1. 1
Why Health Economics?
15 November 2018

2. Learning Goals
Assess why the special study of health economics makes sense
Understand novel aspects of health care and ways to approach the issues.
Identify how health care markets differ from others, particularly understanding the unique role of health insurance.
Ascertain how medical spending has evolved over time (and why), dissecting the changes over the years in medical spending.
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3. Almost every person deals with the health care system at some point
In the U.S. in 2016, the services, products, institutions, regulations, and people involved in health care accounted for about 18% of gross domestic product (GDP).
$3.3 trillion
$10,500 per person (325 million people)
Almost every person deals with the health care system at some point
There are fundamental differences between health care markets and most other sectors of the economy.
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4. 1.1 Important (If Not Unique) Aspects of Health Care Economics
Extent of government involvement
Dominant presence of uncertainty at all levels of health care (from randomness of illness to understanding of how well treatment options may work)
Large difference in knowledge between health care providers and their patients (consumers of health care)
Externalities—behaviors that impose costs or benefits to those outside the market
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5. 1.1 Important (If Not Unique) Aspects of Health Care Economics
Government Intervention
Licensing of health professionals, often also including private certification of competence
Government intrusion into the market in uncommon ways
2010 Patient Protection and Affordable Care Act (PPACA or ACA) requires:
Citizens must maintain a minimum level of health care coverage
Insurers cannot use preexisting conditions to determine access to health care or premium cost
The establishment of regional “exchanges” to provide insurance in small-group setting
Government provides or subsidizes insurance for a variety of groups (elderly, poor, military, disabled, schoolchildren, those with birth defects or kidney disease)
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6. 1.1 Important (If Not Unique) Aspects of Health Care Economics
Government Intervention, continued.
Price controls, particularly in terms of prices paid by the government to physicians
Control of entry and exit into the market
Hospitals often must comply with regulations to expand or contract number of beds and purchase of some diagnostic devices.
Financial aid by states and federal government for students entering health care fields.
Government research
National Institute of Health (NIH), in Bethesda, MD
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7. 1.1 Important (If Not Unique) Aspects of Health Care Economics
Government Intervention, continued.
Rigorous testing of new drugs and medical devices before they can come to market
Favored tax treatments
Employer-paid insurance exempt from taxation
Most hospitals and insurance plans are granted corporate immunity from taxation
State governments largely exempt such institutions from sales taxes
Local governments largely exempt such institutions from property taxes
Extent of government intervention in health care markets is actually less in the U.S. than in almost all other countries.
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8. 1.1 Important (If Not Unique) Aspects of Health Care Economics
Uncertainty
The need for health care often arises from random events.
Providers confront large amounts of uncertainty.
Different treatment recommendations
Therapies of choice change over time, often with little scientific basis.
Approach to uncertainty differs widely by area
Rigorous testing of new drugs versus discretion on the part of a licensed surgeon
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9. 1.1 Important (If Not Unique) Aspects of Health Care Economics
Asymmetric Knowledge
Asymmetric information problems arise when one party to a transaction has more relevant knowledge than another.
Doctors (and other providers) may have far greater levels of knowledge than patients.
Patients and doctors may have different incentives to reveal or conceal information.
Arrow (1963) stressed the desirability of professional codes of ethics and licensing
“Doctor-patient” relationship
May be difficult to obtain good information about quality of health care
Mistakes may be difficult to correct
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10. 1.1 Important (If Not Unique) Aspects of Health Care Economics
Externalities
Positive externalities create benefits for those not involved in the market.
A flu shot creates benefits both for the person who gets it and for those that the person is in contact with.
Private benefits are less than public benefits, so people will underinvest in flu shots.
Negative externalities create costs for those not involved in the market.
Within the system: use of antibiotics fractionally increase the probability of the development of an antibiotic-resistant strain of bacteria
Outside the system: actions such as drinking and driving impose injuries on others
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11. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Framework for analysis
Assumes that markets are static
Medical Care Markets with Fixed Technology
Supply and demand interact to create the observed quantity demanded and observed price.
Supply and demand are assumed to be independent of each other.
In health care markets, one major difference is that the price that consumers pay is different from the price that sellers receive.
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12. 1.2 How Markets Interrelate in Medical Care and Health Insurance
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13. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Medical Care Markets with Fixed Technology, continued
Some important points from Figure 1.1
The markets for health care and health insurance are interrelated.
Health insurance is different from other types of insurance because there is no objective valuation of the underlying asset.
The PPACA has created new parts of the health care market.
Medical care is a collection of goods and services rather than a single good or service.
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14. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Dynamic Issues: Changes Through Time
Economywide Income Growth
Health care is a normal good, so demand is expected to increase with income.
Real per capita purchasing power has increased by about 2% per year since World War II.
Table 1.1: Per Capita Gross Domestic Product (2015 $)
Year
Per Capita GDP
Medical Care (% of GDP)
1960
$24,100
5.0
1970
$31,900
6.9
1980
$35,400
8.9
1990
$43,300
12.1
1995
$44,600
13.3
2000
$50,100
2005
$53,200
15.0
2010
$52,200
17.4
2015
$56,100
17.8
Source: Bureau of Labor Statistics for per capita GDP. National Center for Health Statistics for medical spending data to compute budget shares.
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15. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Dynamic Issues: Changes Through Time
Demographics
The population of the U.S. is aging.
As people age, health stock deteriorates, and more medical care is used.
Table 1.2: Age Distribution of the U.S. Population
Year
Percentage over 65 Years Old
Percentage under 5 Years Old
1950
8.1
10.8
1960
9.2
11.3
1970
9.8
8.4
1980
7.2
1990
12.6
7.4
2000
12.4
6.8
2010
13.2
6.7
2015
14.9
6.2
Source: census.gov/quickfacts/table/PST04
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16. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Dynamic Issues: Changes Through Time
R&D and Technical Change
Technical change has been extensive, fueled largely by biomedical research
Much is private, and data is hard to obtain.
Government research is extensive, although declining since the 1980s
Table 1.3: Federal Investments in New Knowledge: The NIH Budget Through the Years
Year
Total ($ Million)
Total (Year 2000 $ Million)
Annual Percentage Real Growth
1950 59
360 --
1960 81
431
1.8
1970
1,444
5,630
29.3
1980
3,573
6,823
1.9
1990
7,581
9,299
3.1
2000
17,800
6.7
2010
31,000
24,000
3.0
2015
30,362
22,000
-1.8
Source:
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17. 1.2 How Markets Interrelate in Medical Care and Health Insurance
The Growth in Medical Prices
Difficult to measure because the nature of the service changes
Medical Consumer Price Index (CPI) has two main areas
Medical care services (MCS), largely professional services
Medical care commodities (MCC), drugs and medical equipment
Measurement units:
Standardized list of professional services
Hospital visits
Prescription drugs based on random sampling of pharmacies
Higher prices may mean better quality of service rather than inflation
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18. 1.2 How Markets Interrelate in Medical Care and Health Insurance
The Growth in Medical Prices, continued
Figure 1.2 here
Figure 1.2 shows the overall time trends for the total CPI and the medical component of the CPI since 1960.
With as the base, total CPI is now about 240 while the medical CPI is about 450.
Overall CPI has averaged 3.85% annual growth while the medical CPI has averaged 5.6% annual growth.
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19. 1.2 How Markets Interrelate in Medical Care and Health Insurance
The medical CPI gives an idea of the cost of an activity, but would be better to know the cost of treating an illness
Shifting treatments may lower the cost of hospital stays and thus the cost of treatment, but CPI does not show this
New drugs may be more expensive but require less physician monitoring
Masks important differences in the parts that make up the health care sector
Tables 1.4 shows medical expenditures broken down by category.
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20. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Table 1.4 Price Levels Through Time (Base =100)
Year
CPI
Medical Care
Hospital Services
Physician Fees
Dentist Fees
Prescription Drugs
1960
29.6
22.3
9.3
21.9
27.0
54.0
1965
31.5
25.2
12.3
25.1
30.3
47.8
1970
38.8
34.0
23.6
34.5
39.2
47.4
1975
53.8
47.5
38.3
48.1
53.2
51.2
1980
82.4
74.9
68.0
76.5
78.9
72.5
1985
107.6
113.5
115.4
113.3
114.2
120.1
1990
130.7
162.8
175.4
160.8
155.8
181.7
1995
153.5
223.8
253.0
208.2
205.3
238.1
2000
172.2
260.8
317.3
244.7
258.5
285.4
2005
196.8
323.2
439.2
287.5
324.0
349.0
2010
225.0
400.0
600.0
340.0
425.0
2015
236.0
454.1
772.6
370.3
455.5
481.1
Source: Bureau of Labor Statistics, Consumer Price Index
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21. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Examining Table 1.4 shows that looking only at the aggregate figures is misleading.
Between 1960 and 2015, overall prices had increased by a factor of 8, and medical prices by a factor of 20.
Hospital services increased by a factor of 83, physician and dentists’ services both by a factor of about (a bit more than twice the CPI rate), and prescription drugs by about the same as the CPI.
In recent years, prescription drugs have been the fastest growing part of the medical market basket.
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22. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Table 1.5 Annual Nominal Expenditures for Medical Services ($ billions)
Year
Total
Hospital
Physician
Drug
Other
Nursing Home
1960
23.3
9.2
5.4
2.7
5.3
0.8
1970
62.9
27.6
14.0
5.5
11.8
4.0
1980
215.0
101.0
47.1
12.0
36.2
19.0
1990
608.0
252.0
157.5
40.3
106.0
52.6
1995
864.0
341.0
220.5
60.9
168.0
74.1
2000
1,140.0
417.0
288.6
121.0
218.0
95.3
2005
1,661.0
612.0
421.2
201.0
306.0
122.0
2010
2,596.0
822.0
513.0
253.0
450.0
140.0
2015
3,206.0
1,036.0
634.0
325.0
602.0
157.0
Relative Amount
2015/1960
138.0
113.0
117.4
120.0
114.0
196.0
Source:
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23. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Medical Spending Patterns
Although technical change makes simple measures misleading, examining spending on health care provides some insight.
Table 1.5 shows nominal spending on various health care categories.
Over the period, most spending increased by a factor of about 100.
Nursing home care increased by a factor of 200, due to the aging of the population.
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24. Dynamic Issues—Changes Through Time
Table 1.6 Annual Expenses for Medical Services (2015 dollars, billions)
Year
Total
Hospital
Physician
Drug
Other
Nursing Home
1960
153.0
73.7
43.2
21.5
42.4
6.4
1970
316.0
169.0
85.5
33.6
72.1
24.4
1980
510.0
290.0
135.5
34.5
104.0
54.6
1990
908.0
456.0
285.6
73.1
191.0
95.4
1995
1,107.0
530.0
342.9
94.7
260.0
115.0
2000
1,293.0
574.0
397.2
166.0
300.0
131.0
2005
1,661.0
742.0
511.1
244.0
371.0
148.0
2010
2,147
893.0
557.3
275.0
489.0
152.0
2015
3,206.0
1,036.0
634.0
325.0
602.0
157.0
Relative Amount
2015/1960
20.9
14.1
14.7
15.0
14.2
24.5
Source:
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25. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Medical Spending Patterns
Dividing nominal spending by the CPI gives a measure of real spending in these categories (Table 1.6).
Table 1.6 shows that most of the spending increases over the period were actually due to inflation.
Table 1.7 adjusts spending on the assumption that population had been the same in every year as it was in 2015.
Table 1.8 adjusts spending on the assumptions that population was the same as in 2015 and that prices were constant (and that medical prices stayed the same relative to the overall price level).
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26. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Table 1.7 Annual Expenses (constant 2015 dollars, 2005 population, $ billions)
Year
Total
Hospital
Physician
Drug
Other
Nursing Home
1960
273.1
131.0
77.0
38.5
75.5
11.4
1970
496.0
264.0
134.1
52.7
113.0
38.3
1980
720.0
410.0
191.2
48.7
147.0
77.1
1990
1,166.0
586.0
366.7
93.8
246.0
122.0
1995
1,342.0
642.0
415.5
115.0
316.0
140.0
2000
1,471.0
653.0
451.8
189.0
341.0
149.0
2005
1,801.0
805.0
554.1
403.0
160.0
2010
2,227.0
926.0
578.2
285.0
507.0
158.0
2015
3,206.0
1,036.0
634.0
325.0
602.0
157.0
Relative Amount
2015/1960
11.8
7.9
8.2
8.4
7.8
13.8
Source:
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27. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Table 1.8 Annual Expenses in Constant 2015 Population and Constant Relative Prices (constant 2015 dollars, 2015 population, $ billions)
Year
Total
Hospital
Physician
Drug
Other
Nursing Home
1960
686.0
330.0
193.5
96.8
190
28.7
1970
1,070
571.0
289.4
84.1
244.0
82.7
1980
1,498.0
853.0
397.8
70.2
306.0
160.0
1990
884.0
553.2
98.4
371.0
185.0
1995
1,748.0
837.0
541.4
101.0
411.0
182.0
2000
1,835.0
815.0
563.7
426.0
186.0
2005
2,055.0
918.0
632.3
201.0
460.0
183.0
2010
2,360.0
982.0
612.6
255.0
537.0
167.0
2015
3,206.0
1,036.0
634.0
325.0
602.0
157.0
Relative Amount
2015/1960
4.7
3.1
3.3
2.6
3.2
3.5
Source:
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28. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Table 1.9 Selected Medical Care Use by Age, Per Person, 2005
Age
Ambulatory Visits
Hospital Days
Ambulatory Prescriptions
Total Personal Spending
Under 18
2.53
0.20
3.30
$2,650
18-44
2.24
0.33
4.70
$3,370
45-54
3.44
0.47
8.40
$5,210
55-64
4.58
0.71
12.40
$7,787
65-74
6.47
1.40
18.40
$10,778
75+
7.68
2.59
23.60 --
75-84
$16,389
85+
$25,691
Sources: CDC, Health 2008, Table 92 (ambulatory), Table 99 (hospital days), and Table 128 (prescription use). Total personal medical spending from personal communication, Sean Keehan, Center for Medicare Services, Office of the Actuary, National Health Statistics Group.
Note: Total personal spending accounts for only 83 percent of total health care spending (by excluding, e.g., research and administrative costs) so these totals are lower than total per capita medical spending for the U.S.
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29. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Table Age Distribution of the U.S. Population
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30. 1.2 How Markets Interrelate in Medical Care and Health Insurance
Medical Spending Patterns
From Table 1.7, real per capita spending on health care has increased by a factor of 11.8.
Real per capita income doubled, increasing the demand for health care.
Demand in income-elastic, increasing budget share over time.
The relative price of medical care increased by a factor of 2.5 over the period.
The bottom rows of Tables 1.7 and 1.8 differ due to the increase in the relative price of health care – a growth factor of 11.8 counting the increase in relative prices becomes “only” 4.67 if relative prices had not changed.
From this, we can also estimate that the income elasticity of demand for medical care is about 2.5.
Decomposing the changes over time into annual growth rates shows that the relative price of medical care has increased at 1.7 percent faster over time than the overall CPI.
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31. 1.2 How Markets Interrelate in Medical Care and Health Insurance
How Much Spending Growth Arises from Population Aging?
Table 1.9 shows selected medical care use by age, per capita.
Table 1.10 shows the age distribution of the population.
Using these two tables allows calculation of estimated spending if the age distribution had not changed.
Using the 1960 population distribution, the average is only 82 percent of what we get using the 2015 population distribution.
Thus 18 percent of the growth in medical spending is due to the aging of the population.
Had the age mix of the population remained constant at the 1960 levels, we would be spending 82 percent of that, or percent of our GDP. The remaining 3.25 percent of GDP is a result of the aging population.
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32. 1.2 How Markets Interrelate in Medical Care and Health Insurance
How Much Spending Growth Arises from Population Aging?
Extrapolating to 2050, using the Census Bureau projections, estimated spending is 30 percent higher than in 2015 simply because of the changing age mix.
If nothing else changes in our health economy between now and 2050 except for the age mix of the population, we will spend 23 percent of our GDP on health care.
If medical care prices continue to rise at 1.7 percent per year above inflation, we would that forecast 42 percent of GDP will be devoted to health care spending in 2050.
15 November 2018