Lecture 5 FGS - Chapter 7 – Health Capital 2014

How to Manage Dental Costs, With or Without Insurance By WALECIA KONRAD Published: September 4,

100 million without dental coverage Much has been said and written about the tens of millions of Americans without health insurance. But often overlooked in these discussions is another vital medical statistic: more than 100 million Americans go without dental coverage. Many employer-sponsored health care plans do not include dental insurance, and those that do will typically offer only limited benefits. Individual private insurance is often too costly to be feasible. And Medicaid and Medicare offer only limited safety nets.

35% have not visited a dentist in last 12 months For most of people, a toothache that turns into an expensive procedure like a crown or implant means thousands of dollars out of pocket. Routine checkups, cleanings and fillings can set you back hundreds. No wonder 35% of Americans have not visited a dentist in the last 12 months, according to a recent Gallup report. Even if you’re fortunate enough to have some kind of coverage, you have probably discovered just how little it pays if you have big problems. Most dental policies pay for preventive care like twice-a-year checkups, but cover only a fraction of higher-cost procedures like root canals. Even fillings can get short-changed, if the insurer decides the tooth-colored filler the dentist used was too “cosmetic” for the pothole being patched.

Without Dental Insurance DISCOUNT NETWORKS If you do not have group dental insurance through your employer, there are very few viable insurance alternatives, unfortunately. Paying the premiums for individual dental insurance, Dr. Wolff said, is almost always unaffordable. “In most cases, you’ll end up paying as much or more as you would if you pay for treatment out of pocket,” he said. Some discount networks have formed to fill the void. Consumers pay roughly $100 to $200 a year in exchange for 15 to 50 percent discounts on service and treatments from participating dentists. “Be sure to compare plans carefully,” said Ms. Rogers of Oral Health America. And, she added, make sure the discounts you are likely to use will be enough to cover the annual fee — and look carefully for any limits and restrictions.

Under ACA “Essential Benefits” require pediatric (under the age of 19) dental coverage. DO NOT require adult dental coverage.

Health Capital Your body is like a “car.” Huh ???Huh ??? How do we think of the body as a capital good, and medical care as a health investment ???

Inv. and Capital are related. I is a flow, Cap is a stock. We use I to build Cap. The Economics – Health Capital Your body is like a car (!?) You invest! MEI – mgl efficiency of investment User cost of capital. Deferred Maintenance? MEI = Mgl Efficiency of Investment Health Investment Cost,Return in % User Cost I*

Health Care Diet Exercise Environment Income Time Health Outcomes Healthy days: Physical Health Mental Health Activity Health Limitations Health Inputs Health Capital Stock Over Time Health Outputs Each Year Investing in Health Capital Change in health stock implies differing levels of investment.

Discounting and the Evaluation of Health Care Investments Investment aspect to health expenditure. Economists are often asked to compare investments that provide different streams of income over a number of periods. Why, for example, should George pay for a physical check-up (Investment H), when instead he can have his car serviced (Investment S) for the same cost. We look at Present Discounted Value (PDV).

The Million Dollar Gift I’m going to give WSU a million dollar gift. $1 per year for the next million years. How much should they put on their books? Why?

Evaluating Investments Compare Investment H, which provides $20 at the end of Year 1, and $20 at the end of Year 2, with Investment S, which provides $28 at the end of Year 1, and $11 at the end of Year 2. PDV = R 1 /(1+r) + R 2 /(1+r) 2 a. Interest rate = 5% Health (H)ReturnCar (S)Return Period 1 20Period 1 28 Period 2 20Period 2 11 PDV37.19PDV Health has a higher PDV! What does this mean? Make a spreadsheet. spreadsheet. Make a spreadsheet. spreadsheet.

Evaluating Investments Compare Investment H, which provides $20 at the end of Year 1, and $20 at the end of Year 2, with Investment S, which provides $28 at the end of Year 1, and $11 at the end of Year 2. b. Interest rate = 15% HealthReturnCarReturn Period 1 20Period 1 28 Period 2 20Period 2 11 PDV32.51PDV32.66 Car has a higher PDV!

Investment Over Time - (Cost of Capital) Since health is a capital good, we want to understand the cost of capital as well as the capital good demand process. A health clinic, for example, purchases thousands of dollars of X-ray equipment. The return to the X-ray equipment is in the future earnings that ownership of the equipment can provide. Suppose that an X-ray machine costs $50,000, and that its price does not change over time. Suppose that the annual income attributable to the use of the X-ray machine is $10,000. Is this a good investment? Consider the alternative: Instead of purchasing the X-ray machine the clinic could have put the $50,000 in a savings account, at 5 percent interest, yielding:

Cost of Capital 50,000 * 1.05 = 52,500, at the end of Year 1. 52,500 * 1.05 = 55,125, at the end of Year 2. 55,125 * 1.05 = 57,881, at the end of Year 3. 57,881 * 1.05 = 60,775, at the end of Year 4. 60,775 * 1.05 = 63,814, at the end of Year 5. For the investment in an X-ray machine to be desirable by these criteria, it should provide at least $13,810 in incremental revenue over the five years.

Depreciation How much is a five year old computer worth? Why?

Depreciation How much is a five year old piano worth? Why?

Cost of Capital The problem is more complicated, however, because most capital goods depreciate over time. Suppose that the clinic knows that the X-ray machine (or one of its computers, for that matter) will wear out (or depreciate), so that after five years, it will be worth only half its original value. The clinic must earn enough not only to cover the opportunity cost from the bank, but also to maintain the value of the machine. For the investment to be worthwhile, then, it must not only earn the competitive 5 percent return each year, but it must also provide enough return to cover depreciation of the machine.

Cost of capital This suggests that the cost of holding this capital good for any one year, as well as over time, will equal the opportunity cost of the capital (interest foregone) plus the depreciation (deterioration of value). Had the price of the asset changed, leading to capital losses or gains, this feature too would have to be considered. How do we consider this? If there is an expected capital gain, we expect a lower cost of holding the capital.

The Demand for Health Capital Conventional economic analysis provides a powerful conceptual apparatus by which to analyze the demand for a capital good. The cost of capital, in terms of foregone resources (for health capital, both time and money) is a supply concept. The other needed tool is the concept of the marginal efficiency of investment, the MEI, a demand concept which relates the return to investment to the amount of resources invested.

Marginal Efficiency of Investment (MEI) and Rate of Return The MEI can be described in terms of the X-ray machine example. A clinic which does considerable business may wish to own more than one such X-ray machine. How many? The clinic management may logically consider them in sequence. Size of I (in $) Rate of Return (%)

The first X-ray machine purchased (if they were to buy only one) would yield a return. Suppose that return each year was $10,000. We can also calculate the rate of return, which would be $10,000/$50,000 or 20% per year. They would buy this X-ray machine if the return covered opportunity of capital and depreciation. Size of I (in $) Rate of Return (%) Marginal Efficiency of Investment (MEI) and Rate of Return

Management would choose to own the first X-ray machine as long as the rate of return, 20%, was greater than the interest rate (the opportunity cost of capital) plus the depreciation rate. Size of I (in $) Rate of Return (%) Marginal Efficiency of Investment (MEI) and Rate of Return Cost of capital = interest rate + depreciation rate

Marginal Efficiency of Investment If they considered owning two X-ray machines, they would discover that the rate of return to the second X- ray machine was probably less than the first. Consider that a clinic buying only one X-ray machine would assign it to the highest priority uses, those with the highest rate of return. If add a second X-ray machine, then logically it could only be assigned to lesser priority uses (and might be idle on occasion). Thus it would have a lower rate of return than the first. The clinic would then purchase the second X-ray machine as well, only if its rate of return was still higher than interest plus depreciation.

So, we get: Size of I (in $) Rate of Return (%) Marginal Efficiency of Investment (MEI) and Rate of Return Cost of capital = interest rate + depreciation rate YES! NO!

Decreasing MEI Let the marginal efficiency of investment curve, MEI, describe the pattern of rates of return, declining as the amount of investment (measured on the horizontal axis) increases. The cost of capital, that is, the interest rate plus the depreciation rate, is shown as the horizontal line labeled (r +  ). Size of I (in $) Rate of Return (%) Cost of capital = interest rate (r) + depreciation rate (δ)

Optimum amount of capital The optimum amount of capital demanded is thus K o, which represents the amount of capital at which the marginal efficiency of investment just equals the cost of capital. Like the mgl efficiency of investment curve in this example, the MEI curve for investments in health would also be downward sloping. Size of I (in $) Rate of Return (%) Cost of capital = interest rate (r) + depreciation rate (δ) I* MEI Curve

Diminishing Marginal Returns This occurs because the production function for healthy days (Figure 7.4) exhibits diminishing marginal returns. Health Inputs Healthy Days 365 Total Product

Equilibria The cost of capital for health would similarly reflect the interest rate plus the rate of depreciation in health. A person's health, like any capital good, will also depreciate over time. Thus the optimal demand for health is likewise given at the intersection of the MEI curve and the cost of capital curve, (r +  ). Size of I (in $) Rate of Return (%) Cost of capital = interest rate (r) + depreciation rate (δ) I* MEI Curve Increased depreciation rate I**

Equilibria Increased Education! Size of I (in $) Rate of Return (%) Cost of capital = interest rate (r) + depreciation rate (δ) I* MEI Curve Increased depreciation rate I** Increased Age! Why? MEI Curve w/ increased Education MEI Curve w/ increased Age

Pure Investment and Pure Consumption Models Do we invest in health because it makes us feel good, or do we invest in health because it makes us more productive? If all we care about is the money we can earn, then all we care about is bread. We have vertical indifference curves. We want only the amount that will allow us to earn as much as we can. Health Bread PPP B* H*

If all we also care about health, we get more conventional indifference curves. Health Bread PPP Less bread -- more health PPP B* H* B** H** Pure Investment and Pure Consumption Models

Obesity

Obesity – Health Capital Approach A leading risk factor for heart disease, hypertension (high blood pressure), certain cancers, and type-2 diabetes. According to reports from the CDC in 2012, over one third of U.S. adults (more than 72 million) people and 17% of U.S. children are obese. From 1980 through 2008, obesity rates for adults doubled and rates for children tripled. Obesity describes health capital: –may make the body less productive, –more susceptible to disease, and –possibly cause it to depreciate more quickly.

Obesity and Earnings – Dor et al 2011 For 2004 and 2008 Both obese men and women experienced lower wages compared to their normal weight counterparts. For both genders and all racial categories except Hispanic men, the wage differential narrowed between 2004 and 2008, despite the economy worsening. Obese Caucasian women experienced a wage penalty in both 2004 and 2008, while Caucasian men only experienced a differential in Obese Hispanic women experienced a wage differential in both 2004 and 2008, while obese Hispanic men only experienced a wage differential in Both years, wages for obese African-American men were higher than their normal weight counterparts, while for African-American women, wages were similar between obese and normal weight women.

BMI Health analysts usually measure obesity in terms of Body Mass Index, or BMI, with the formulaBMI CategoryBMI range Severely underweightless than 16 Underweight16 to 18.5 Normal18.5 to 25 Overweight25 to 30 Obese Class I30 to 35 Obese Class II35 to 40 Obese Class III40 and above

2000 Obesity Trends* Among U.S. Adults BRFSS, 1990, 2000, 2010 (*BMI 30, or about 30 lbs. overweight for 5’4” person) No Data <10% 10%–14% 15%–19% 20%–24% 25%–29% ≥30%

2013

Yaniv, Rosin, and Tobol Calories are expended in both in physical activity and when the body is at rest. The rest component, known as Basal Metabolic Rate (BMR), is the largest source of energy expenditure, reflecting blood circulation, respiration and daily maintenance of body temperature. Differing BMRs among individuals indicate why one person can “eat like a horse” and gain little weight, while another may gain weight with far less intake of food.

Obesity – Economic Theory Weight gain as the outcome of rational choice that reflects a willingness to trade off some future health for the present pleasures of less restrained eating and lower physical activity. “Diets” reverse this.

Model Overweight individuals can determine consumption of junk-food meals, F, and healthy meals, H. They may also choose their level of exercise, x. The model defines the weight gain during a period, or obesity, S, as: S = δF + εH − μx − BMR YRT develop the model showing that taxes on junk food (reducing consumption), or subsidies to healthy food (increasing its consumption) could have important impacts on formation of health capital. What do coefficients mean?

Why has obesity increased? Cutler, Glaeser, and Shapiro (2003)

Changes in the time costs of food production Vacuum packing, improved preservatives. Mass preparation –French fries are a pain to make at home –Quick and easy at the restaurants –Food professionals and economies of scale

Time Costs by Group Cutler, Glaeser, and Shapiro (2003) 104.4

References Cutler, David M., Edward L. Glaeser and Jesse M. Shapiro, “Why Have Americans Become More Obese?” Journal of Economic Perspectives 17 (3): 93–118 Yaniv, Gideon, Odelia Rosin, and Yossef Tobel, “Junk-food, Home Cooking, Physical Activity and Obesity: The Effect of the Fat Tax and the Thin Subsidy,” Journal of Public Economics 93 (2009): 823–830