1. CHAPTER 9 The Health Care Market McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

2. U.S. Expenditures of Selected Goods and Services as Share of GDP (1960-2007)
Source: US Bureau of the Census [2009, pp. 95, 425], and National Income and Product Accounts

3. Social Insurance
Social insurance - government programs that provide insurance to protect against adverse events
Examples
Medicaid
Medicare
Social Security
Unemployment Compensation

4. How Health Insurance Works
Insurance premium
Expected Value
Expected value (EV) = probability of outcome 1) * (Payout in outcome 1) + probability of outcome 2)*(Payout in outcome 2) + … + (probability of outcome n)*(Payout in outcome n)

5. Expected Value Computation
Draw cards from deck of cards
Draw heart and receive $12
Draw spade, diamond or club and lose $4
Probability of drawing heart = 13/52 = ¼
Probability of drawing spade, diamond or club = 39/52 = ¾
EV = (1/4)($12) + (3/4)(-$4) = $0

6. Actuarially Fair Insurance Policy
Why Buy Insurance?
Insurance Options
Income
Probability of Staying Healthy
Probability of Getting Sick
Lost Income if She Gets Sick
(A)
(B)
(C)
Income if She Stays Healthy
Income if She Gets Sick
Expected Value
Option 1: No Insurance
$50,000
9 in 10
1 in 10
$30,000
$20,000
$47,000
Option 2: Full Insurance ($3,000 premium to cover $30,000 in losses
Actuarially Fair Insurance Policy

7. Why People Buy InsuranceUB
Utility D UD UC C
Expected Utility
Risk Smoothing A UA
Income
20,000
47,000
50,000

8. Do People Buy Insurance with Loading Fees?
Risk Aversion
Risk Premium
Loading Fee

9. The Role of Risk Pooling
Insurance in a small population
Insurance in a large population
Law of large numbers

10. Adverse Selection in the Health Insurance Market
Asymmetric information

11. Asymmetric Information and Adverse Selection
(A)
(B)
(C)
(D)
(E)
(F)
Expected Benefit
Probability of
Lost Income
Expected
Minus Premium
Insurance Buyer
Getting Sick
if Sick
(Differential Premiums)
(Premium = $3,000)
(Premium = $4,500)
Emily
1 in 5 (High Risk)
$30,000
$6,000 $0
$3,000
$1,500
Jacob
Emma
Michael
Madison
Joshua
1 in 10 (Low Risk)
-$1,500
Olivia
Matthew
Hannah
Ethan
Insurer's Net Profits
-$15,000

12. Does Adverse Selection Justify Government Intervention?
Experience rating
Experience rating and equity
Community rating

13. Insurance and Moral Hazard
Deductible
Co-payment
Co-insurance

14. Moral Hazard Flat-of-the-curve medicine Price per unit deadweight lossb Sm
Axes and labels
1st click – Dm
2nd click – Sm,
3rd click - brown rectangle
4th click - .2P0
5th click - gray rectangle
6th click – deadweight loss triangle
7th click – “Flat-of-the-curve medicine” P0 h
.2P0 Dm M0 M1
Medical services per year

15. Additional Considerations
The Elasticity of Demand for Medical Services
Does Moral Hazard Justify Government Intervention?
Third Party Payment

16. Other Market Failures in the Health Care Market
Information Problems
Externalities

17. Do We Want Efficient Provision of Health Care?
Paternalism
The Problem of the Uninsured
Who are the uninsured?
Does health insurance improve health?

18. High Health Care Costs
Source: Organization for Economic Cooperation and Development [2008a].

19. Causes of Health Care Cost Inflation
The Graying of America
Income Growth
Improvements in Quality
Commodity Egalitarianism