work that fits her theories exceptionally well. An indication of its importance and respect within the wider economics profession is that Finkelstein was awarded the J.B. Clark medal in 2012 for the outstanding economist under the age of 40. Her work has appeared frequently in the best economic journals. She addresses the effect of government insurance programs. In recent years she has joined with several others to investigate a rich natural experiment in which the State of Oregon gave Medicaid to new recipients on a randomized basis, ideal for scientific research (Finkelstein et al. (2012), Baiker et al. (2013), Taubman et al. (2014)). These data are “rich” because Oregon gave Medicaid access to new recipients on a randomized basis, ideal for scientific research. In short, Medicaid helps recipients to avoid financial disaster. There was also a decline in depression scoring and greater diagnoses of diabetes. More results will become clear as the progress on the study continues. Does Economics Apply to Health and Health Care? Many observers complain that economics is irrelevant to the study of health. This issue is raised often enough in serious contexts to require consideration. The complaint suggests a model of health care in which health is primarily a technical issue of medical science, better left to experts. One gets sick and one sees a doctor, who provides the medically appropriate treatment. 41 Introduction If economics studies how scarce resources are used to produce goods and services and then how these goods and services are distributed, then clearly economics applies. Certainly health care resources are scarce; in fact, their cost concerns most people. There is no question that health care is produced and distributed. Nevertheless, one can question whether the characteristic approaches of economics apply to health care. Are health care consumers rational? Do they calculate optimally at the margin? Imagine a loved one suffering cardiac arrest. Is there time or reasoning power left to calculate? Would anyone question the price of emergency services under such circumstances? However, much of health care simply does not fit this emergency image. A considerable amount of health care is elective, meaning that patients have and will perceive some choice over whether and when to have the diagnostics or treatment involved. Much health care is even routine, involving problems such as upper respiratory infections, back pain, and diagnostic checkups. The patient often has prior experience with these concerns. Furthermore, even in a real emergency, consumers have agents to make or help make decisions on their behalf. Traditionally physicians have served as agents and more recently, care managers have also entered the process. Thus, rational choices can be made. An Example: Does Price Matter? Does price matter? Many have argued that health care is so different from other goods that consumers do not respond to financial incentives. These views have been justified by arguments that demand is based on need, or arguments that patients leave decisions entirely to their providers, who are concerned with their own interests rather than how much patients have to pay. Data from the RAND Health Insurance Experiment, a pioneering project of the 1970s that examined consumer choices and health outcomes resulting from alternative insurance Coinsurance rate .95 Medical care Mental health care .75 .50 .25 0 25 50 75 100 Expenditures as a percent of use in free care Figure 1.2 Demand Response of Ambulatory Mental and Medical Care in the RAND Health Insurance Experiment Sources: Keeler, Manning and Wells (1988) for mental health care; Keeler and Rolph (1988) for medical care. 42 Introduction arrangements, give an unequivocal answer to this question: Yes, economic incentives matter. Figure 1.2 examines the use of ambulatory mental health and medical care where amounts of health care consumed are measured along the horizontal axis. These amounts are scaled in percentage terms from zero to 100 percent, where 100 percent reflects the average level of care consumed by the group that used the most care on average. This group, not surprisingly, is the group with “free” care. The vertical axis measures the economic incentives as indicated by the coinsurance rate—the percentage of the bill paid out directly by the consumer. Thus, a higher coinsurance rate reflects a higher price to the consumer. The curve shown in Figure 1.2 is similar to an economist’s demand curve in that it shows people consuming more care as the care becomes less costly in terms of dollars paid out-ofpocket. More importantly, the curve demonstrates that economic incentives do matter. Those facing higher prices demand less care. Is Health Care Different? Although economics certainly applies to health care, it is more challenging to answer the question of how directly and simply it applies. Is economic theory so easily applicable that a special field of health economics is not even necessary? Is health care so special as to be unique? Or is the truth somewhere in between? We argue that health care has many distinctive features, but that it is not unique in any of them. What is unique, perhaps, is the combination of features and even the sheer number of them. We review these distinctive features to alert students as to those salient features of health care that require special attention. In each case where health is distinctive in economic terms, a body of economic theory and empirical work illuminates the issue. Presence and Extent of Uncertainty When Arrow directed his attention to the economics of health, he helped establish health economics as a field. He stressed the prevalence of uncertainty in health care, on both the demand side and the supply side. Consumers are uncertain of their health status and need for health care in any coming period. This means that the demand for health care is irregular in nature from the individual’s perspective; likewise, the demand facing a health care firm is irregular. Uncertainty is also prevalent on the supply side. Standard economic analysis often assumes that products, and the pleasures that they bring, are well understood by the purchasers. The purchase of steak, milk, new clothes, or a ticket to a basketball game provides expected well-being that is easily known and understood. In contrast, several cases of product uncertainty exist in the health field. Consumers often do not know the expected outcomes of various treatments without physicians’ advice, and in many cases physicians themselves cannot predict the outcomes of treatments with certainty. Prominence of Insurance Consumers purchase insurance to guard against this uncertainty and risk. Because we have health insurance, neither most Americans nor citizens of other countries pay directly for the full costs of their health care. Rather, the costs are paid indirectly through coinsurance and through insurance premiums that are often, although not always, purchased through participation in the labor force. 43 44 2,194.1 2,280.4 2,371.8 2,441.3 2,563.6 2010 2011 2012 2013 2014 2,000.3 1,893.7 1,841.6 1,772.1 1,700.5 844.2 402.9 132.1 868.8 834.6 822.0 790.6 754.8 406.1 204.8 61.5 14.1 5.0 Insurance Private Health Health Insurance 580.7 551.2 534.8 513.4 489.8 216.3 107.3 36.3 7.3 Medicare 444.9 407.7 387.8 373.6 365.7 186.9 69.7 24.7 5.0 Medicaid 105.9 100.2 97.1 94.6 90.2 34.9 21.2 9.6 3.3 Insurance Programs Other Health 233.5 222.1 211.5 198.6 194.1 118.9 74.5 26.7 8.5 5.5 Party Payers Other Third- 329.8 325.5 318.7 309.7 299.5 199.0 137.9 58.1 25.0 12.9 Pocket Out-of- 12.9 13.3 13.4 13.6 13.6 17.1 22.4 26.8 39.6 55.1 Pocket % Out-of- Values for 1960 from Health United States, 2005, Table 123. Sources: Centers for Medicare and Medicaid Services, NHE Tables, Table 6—Personal Health Care Expenditures1; Levels, Percent Change, and Percent Distribution, by Source of Funds: Selected Calendar Years 1970–2014, www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccounts Historical.html, accessed August 2016. Health insurance is equal to the sum of private health insurance, Medicare, Medicaid, and other health insurance programs. Notes: Total spending is equal to the sum of health insurance, other third-party payers and out-of-pocket. 615.3 1,162.0 2000 1980 1990 63.1 217.0 1970 29.6 Insurance Spending 23.4 Health Total 1960 Year Table 1.5 Personal Health Care Spending, Selected Years (in $ Billions) Introduction Table 1.5 provides data on the sources of payment for personal health care services for selected years since 1960. In addition to out-of-pocket costs, these payment sources include private insurance; Medicare and Medicaid (the major government programs for the elderly and certain lower income households); and other public and private programs. In 1960, 55 percent of all personal health care expenditures were paid out-of-pocket, meaning that 45 percent was paid by third-party payers (either private or government). Out-of-pocket costs dropped dramatically following the introduction of Medicare and Medicaid in 1966, the continued growth of private insurance, and the introduction of new programs such as the Children’s Health Insurance Program (CHIP) established in 1997. By 2014, 87 percent of personal health care spending was paid by third parties. We will carefully study this phenomenon and its effects for both private and public insurance. It should be clear, even prior to our focused analyses, that the separation of spending from the direct payment for care must weaken some of the price effects that might be expected in standard economic analysis. Insurance changes the demand for care, and it potentially also changes the incentives facing providers. Changed incentives that face providers concern us more as the insurance portion of the bill increases. How the insurers pay the health care firm thus becomes a critical fact of economic life. Whether insurers cover a procedure, or a professional’s services, may determine whether providers use the procedure. Furthermore, changes in insurance payment procedures can substantially change provider behavior and provider concerns. In the 1980s Medicare, faced with rapidly increasing expenditures, changed its hospital payment system from one based largely on costs (i.e., retrospective reimbursement) to one with fixed payments per admission determined by the resources typically used to treat the medical condition (as classified by Diagnosis Related Groups, or DRGs). With a prospective DRG payment system, an extra day of care suddenly added to the hospital’s costs, rather than to its revenues. This reimbursement system, still used today, led to shorter stays, reduced demand for hospital beds, and ultimately the reduction in size and/ or closing down of many hospitals. Problems of Information Uncertainty can in part be attributed to lack of information. Actual and potential information problems in health care markets raise many economic questions. Sometimes information is unavailable to all parties concerned. For example, neither gynecologists nor their patients may recognize the early stages of cervical cancer without Pap smears. At other times, the information in question is known to some parties but not to all, and then it is the asymmetry of information that is problematic. The problems of information mean that careful economic analysts must modify their methods. Standard analyses often assume that consumers have the necessary knowledge about the quality of the food or the clothing that they purchase. People purchase beef as opposed to fish, or cotton as opposed to nylon fabrics, basing their decisions on the characteristics of the goods, their prices, and the goods’ abilities to bring pleasure. Health goods and services depart substantively from this model. Consumers may not know which physicians or hospitals are good, capable, or even competent. Consumers may not know whether they themselves are ill or what should be done if they are. This lack of information often makes an individual consumer, sometimes referred to as the principal, dependent on the provider, as an agent, in a particular way. The provider offers both the information and the service, leading to the possibility of conflicting interests. Newhouse (2002), for example, speaks of a health care “quality chasm” that may be traced to both 45 Introduction inadequate consumer information and to inadequate financial incentives. Health economics must address the provision of health services in this context. Large Role of Nonpro?t Firms Economists often assume that firms maximize profits. Economic theory provides models that explain how businesses allocate resources in order to maximize profits. Yet many health care providers, including many hospitals, insurers, and nursing homes, have nonprofit status. What, then, motivates these nonprofit institutions if they cannot enjoy the profits of their endeavors? The economist must analyze the establishment and perpetuation of nonprofit institutions, and understand the differences in their behaviors from for-profit firms. This problem has recently emerged in the context of academic medical centers in the United States. Many current college students, and most certainly their parents and grandparents, know of the prominent roles of great hospitals affiliated with great universities such as Harvard or Johns Hopkins. The public and the larger medical community are aware of the major hospitals as centers of health care, teaching, and research. Yet with the changing health economics of the twenty-first century, the organization of these hospitals and the funding of their activities are continuously evolving. Restrictions on Competition Economists and policymakers generally laud the competitive market because the entry of firms or providers in the face of high prices and/or profits will cause the other firms or providers to lower their prices. This entry and the resulting price reduction improve the well-being of consumers. Nevertheless, the health sector has developed many practices that effectively restrict competition. These practices include licensure requirements for providers, restrictions on provider advertising, and standards of ethical behavior that enjoin providers from competing with each other. We must explain the forces that generated such practices and understand their potential benefits, but we must also understand their anticompetitive impacts and measure the magnitudes of the higher costs they may impose on society. Regulation to promote quality or to curb costs also reduces the freedom of choice of providers and may influence competition. There is often substantial interest in regulating the health care sector. The causes, as well as the impacts, of the regulations require considerable attention. The pharmaceutical industry, for example, contends that patent protection is crucial for its financial stability. Economists must consider how regulations are developed, as well as who gains and who loses from them. Role of Equity and Need Poor health of another human being often evokes a feeling of concern that distinguishes health care from many other goods and services. Many advocates express this feeling by saying that people ought to get the health care they need regardless of whether they can afford it. In practice, “need” is difficult to define, and distributing care under certain definitions of need may cause more economic harm than good. Yet the word signals a set of legitimate concerns for analysis. 46 Introduction Government Subsidies and Public Provision In most countries, the government plays a major role in the provision or financing of health services. In the United States in 2014, Medicare and Medicaid alone accounted for 40 percent of personal health care spending. However, there are many other government programs, both federal and state and local, including those for public health, military veterans, eligible children, and for mental health and substance abuse. Federal government subsidies are also prominent in the ACA by making insurance coverage more affordable for low and moderate income households. Conclusions In this introductory chapter we have sought to explain and support several themes. One is that health and health care markets present a combination of unusual features that together form a unique discipline. Health economists frequently engage in companion disciplines, such as labor economics, public finance, and industrial organization, and recognize that each presents distinctive issues. Health care markets confront risk and uncertainty with unusual information problems. Health professionals have substantial knowledge advantages over their patients. Society norms regarding health and health care make nonprofit motives often preferred, and government provision prominent. Back in the 1960s and 1970s, few economists wrote about health care issues, but now some of the most distinguished economic researchers call themselves “health economists.” Second we have explored the fact that the health economy is “big,” so big it is imposing. Nearly 18 percent of GDP in the United States goes to the health sector. Until very recently health care inflation has risen rapidly, raising the question of whether it will begin to gallop again. Prices for health care have grown much more rapidly than consumer prices generally, presenting difficulty for people of modest means to get access. Prior to the ACA, insurance companies often avoided high risk beneficiaries by denying those with pre-existing conditions from buying insurance or by denying them policy renewals. Finally we have examined the standard methods of economic analysis and suggested how they must be modified to address the characteristics of health and health care markets. While full information is often assumed in introductory microeconomics, it may be asymmetric in health in health insurance markets or even imperfect on both sides. Ordinary firms are often for-profit, while health market norms often prefer nonprofits. A CEO of a business is typically praised for seeking greater profits, while a health professional who does so may not be trusted. And, health economists must study “health bads,” where the reduction of the amount consumed is considered an improvement. The many chapters that follow address these issues. They focus on the ideas, that is the theories, and they describe the empirical work that assesses how well the theories work in reality. These are organized by standard economic categories of demand and supply but also by the relevant health care markets and salient issues of health economics. The biggest and most important health care issue in America is the Affordable Care Act (ACA), often called “Obamacare.” It rivals Medicare and Medicaid in the United States in terms of size and impacts of the reforms. The ACA’s principal goal is to reduce the number of people lacking health insurance, which had risen to 50 million people. The ACA also introduced many other reforms that will be described and evaluated in our Health System Reform chapter (22) and elsewhere in the text. 47 Introduction What can economics say about such issues generally? Distinguished economist Victor Fuchs, a past president of the American Economic Association, is optimistic that health economics will meet these challenges and continue to flourish. The greatest strengths of economics and economists are a framework of systematic theory, an array of concepts and questions that are particularly relevant to the choices facing policy makers, and skill in drawing inferences from imperfect data. Because health economists often take standard economic theory for granted (like being able to walk or talk), it is easy to underestimate the advantage this framework offers economics over the other social and behavioral sciences. When economists encounter a new problem, one with which they have had no previous experience, they immediately have a way to begin thinking about it long before data collection begins. Scholars in the other “policy sciences” do not. They typically require some detailed knowledge of the particular problem before they can begin to think productively about it. Economists’ framework of systematic theory facilitates the transfer of knowledge drawn from other fields of study to the health field. Health economists have also inherited from economics a set of concepts and questions that have proven to be particularly relevant to the policy problems that have emerged in health during the past three decades. Scarcity, substitution, incentives, marginal analysis, and the like were “just what the doctor ordered,” although in many cases the “patient” found the medicine bitter and failed to follow the prescribed advice. (Fuchs, 2000, p. 148) Professor Fuchs’s insights have become even more relevant following passage of the 2010 Affordable Care Act. These reforms have brought unprecedented change, including an individual mandate for insurance coverage. We share Professor Fuchs’s optimism that the theoretical framework and tools used by economists will greatly improve our understanding of these changes and their potential effects. Postscript Two significant and related events in November 2016 followed completion of this revised edition. First, Donald Trump, who campaigned on the promise to repeal and replace the ACA, was elected President of the United States. O Second, National Health Expenditure (NHE) data for the United States, published shortly after the election, showed that nominal NHE in 2015 reached $3.2 trillion, an increase of 5.8 percent over 2014. As a share of GDP, NHE increased from 17.4 percent in 2014 to 17.8 percent in 2015. O Our text includes extensive descriptions and analyses of these ACA program provisions and we note that the faster 2014 and 2015 growth rates coincided with major expansions in public and private health insurance coverage under the ACA. While Mr. Trump has pledged to repeal and replace the ACA, many political and health care analysts have speculated 48 Introduction that the major provisions will be difficult to dismantle under a Trump administration. We can only leave it to our students and their instructors to monitor and evaluate any future legislation. Summary 1 Health care spending has grown rapidly in absolute and relative terms. In 2015, it accounted for nearly 18 percent of U.S. GDP, and its share of GDP is projected to grow. 2 The growth in health care spending is attributable to more services, higher-quality services, and relative increases in the prices of health care services. Health economists seek to determine the underlying causes of these phenomena. 3 The size of the health economy is also reflected through other measures such as the number of jobs in health care professions and amount of capital. 4 Time spent obtaining and providing health care represents a key “unpriced” factor in the health economy. 5 The health economy is considerably larger in the United States, as a share of GDP, than in other countries. 6 There are significant policy concerns not only with the growth of spending but also with access and quality. 7 Economists use models to explain economic behavior. The models are abstract simplifications of reality. 8 Health economists still disagree on some fundamental issues, such as the extent to which the competitive model applies to the health economy. 9 Health care services and the health economy possess a unique set of distinguishing features, such as the prevalence of uncertainty or insurance coverage. Health care is unique because of this entire set of features. 10 The health care system has changed dramatically over the past 50 years. The role of government, reimbursement methods, and the dominance of managed care represent some of the major changes. The Affordable Care Act (ACA) of 2010 is the most important recent change. 11 An important consequence of many of these changes is the substantial drop in out-ofpocket costs for consumers, meaning that private insurance and public programs have correspondingly grown. 12 Technological change through improved procedures, and new drugs, provides potential improvements in health care, but also possibilities of increasing costs, in all countries. 13 Economics provides valuable theoretical tools and a systematic framework for understanding the health care system and evaluating alternative policy proposals. Discussion Questions 1 Suggest several reasons why health care spending is higher in the United States than in other countries. Is the fact that the U.S. population spends more per capita on health care than people in any other developed country evidence of a failure of the U.S. system? What issues do you think are involved in answering the question? 2 Describe several key issues facing policymakers with regard to health care spending. 49 Introduction 3 If greater health care spending leads to more jobs, why is there such concern about the rapid growth rates of spending? 4 Do consumers take the net price (including insurance and time) they face into consideration when choosing health care? What evidence suggests that price matters? Suggest real-life scenarios in which price may affect choices regarding health care. 5 Suppose that a woman works 40 hours per week with no opportunity for overtime. She also takes care of a sick parent. Can we say that her time has no value in providing this health care because she could not earn more at work? 6 What is meant by marginal analysis? Provide an example in which marginal analysis is useful in looking at policy questions. 7 Give three examples of quality of care in the provision of health services. Why might consumers be willing to pay more money to have each of them? 8 Describe the size of the health economy when measured by the quantities of capital and labor used to produce health care. What important inputs to the production of health are not being counted among these? Exercises 1 Health care spending (S) can be summarized by the following equation: S = (population size) × (health care quantity per person) × (price per unit of health care) 2 3 4 5 6 7 50 (a) Identify three factors that might lead to the rapid growth o...