2. Technology © Allen C. Goodman, 2013

3. Introduction Start with a typical production relationship of: Q = f (K, L) Ignoring returns to scale, or anything of that type, we could conceive of technology as: Q t+1 = f t+1 (K 0, L 0 ) Q t = f t (K 0, L 0 ). The difference in Q is often referred to as technological change. Labor Capital L0L0 K0K0 Q t+1 QtQt QtQt

4. More Technological Change At a given factor price ratio, we simply re-label the isoquant, so at the same total costs, the cost per unit has fallen. Alternatively, for the same quantity, the total costs have fallen. Labor Capital L0L0 K0K0 Q t+1 This might be considered to be "neutral" technological change; alternatively we might have "labor-saving" or "capital- saving" depending on what the new equilibrium is. Typically, technology is measured as a residual. Once you've controlled for changes in labor and capital, what's left?

5. Technology ↔ Costs Average Cost = Total Cost/Quantity, so suppose TC = $1,000,000 and Q = 1,000. AC = $1,000/unit If (given same input costs) Q ↑ to 1,010, AC = $990.10.

6. Health Care Health care technology has some interesting twists. For example, consider innovations that are considerably higher cost, but also are much higher quality. For example, various major surgeries, or things like heart valves. They are more expensive, but they also allow people to live longer. Plotting the cost of a unit of output, we see that technological change might lead to increases in costs. So we see curiously outward shifting (indexed on quality isoquants).

7. Weisbrod’s Examples Polio vaccines have decreased the demand for insurance by decreasing both the expected cost of treating the illness, and the cost variance. They have reduced the expected level of expenditures, as well as the variance around the mean. In the process, they have reduced the demand for health insurance. Organ transplants, on the other hand, have both increased the mean and the variance of desired individual expenditures, conditional on medical need. Before, a person with serious liver malfunction, simply died, with comparatively little health care expenditure. Here are some numbers!

8. Allogenic: Taken from others; Autologous – From Self Milliman, 2011

11. Quality Adjusted Cost Indices If quality increases, then what may appear to be increase costs, may in fact decrease costs. Cutler et al recalculated costs for myocardial infarction (heart attack) treatment. Adjusted for gains in either life years or in QALYs.

12. Comparing Approaches Unadjusted IndicesAve. Annual Price Change Official Medical Care CPI Hospital Component3.4% Room6.2 Other Inpatient Services6.0 Heart Attack – unadjusted2.8 Quality Adjusted Indices Quality (extra years of life)-1.5% Quality (extra QALYs)-1.7%

13. Adjusting for Quality Consider a procedure. Costs $500,000 and provides 10 QALYs. Cost/QALY = $50,000. Suppose the next year the procedure costs $520,000. It looks like Cost/QALY has risen by 4%. Suppose, however, that it raises # of QALYs to 10.5. Costs have ↑ by 4%, QALYs have ↑ by 5%. Costs/QALY have fallen by about 1%. $520,000/10.5 = $49,524. So, with tech change, what looked like a cost increase is a cost DECREASE.

14. Goddeeris Model (Chapter 11) Goddeeris - 1984 SEJ He takes an interesting look at the interaction between insurance and incentives in medical care. He finds: - If willingness to pay is not related to income, then insurance fundamentally biases innovation toward more expensive procedures. Godderis grew up in East Detroit, went to U of M, Wisconsin, has taught at MSU for a number of years.

15. Innovation Possibility Curve Increased Health Expenditures,  m Improvements in Health,  h  h (  m) Traditional Depiction of Technological Improvement Cost- Reducing Cost- Increasing (0,0)

16. Innovation Possibility Curve Increased Health Expenditures,  m Improvements in Health,  h Dh (Dm) Traditional Depiction of Technological Improvement Cost- Reducing Cost- Increasing Extra Profits (E) =  h/z -  m   h =zE + z  m E1E1 E2E2 E3E3 E4E4 E5E5 Provider would like to make money by innovating with  m and charging  h.

17. Innovation Possibility Curve Increased Health Expenditures,  m Improvements in Health,  h Dh (Dm) Traditional Depiction of Technological Improvement Cost- Reducing Cost- Increasing Equilibrium occurs at tangency of Extra Profits curve and innovation curve. Why there? E1E1 E2E2 E3E3 E4E4 E5E5  m*  h*

18. Innovation Possibility Curve Increased Health Expenditures,  m Improvements in Health,  h Dh (Dm) Traditional Depiction of Technological Improvement Cost- Reducing Cost- Increasing What happens if the coinsurance rate decreases? A> z decreases. E1E1 E2E2 Extra Profits (E) =  h/z -  m  h =zE + z  m

19. Innovation Possibility Curve Increased Health Expenditures,  m Improvements in Health,  h Dh (Dm) What happens if the coinsurance rate decreases? A> z decreases. E1E1 E2E2 Extra Profits (E) =  h/z -  m  h =zE + z  m Increase in rate! Increase in health!