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Chapter 2 Medical Care and Health Insurance


Health insurance acts to subsidize medical care at the point of purchase ... Increased use of 'physician extenders' (physician assistants, nurse practitioners) ... – PowerPoint PPT presentation

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Title: Chapter 2 Medical Care and Health Insurance

Chapter 2 Medical Care and Health Insurance
  • Amount of health at the end of the period
  • H H0 l g(m)
  • l illness event
  • m medical care

Demand for Medical Care
  • Beyond illness events
  • Systematic factors (age, gender including
    childbirth, genetic)
  • Beliefs about the efficacy of medical care
  • Advice from medical professionals
  • Income health insurance
  • Price (opportunity cost of time, money)

Supply of Medical Care
  • Price
  • Input costs
  • Regulation, taxes, subsidies
  • Not-for-profit status under tax laws

Demand for Health Insurance
  • Price (loading on top of expected benefits is
    the price of insurance)
  • Risk aversion
  • Tax laws (subsidies)
  • Health insurance is not taxable income
  • Your marginal tax rate determines the subsidy

Demand for Health Insurance
  • Example of expected benefit calculation
    0 (.95) 50,000 (.05)
  • What is this worth to you if you are risk averse?

Expected benefit 0 (.95) 50,000 (.05)
2,500 Premium (1 L) x (expected benefit) L
loading fee expressed as a fraction of expected
benefits If L 0, premium expected benefit
(would you expect to see this?) Examples If the
insurance premium (what you pay) is 2,500, the
insurance is free (why?) If the insurance
premium is 3,000, the loading fee is 500 and L
.2 To check this, note that (1 .2) x 2,500
Supply of Health Insurance
  • Supply g(Price)
  • Administrative costs
  • Risk bearing costs
  • Taxes/subsidies

Supply Curve shows that higher prices induce
new firms to enter (reflects increasing
opportunity costs of entrants)
Price per unit of insurance
Quantity (units of health insurance)
Health Insurance vs. Other Insurance
  • Health insurance acts to subsidize medical care
    at the point of purchase
  • Consumer trades lower income (cost of insurance)
    for lower price of medical care
  • Some policies limit your purchases with
    physician/gatekeeper/third party oversight and
    limits to coverage/lifetime limit
  • Rationing (because the price mechanism is not
    rationing consumption)

Health Insurance vs. Other Insurance
  • Consumer insures against cost of medical care,
    not health events
  • Example broken leg vs. broken fender

Industry Structure
  • Vertical integration
  • Health Maintenance Organizations (HMOs) integrate
    provision and insurance (Kaiser or Facey)
  • Preferred Provider Organization (PPO) (Blue
    Cross/Blue Shield)
  • Integrated Delivery System (IDS) (contractual or
    ownership arrangement)
  • Horizontal integration hospital industry

Historical Perspective to Health Care Industry
  • 1965 Medicare/Medicaid
  • Paid whatever it cost to provide care
  • Huge increase in demand for health care
    tremendous expense
  • FMGs allowed to immigrate 1965-72 to keep prices

Historical Perspective to Health Care Industry
  • Rising federal costs led the government to set
    reimbursement limits (monopsony pricing)
  • Shift to outpatient procedures led to an excess
    supply of beds
  • Shortage of primary care physicians
  • Low reimbursement combined with requirement to
    accept all those who need emergency care caused
    some emergency rooms to shut down
  • Increased use of physician extenders (physician
    assistants, nurse practitioners)

How will this affect health care?
  • Prime Healthcare Services (Dr. Prem Reddy) is
    buying hospitals
  • They cancel all insurance contracts (which pay
  • They stop services that dont cover their costs
    (so not full service)
  • They encourage emergency room traffic (moved lab
    equipment to ER to speed things up goal of
    waiting time 20 minutes)
  • The hospital charges rates that are not
    negotiated with insurers and the LA Times says
    insurers have to pay.
  • Prime Healthcare is profitablehospitals that are
    doing poorly are calling him.

Long run influences on demand for medical care
  • Rising incomes
  • Demographics (baby boom)
  • Innovation and technical change
  • Increased health insurance coverage

Rising Prices and Expenditures
  • Medical CPI has problems
  • e.g. uses list prices, looks at cost-per-day,
    cant adjust for quality
  • Combines components proportional to out-of-pocket
    for consumers not total expenditures
  • Consumers better off if this spending reflects
    their preferences or higher quality
  • Consumers worse off if government mandates higher
    quality/quantity than consumers would buy on
    their own

Source Samel L. Baker, U South Carolina,
Health Care Spending
  • Physicians direct over 85 of all spending on
    health care in the US
  • Between 1950 and 2000
  • Health care expenditures in 2000 were 11 times
    what they were in 1950
  • biggest increase hospital expenditures
  • but in per capita terms hospital expenditures
    fell from 1995 to 2000
  • Spending on drugs rose a lot between 1950 and
  • Health care expenditures increased from 5 to 14
    of Gross National Product
  • 1965 Medicare/Medicaid legislation expanded
    health care for elderly in particular
  • Real income doubled
  • What can we say about the income elasticity of
    demand for health care?

Chapter 2 End-of-Chapter Questions
  • Problems 4, 5, 6, 7, 8, 9