Health Care Economics Study Guide PDF

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Lecture 2 •

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Price Elasticity o Elasticity is defined as the responsiveness of a dependent variable to changes in an independent variable, for price elasticity that would be the responsiveness of quantity demanded to changes in price o Ep = % change in Qd ÷ % change in P, or (ΔQ/Q) ÷ (ΔP/P) o Inelastic demand- price change does not affect the demand as much o Elastic demand- price change does affect the quantity demanded Production Function o A production function shows the maximum sustainable output that can be obtained from various combinations of inputs, with existing technology. The Marginal Product is the CHANGE in Total Product associate with each additional INPUT Isoquant represents all the combinations of capital and labor that could be used to produce X units of output.

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Marginal and Average Cost o The long-run average cost curve represents the minimum cost per unit of output achievable when all inputs are variable. o The long-run marginal cost curve represents the increment in total cost resulting from a one unit increase in output. o (TOTAL COST)/ (Quantity) = Average Cost

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Different Costs of Production for standard clinic o Office Space, Examination Tables, Medical Equipment, Lab Equipment, Office Equipment and Furniture, Medical Supplies, Personnel, Insurance: Business and Professional Perfect Competition o Individuals are the best judge of their own well-being o Individuals have sufficient information to make good choices o Consumers can accurately predict the results of their consumption o We are rational, and never impulsive o Social welfare is solely the sum of individual utilities o There are no externalities from consumption o There are no increasing returns to scale o No pricing power o Firms maximize profits o Society accepts the distribution Competitive Model o A sufficient number of buyers and sellers of the good exist so that no single buyer or seller has any power over the price.

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The good is homogeneous; that is, all producers produce the exact same good. Information is perfect. All buyers and sellers have information on all relevant variables such as prices and qualities. o No barriers to entry or exit are present. Monopoly o Industry with a single seller of a product or service that has no close substitutes. Pharmaceutical companies that control patents for certain drugs are a good example of monopoly Welfare Loss Due to Monopoly o Monopoly results in a restriction in output that produces a higher market price for the product; this produces a welfare loss indicated by the triangle ABC in the diagram. Monopolistic Competition o Industry with many sellers of a product or service that is differentiable between sellers. ▪ Individual physician practices differentiated by reputation, patient loyalty, and patient/practice distance would be an example of a monopolistically competitive market. Oligopoly o Industry with few sellers of a good or service. ▪ Many towns have only a couple of hospitals to choose from making the market for hospital services in that town oligopolistic. o o

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Lecture 4 •

Economic Efficiency o Economic efficiency exists when the economy has squeezed out every opportunity for net benefits through voluntary means. o In competitive markets, supply and demand provide the efficient quantities of goods to the market o Prices ration supply and demand according to consumer preferences and producer costs.

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Maximum Social Welfare o The economic criterion for maximizing well-being is to maximize the sum of the consumer and the producer surplus. Market Failure o Market Structure o Nature of the good ▪ Not a Private Good: Rivalry in Consumption and Excludability in Ownership and Use ▪ Externalities: aspects of the production or consumption are not incorporating all of the costs or benefits. COST-BENEFIT ANALYSIS o Public policies usually create both benefits and costs.

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o Cost-benefit analysis (CBA) measures benefits and costs of projects in money terms. Cost-Effectiveness Analysis (CEA) o CEA applies to problems where the goal is accepted at the start and the problem is only to find the best, most efficient, means to achieve it. Cost-Utility Analysis (CUA) o CUA is a special form of CEA that introduces measures of benefits that reflect individualsʼ preferences over the consequences of alternative programs that affect them. COST-BENEFIT ANALYSIS: BASIC principles o CBA rests on the premise that a project or policy will improve social welfare if the benefits associated with it exceed the costs. o The benefits and costs that are counted must include not only those directly attributed to the project but also any indirect benefits or costs through externalities or other thirdparty effects. Measurement Issues o Costs are measured as opportunity costs. o In public projects, many of the costs and benefits do not have a market to help guide monetary evaluation. o For example, a dam can destroy animal habitat or attract waterfowl; how do we value the loss and gains? Discounting o Many public projects incur costs immediately but have benefits that occur well into the future. o Because benefits or costs that occur in the future are not equivalent to benefits or costs that occur today, the future benefits and costs must be discounted. Reasons for Discounting o First, a dollar today has opportunities other than the project of study. Second, people have a tendency to prefer the present when allocating spending. o PV=(b-c)/(1+i)^n CBA Adjustments o Risk – which interest rate? o Disproportionately distributed benefits adjustments. o Inflation. VALUING HUMAN LIFE Overview of Methods o The human capital approach, estimates the present value of an individualʼs future earnings. o The willingness to pay or willingness to accept approach measures what individuals are willing to pay (accept) to avoid (accept) additional risk to life and limb. o The contingent valuation approach elicits individuals valuation of alternative contingent risks. CEA Measurement

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C1-Co/E1-Eo ▪ Conceptually, identify the lowest cost approach of producing a given benefit. ▪ CEA can be a useful first step toward undertaking a cost-benefit study.

QALY (think elderly how they spend 25 percent on healthcare on final years in life, but is it really worth it? given a number between 1 and 0 to assess if the medical intervention is worth it and how much of an affect it will have o Fiqi/(1+d)^t ▪ Provides another technique for judging public projects. ▪ Accounts for the notion that each person is entitled to a life in which he or she can use a basic set of capabilities to achieve personal goals in life. ▪ Importantly, these capabilities include basic health and functioning. Health Care Observations o Health and Medical Care are not synonymous. o Except for the very poor, health and per capita income no longer correlate. o Patient has the most impact on health but it is the physician that has the most influence on medical care spending. o Access is not as much a Physician shortage issue per se but a miss-allocation of provider resources. o By and large, the costs of medical care are borne by individuals – not business – not government. o We will need to make choices – but economics can only focus on the questions of efficiency and not equity, per se.

Lecture 5 •

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Health Care Reform o Efforts at the Federal, State, or Local community level to improve the quality of care, enhance access to care, or ensure that expenditures are necessary and reflect their costs. The Catalysts o 1981 Recession: Oil Embargo and cost-push inflation in the late 1970s, followed by the 1980 recession and the 1981-82 recession. o Medicare changes how it reimburses health care providers(1983) The enablers o Studies of Small Area VariaIon (Wennberg,1967) o 2. Employee ReIrement Security Act (1974) o 3. Rand Health Insurance Experiment (1974-1982) Employers/Insurers o Concerned about the value of health spending ▪ Aggressively move away from 1st dollar coverage ▪ Aggressively move towards self-insuring

Insurers: concerned about maintaining a relevant business model adopt element of managed care. ▪ Began to create and then sell network’s of healthcare providers ▪ Begin to form versions of managed care plans Providers o In reaction to Insurers Movement Towards Managing Care o Hospitals moved to secure their referral basis. o Health Care Providers moved to increase their bargaining position with insurers. o In reaction to Medicare’s changes in Reimbursement o Hospitals expanded dramatic into rehabilitative and supportive care services following a hospital discharge (post-acute care) Structural Shift o Before 1982, the financing of care was separate from the delivery of care. o After 1982 organization and delivery of health care is increasingly integrated with the pooling of the financial risks for care. o Prior to 1982: pooling of risk focused on individual financial risk. o After 1982: increased focus on pooling societal financial risk. o

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Lecture 6

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Health Insurance Mandate o Citizens & Legal Residents o Exemptions: religion, circumstances, financial hardship o INCOME TAX if you do not have insurance: greater of 2.5% of household income or $695 per person (limited to 3 x 695);assuming your income is above the Threshold for taxation Health Insurance Coverage of the Nonelderly Population, 2011 o Expand Medicaid to 133% FPL and Eliminate Categories o Non-Group Market Reforms & Subsidies o Define “Dependent” as children Age 25 and younger. o Encourage Employers to Provide Coverage Coverage (Standardized)

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Premium Variation Limited by: Geography, Family Size, Age (3:1), Smoker (1.5:1) Payments for health care must exceed 80% of premiums.

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If you have 50 or more full time employees with an employee eligible for a premium tax credit o If they are part time you don’t have to give insurance Financing o Reduce Medicare and Medicaid aments t providers ▪ Restructure Medicare payments to Medicare Advantage plans based on performance, which in general will be a reduction. ▪ Ignore a portion of local inflation when computing reimbursement – which will result in a slightly lower rate of increase in Medicare reimbursement

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Reduce Medicare Disproportionate Share Hospital payments 75 percent (initially) ▪ Reduce the Federal match for Medicaid Disproportionate Share Hospital Payments ▪ Reduce hospital payments for readmissions. ▪ Reduce hospital payments for specific hospital acquired conditions. ▪ Allow health care providers to contract for greater risk sharing Arrangements via ACOs. o Taxes directly on taxpayers ▪ 10% excise tax on indoor tanning services. ▪ Narrow FSA coverage and reduce contributions. ▪ Increase the threshold for itemized deductions from 7% to 10% of AGI. ▪ Increase HI payroll tax from 1.45% to 2.35% earnings above $200,000 (single) and $250,000 for married individuals. ▪ Impose 3.8% tax on unearned income for higher income individuals. ▪ Reduce the Part B subsidy to higher income Medicare beneficiaries. ▪ Tax those required to have coverage who file federal income taxes. o Indirectly on taxpayers ▪ Taxes on Health Insurance companies, allocated by premiums. ▪ Limit the deductibility of compensation to health insurance employees to $500,000. ▪ Excise tax on insurers of employer provided plans with benefits that exceed $10,200 for individuals and $27,500 for families. ▪ Tax employers with employees in the exchange. ▪ New taxes on pharmaceutical manufactures and medical device manufactures. ▪ Reduce the tax credit provided to biofuel producers Potential of the Insurance Reforms o Expand better Coverage o Enhance Job Portability o Lower Administrative Costs of Selling Insurance in the Individual Market o Reduce Uncompensated Care particularly to hospitals and clinics ▪

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Potential on Organization/Delivery of Care o Focus attention on the health care needs of communities. o Focus attention on patient-centric care. o Focus attention on aligning reimbursement with appropriate and effective care. o Systematic assessment of effective benefits and effective care. o Enable Congress to avoid some of the political pressure if they want to cut the rate of growth in Medicare reimbursement. Transformative? o Changes in Medicare can be very influential but it is an indirect and imprecise means to an end.

The Affordable Care Act does not mandate experimentation or delivery changes in all areas relevant to true health care reform. o Legislation is a political compromise that needs to be adjusted over time. o It will be relatively easy to eliminate the discretionary spending associated with research. Inherent Opposition o Subsidies necessitate a re-distribution of income. o Clear losses to some stakeholders. o Change imposed on many. o Gains on Some are Dramatically Clear but Gains on Most are Vague. o Clear losses; Few Clear Gains; Many Unclear gains make it easy to ferment anxiety. Tone Matters o Last year the U.S. House of Representatives voted 47 times to “repeal” the ACA. o Only 17 states set up the health insurance exchanges – leaving the Federal Government responsible. o About 24 states have not yet expand Medicaid with Federal dollars. o We need to give our political leaders permission to lead; but given the anxiety of these changes we gave them permission to challenge the changes irresponsibility. Change Begets Change o Prior to ACA: Big scale changes were coming – particularly in provider reimbursements. o The ACA may have accelerated the pace of this potential change, particularly as providers sought to position themselves in response to the legislated demonstrations. o However the primary mechanisms in the ACA are changes in how Medicare pays for care, demonstration projects in Medicare and Medicaid, and additional research. Getting from Here to Where? o The ACA provides a framework and a partial Road Map. o It has endured key legal challenges – and it continues to inspire opposition, while struggling to be implemented. o Derailing it, may delay or circumvent the opportunity to truly reform the organization and delivery of effective care. o Derailing it, however, will not circumvent pressures to improve efficiency and the quality of care with no clear road map to achieve such goals. o

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Lecture 8 •

Why not Just pay the $9,600? o The average cost of health care is about $9,600 per person. o 15 percent of the population had less than $300 in total medical expenses. o 75 percent of the population had expenses averaging around $3,000 per year.

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9 percent of the population had expenses in excess of $35,000 for the year -- accounting for 40 percent of all medical expenses. 1 percent of the population had expenses that exceeded $100,000.

Why Insurance Improves Welfare o Most people are Risk Averse o That is, we do not favor an actuarially fair bet – ▪ For $50 I will flip a coin: tails you lose and heads you win $100. ▪ Actuarially fair since P($100) = (0.5*$100) =$50. ▪ If losing $50 is more costly than winning $50 then you are normal – and hence risk averse. o Risk Aversion and a Diminishing Marginal Utility suggests that an actuarially fair insurance policy will lead to a welfare gain If Risk Averse, why Insurance Makes Sense o Utility to forgo, to avoid a potentially bigger loss Insurance markets work best, when o The risk is low but the financial consequences can be substantial. o The number of insured is large and independent of the potential loss. o Covered losses are easy to define in terms of time, place, and amount. o The risk of loss should be measurable. o The loss should be accidental from the viewpoint of the person who is insured Actuarially Fair Premium o When expected benefits paid out equal the premiums taken in. o Actuarially Fair Premiums = (Actuarially fair policy plus Administrative Load)/Insured population. Voluntary Market Concerns o Selection Bias ▪ Those who need medical care are more likely to seek health insurance o Adverse Selection ▪ Higher Risk will Drive out Lower Risk Asymmetrical Information o Potential insured tend to have better information than the insurance company. o If lower risked are grouped with higher risk and everyone pays the same premium, then lower risk face an unfair premium. o They either pay too much or purchase too little insurance – neither is optimum. o Higher risk will tend to insure even more. o Redistribution of income from lower risk to higher risk. Adverse Selection: Inefficiencies o If individuals with lower risks are grouped with individuals at higher risk and all pay the same premium, those with lower risks face an unfavorable insurance rate and will tend to underinsure.

Those with lower risks sustain a welfare loss by not being able to purchase insurance at rates appropriate to their risk. o Conversely, the higher risk individuals will face a favorable premium and therefore overinsure; i.e. they will insure against risks that they would not otherwise insure against. This, too, is inefficient. Moral Hazard o Moral Hazard: Buying insurance effectively lowers the price per unit of service at the time that the services are purchased. o Morale Hazard: Because of insurance I am less careful about needing health care. o We can ignore intent and focus on behavior. Group Insurance: Market Solution to Adverse Selection o Group plans enable insurers to implement experience rating, a practice where premiums are based on the past experience of the group, or other risk-rating systems to project expenditures. o Because employees usually have limited choices both within and among plans, they cannot fully capitalize on their informational advantage. o Small Groups and individuals are “medically underwritten”, meaning that individual risks are evaluated and used in determining either the group rate or individual policy rate. Employers: Self Insure o Replacing some of the Pooling Functions of Insurers. o Hires the insurer to manage how providers are paid. o Avoids State taxes on Insurance o Can avoid State Mandated Benefits EMPLOYER PROVISION OF HEALTH INSURANCE: WHO PAYS? o To minimize costs, employers seek to be at the highest Isoquant relative to their planned (budgeted) expenditures. o Expenditures are based on the cost of labor, cost of capital, and cost of the facility (wage rates, interest rates, rents) o Employers will hire labor, as long as the incremental (marginal) revenue from the goods those workers help to produce exceeds the per hour cost Labor Market Before and After Health Insurance Benefits o Assume workers negotiate a health insurance benefit worth o $1 per hour to them, and costing exactly $1 for the employer to provide. o The employer, who was previously willing to pay a wage of o $20, will now be willing to pay $20 in wages less the $1 cost in insurance. o ($20-$1) = $19 in wages, + $1 in insurance benefits (per hour). o The workers are no worse off at a wage of $19 with the health insurance worth $1 per hour. o The employer earns no less profit for providing the health benefit. o

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Lecture 8

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The Tax System encourages more health insurance o The tax treatment of health insurance benefits to employees amounts to a subsidy for employees which results in the purchase of more health insurance than in the absence of the subsidy. As Medicaid exp...