1. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Using Economics to Make Better Policy Decisions 1.Describe how the Scarcity Principle applies to choices involving health 2.Use the Incentive Principle to explain why health care costs have been rising so rapidly 3.Discuss pollution taxes and effluent permits as a means to reduce the cost of improved air quality 4.Illustrate why free trade is often politically controversial even though it promises to increase total income 5.Assess the economic pros and cons of various components of the social safety net

2. 10-2 Health Care Delivery Health care spending has grown faster than income –Up from 4% of national income in 1940 to 16% in 2010 –Part of the increase is due to improved quality of tests, procedures, drugs, etc. –Part is due to the third-party payment system Growth in use of insurance for payments ( Employer-provided and government-provided) Cost-benefit test assures efficient allocation of health care –Perform a service only if the benefit exceeds the cost Costs are easy to measure Benefits are complicated –Usual measure is willingness to pay marginal cost Some patients are unable to pay for basic services ( government-provided insurance) –Confused by third-party payment system

3. 10-3 Health Care for Employed Employer pays insurance on behalf of employee –Employees pay part of the insurance premiums Medical provider cares for patient / employee –Patient co-pay Medical provider bills insurance –Insurance company pays provider Insurance company periodically reviews employer's policy and adjusts rates Medical Provider Patient / Employee Employer Insurance Company

4. 10-4 Insurance, Demand, and Waste Amount of waste from full insurance depends on the price elasticity of demand for medical services Research compared patients with first dollar coverage to those with $1,000 deductibles –First-dollar coverage pays all expenses for the insured's health care –$1,000 deductible pays all expenses after the patient has paid $1,000 –Deductible patients spent 40 – 50% less on health care and had the same health outcomes

5. 10-5 Policy Implications Research shows that when individuals pay for their health care, they consume less A more efficient system can be designed –Adopt a system of high deductible health insurance –Use stipend payments for the poor An efficient policy will increase the size of the health care pie

6. 10-6 Health Maintenance Organization (HMO) A Health Maintenance Organization is a group of physicians that provides health services for a fixed annual fee –Reduced incentives to prescribe expensive tests The doctor receives no additional fee for prescribing and interpreting tests In most cases, diagnoses and treatment will be the same with conventional health insurance and with an HMO –HMO costs less than conventional health insurance

7. 10-7 US Health Insurance In 2007, 47 million Americans had no health insurance –Cost of a policy for a family of 4 generally exceeds annual health spending for the family –Stigma of being irresponsible is fading –Adverse selection problem If the healthy opt for no insurance, the insured are those with known health problems or risks (Raises costs for remaining insured) A possible solution –Government payment of $5,000 to each family –Health care market efficiency increases Patients decide, not insurance companies –Cost to government would be $350 billion per year Higher taxes offset by higher salaries and reductions in high- cost care for the uninsured

8. 10-8 Price Incentives and the Environment Goods with negative externalities tend to be overproduced Social objective is to reduce pollution by half from its unregulated level –The most efficient solution is one where the marginal cost of pollution abatement is the same for all polluters Cost data are not available to government –One solution is to have all reduce pollution by the same proportion Uneven distribution of costs

9. 10-9 Taxing Pollution If tax is $T per ton, the firms will reduce pollution as long as the cost of reductions is less than $T A tax of $101 moves Sludge to B and NW Lumber to D Total cost is $100 for Sludge + $180 for NW = $280/day –Net savings of $300/day over regulation Process (smoke) A (4 T/day) B (3 T / day) C (2 T/day) D (1 T/day) E (0 T/day) Sludge Oil ($/day) $100$200$600$1,300$2,300 NW Lumber ($/day) $300$320$380$480$700 Cost of Production and Amount of Smoke Emitted

10. 10-10 Price Incentives and the Environment Taxing pollution concentrates pollution reduction in firms that can accomplish it at the least cost –Cost – Benefit Principle –Cost of the last ton of smoke removed is the same for all firms It can be difficult to determine the optimal tax rate –Set the tax too high and you get too little reduction –Set the tax too low and you get too much reduction Marginal cost exceeds marginal benefit to society

11. 10-11 Auctioning Pollution Permits Set a target level for total pollution allowed –Auction 4 permits to allow 4 tons/day Determine price of a permit, who buys them, and the total cost of pollution reductions Process (smoke) A (4 T/day) B (3 T / day) C (2 T/day) D (1 T/day) E (0 T/day) Sludge Oil ($/day) $100$200$600$1,300$2,300 NW Lumber ($/day) $300$320$380$480$700 Cost of Production and Amount of Smoke Emitted

12. 10-12 Auctioning Pollution Permits Process (smoke) A (4 T/day) B (3 T / day) C (2 T/day) D (1 T/day) E (0 T/day) Sludge Oil ($/day) $100$200$600$1,300$2,300 NW Lumber ($/day) $300$320$380$480$700 Cost of Production and Amount of Smoke Emitted # permits1234 Sludge Oil ($/day) $1,000$700$400$100 NW Lumber ($/day) $220$100$60$20 Benefit of Permits

13. 10-13 Resistance to International Trade International trade benefits both exporting country and importing country –Exporter gets a higher price abroad than he could get at home –Importer pays less than he would pay for the same product made domestically Blockades and sanctions limit a country's trade –Civil War blockade of the South –Current trade sanctions against Iran Opposition focuses on groups who lose from free trade and ignores the benefit to the economy as a whole

14. 10-14 Resistance to International Trade Suppose Brazil has a comparative advantage in coffee and the US has a comparative advantage in computers –If Brazil allows the free importation of computers, Brazilians get more computers and pay a lower price –Brazilian computer manufacturers are harmed Price has decreased, so inefficient firms fail Surviving firms earn lower profits In general -- –Consumers are helped by imports –Domestic producers of imported goods are hurt by free trade

15. 10-15 Resistance to International Trade Suppose Brazil exports coffee to the US –Price of coffee in Brazil increases, hurting domestic consumers –Producers of coffee benefit from a higher price and a larger market In general -- –Consumers are hurt by exports –Domestic producers of exported goods benefit from free trade

16. 10-16 Restricting Trade Protectionism is the view that free trade is injurious and should be restricted "Protecting" domestic markets is achieved in several ways –A tariff is a tax on an imported good Raises the price of the import and reduces quantity imported –A quota is a legal limit on the quantity of a good that can be imported Reduces supply of imports and increases the market price for the good compared to free trade

17. 10-17 Income Redistribution Raising incomes of the needy reduces the incentive to work –Difficulty distinguishing between needy and others Risk takers may appear "needy" People who prefer not to work ineligible Hurricane victims No perfect solution –Choose among imperfect alternatives

18. 10-18 Welfare Payments and In-kind Transfers In-kind transfers are direct transfers of goods or services –Food stamps, Medicaid, public housing, free school lunches From mid 1960s to 1996, Aid to Families with Dependent Children (AFDC) provided cash –Sometimes required no adult male in the household Destabilizing for families –Created persistent dependence on AFDC

19. 10-19 Means-Tested Benefit Programs A means-tested program decreases benefits as the recipient's other income increases –Intends to avoid paying benefits to those who can support themselves Administrative structure discourages work –If benefits are reduced by $1 for each $2 earned, participants in multiple programs may lose more benefits than the income they earn Administrative costs are high –Simplify the program and distribute the cost savings to the needy

20. 10-20 Earned Income Tax Credit (EITC) An earned-income tax credit is a policy under which low-income workers receive credits on their federal taxes A family of four earns $15,000 –EITC is $4,750 –Federal taxes are reduced by $4,750 If taxes are less than EITC, a refund is issued EITC does not interfere with market incentives –Affects only people who work –Allows labor markets to reach equilibrium

21. 10-21 Public Employment for the Poor Overcomes the shortcomings of the EITC and NIT –EITC does not help the unemployed –NIT reduces the incentive to work Government could employ the poor –If wages are the same as the private sector, some workers will prefer government jobs Increases the cost of the program –Make-work programs are not productive –Increases size of government

22. 10-22 A Combination of Methods –Use a NIT with payment set below the poverty threshold –Set the public service wage below the minimum wage –Privatize the management of the public service employment program NIT Public Job NIT + Public Job NIT + Private Job Poverty threshold