An important paper on health care economics
Amy N. Finkelstein offers up a juicy abstract and paper:
Abstract: This paper investigates the effects of market-wide changes in health insurance by examining the single largest change in health insurance coverage in American history: the introduction of Medicare in 1965. I estimate that the impact of Medicare on hospital spending is over six times larger than what the evidence from individual-level changes in health insurance would have predicted. This disproportionately larger effect may arise if market-wide changes in demand alter the incentives of hospitals to incur the fixed costs of entering the market or of adopting new practice styles. I present some evidence of these types of effects. A back of the envelope calculation based on the estimated impact of Medicare suggests that the overall spread of health insurance between 1950 and 1990 may be able to explain about half of the increase in real per capita health spending over this time period.
Amy is an assistant professor at MIT; this week's Business Week has an article claiming she is revolutionizing health care economics. Perhaps that is an exaggeration, but her home page is worth a look.
Seeing is believing (in the free market)
Everywhere we look it seems that health care is more expensive: prescription drug prices are increasing, costs to visit the doctor are up, the price of health insurance is rising. But look closer, even closer, closer still. Don't see it yet? Perhaps you should have your eyes corrected at a Lasik vision center.
Laser eye surgery has the highest patient satisfaction ratings of any surgery, it has been performed more than 3 million times in the past decade, it is new, it is high-tech, it has gotten better over time and... laser eye surgery has fallen in price. In 1998 the average price of laser eye surgery was about $2200 per eye. Today the average price is $1350, that's a decline of 38 percent in nominal terms and slightly more than that after taking into account inflation.
Why the price decline in this market and not others? Could it have something to do with the fact that laser eye surgery is not covered by insurance, not covered by Medicaid or Medicare, and not heavily regulated? Laser eye surgery is one of the few health procedures sold in a free market with price advertising, competition and consumer driven purchases. I'm seeing things more clearly already.
Thanks to Jonathan Van Loo for research assistance on this post.
Activity:
Rising health care costs continue to be a source of concern for policy makers. Health care expenditures account for approximately 16% of GDP, up from 6% in 1960. In recent years, the growth rate in spending has been near 7%. Many economists believe that insurance plays a role for the rise in health care costs.
Tyler Cowen linked to the recent research of Amy Finkelstein who wrote, “…the overall spread of health insurance between 1950 and 1990 may be able to explain about half of the increase in real per capita health spending over this time period.”
Alex Tabarrok suggests that the falling real price of laser eye surgery is attributable to a lack of insurance. Private insurance and government programs such as Medicare and Medicaid do not cover the procedure.
In Chapter 3, Cowen and Tabarrok explain that rising prices may result from an increase in demand or a decrease in supply. Since insurance alters the price of health care paid by consumers, it is the demand for health care that is affected by the presence of insurance. Suppose that the market price for a physician office visit is $100. A consumer who has an insurance policy that covers 85% of all costs will only incur a $15 charge for each visit. In this case, the consumer has a 15% coinsurance rate—i.e., she is responsible for 15% of all costs. The consumer will now pay a lower effective price for physician office visits, leading to more visits to the physician.
We can analyze the effect of insurance by using a simple linear demand function, say, of the following form:
Q = 500 – P, where Q is the quantity of physician office visits and P the price per visit.
A graph of the demand function appears below. If the market price is $200, and consumers are without insurance, quantity demanded is 300.
Suppose that the consumers now have an insurance policy that pays 80% of the market price, leaving consumers with a 20% coinsurance rate. The effective price paid by consumers with insurance is $40 (.20 x 200). In general, the effective price with insurance is equal to the coinsurance rate (c) times the market price (P), or cP. The demand equation with insurance becomes:
Q = 500 – cP
Given the 20% coinsurance rate, the demand function is Q = 500 – 0.2P, which is shown below along with the original demand curve.
At the market price of $200, consumers will increase their office visits to 460 (Q = 500 - .2 x 200). The insurance insulates the consumers from the $200 market price; they act as is if the market price is only $40 (.2 x 200) and, as shown above, this causes an increase in demand.
Another interesting aspect of insurance is that it creates a deadweight loss. The market is providing health care at a market price of $200, which reflects the marginal costs of care, but consumers are purchasing units of care that they value less than the cost. The deadweight loss is the triangle area between 300 and 460 office visits. In this range, the market price exceeds the marginal value (reflected in the height of the demand curve) of the visits, creating an inefficiency. Note that higher coinsurance rates reduce the deadweight loss.
Questions:
1.) Graph the market demand for wellness visits, which is given by Q = 200 – 2P. Graph a new demand curve assuming that consumers have an insurance policy with a 50% coinsurance rate.
2.) If the market price per visit is $50, how many visits do consumers purchase with and without insurance?
3.) What is the deadweight loss attributable to insurance?
4.) Given that insurance increases the demand for health care, what is the new equilibrium price of visits if the market supply function is Q = 50 + P.
Answers:
1.)
Note that the demand function with insurance is Q = 200 – 2(.5)P = 200 – P.
2.) Without insurance, quantity demanded is Q = 200 – 2(50) = 100. With insurance, quantity demanded is Q = 200 – 50 = 150.
3.)
The deadweight loss is the area of the triangle, or .5(50 – 25)(150 – 50) = $1,250.
4.) Set quantity demanded with insurance equal to quantity supply.
200 – P = 50 + P
150 = 2P
P = $75
The market price increased from $50 to $75 owing to the presence of insurance.
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