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Health Care; Information
Today: More topics to help you think like an economist
Today
Three more “mini-lectures” Health care The economics of information Asymmetric information
Health care
“By 2017, total health care spending will double to more than $4 trillion a year, accounting for one of every $5 the nation spends, the federal government projects.”(Source: AP article on CBS’ website, “Health Care Will Cost $4 Trillion by 2017,” posted Feb. 26, 2008; see readings on class website for link)
Health care More from the AP article, quoting
Centers for Medicare and Medicaid Services economists "Health is projected to consume an
expanding share of the economy, which means that policymakers, insurers and the public will face increasingly difficult decisions about the way health care is delivered and paid for"
Health care
As we will see, there is often too much money spent on health care, relative to the optimal amount of spending
We will look at a simple case with constant MC
Health care Health care
services, like all goods and services, have a demand schedule Demand denoted
by MB curve
Health care Suppose that
Angela has been admitted to the hospital after being in a car accident
She has a substantial MB for the first night in the hospital, due to the care that she needs
Health care As Angela’s
condition improves, her MB declines
After Q2 days in the hospital, she is completely better
Will Angela pay for the full cost of her hospital stay? Not likely
Most Americans have at least some health insurance
Insured person usually pays a deductible or co-payment for medical services
Some people have complete medical coverage
No direct payment made to those that provide medical services
Equilibrium length of hospital stay with co-payment
Assume that Angela pays X dollars (co-payment) for her hospital stay Let X be small relative to total hospital
bill Angela will then decide to stay in the
hospital as long as MB for each night exceeds its MC Note that Angela’s private MC is zero
under this form of insurance
Equilibrium length of hospital stay with co-payment PUBLIC MC is positive Angela’s PRIVATE MC
is zero If hospital lets Angela
stay in the hospital as long as she wants, equilibrium occurs at Q2
MB and private MC are both zero here
What is optimal? Angela’s optimal
length of hospital stay occurs when the PUBLIC MC equals MB This occurs at
point A
What about a percentage co-payment? What if Angela
had to pay 20% of her costs while in the hospital Her PRIVATE MC
is now two-tenths of MC curve (See dashed line)
Equilibrium is at the yellow circle
0.2 MC
What are some possible solutions to this problem? Health Maintenance Organizations (HMOs)
Patients less likely to receive services with low MB
Higher deductibles Closer to optimal outcome, since out-of-pocket
payments are higher Reimbursement policies for medical
services Review boards Discharge criteria from hospitals
Moral hazard With insurance, people are likely to do
riskier activities, knowing that insurance will cover them if they get hurt Skydiving Bungee jumping Mountain climbing
These activities lead to more medical costs, leading to higher premiums for everyone
Health care costs
Is there a single solution to lowering health care costs? No: Many approaches will be needed
Another issue: Drug costs Research and Development: Often
millions of dollars for a single drug Patent protection Market power
Summary: Health care Insurance often leads to more health
care being used than what is optimal Co-payments help improve efficiency
some, but not completely Some methods to help lower health
care costs include the use of HMOs, higher deductibles, and reimbursement policies
The economics of information
Information is valuable, since the right buyer is more likely to find the right seller Middleman is often knowledgeable
about a market, which is valuable This leads to the question: How much
information is optimal?
Information is typically not complete nor perfect
Since firms and customers are usually not fully informed, we lose efficiency Firms are unable to notify every
potential customer that her/his business is ready to sell
Customers may not know all options of companies that sells a good or service
Do we want full information in every market?
No Prohibitively costly, if it is even
possible In our analysis, we will find the
optimal amount of information
The middleman A good middleman (or
middlewoman) is knowledgeable about the market in question Some customers are willing to pay for
this service Some information providers today
are not human Google and many other search
engines have paid advertising
What is optimal?
As usual, we will use marginal analysis We will search for information is long
as MB > MC The middleman often provides this
information, but at a cost
More on the middleman Basic information can be
provided at low cost, since many people are usually knowledgeable in the topic
Very specialized information can be costly Someone may have to do
substantial research to get this specialized information
MC of information usually increases at an increasing rate
Marginal benefit of information
Basic information about a product is usually very valuable
Very specialized information usually has little value
MB of information typically gets steeper as the number of units increases
Some examples of MC and MB curves of information
Optimal amount of information?
Find the point where MB = MC
Example: Use MC1 and MB1 curves Optimal amount
of information is 7 units, at a cost of $15 per unit
Summary: The economics of information
Information is useful, and thus has value MB/MC analysis still applies The “middleman” often provides
information, at a price
Asymmetric information Some markets have sellers knowing
more about their product for sales than buyers This is known as asymmetric information
Most common example: Used cars Buyer knows less about the car than the
seller Some cars are good: “plums” Some cars are bad: “lemons”
Lemons model
When buyers do not have information as to which cars are lemons and which cars are plums, sometimes only the lemons go on the market
We will go through two examples to show a case where only lemons are available on the market
Example 1 A used car dealer has the
following information about used Yugo limos: Plums are worth
$3,000 to the dealer $1,200 to the owner
Lemons are worth $250 to the dealer $100 to the owner
100 Yugo limos owned privately Half of the limos are plums, half are
lemons
Yugo car
Yugo limo
What should the used car dealer offer for Yugo limos? Suppose the used car dealer offers
$1,201 for used Yugo limos 1,201 > 1,200 Plum owners sell to dealer 1,201 > 100 Lemon owners sell to dealer
Profit if all 100 are bought Total value = 50 3,000 + 50 250 =
$162,500 Total cost of buying Yugos = 100 1,201 =
$120,100 Total profit = $162,500 - $120,100 = $42,400
What should the used car dealer offer for Yugo limos?
Should the used car dealer offer an amount other than $1,201? Offer a higher price increased cost
for no gain in value Offer a price below $1,200 only the
lemon owners would sell their cars Profit if $101 was offered 50 (250 –
101) = $7,450
What is the best price to offer?
Offer $1,201 profit is $42,400 Offer $101 profit is $7,450 Highest profit occurs if $1,201 is
offered
Example 2: Everything is the same except the last bullet point
A used car dealer has the following information about used Yugo limos: Plums are worth
$3,000 to the dealer $1,200 to the owner
Lemons are worth $250 to the dealer $100 to the owner
100 Yugo limos owned privately One-quarter of the limos are plums, three-
quarters are lemons
What should the used car dealer offer for Yugo limos? Suppose the used car dealer offers
$1,201 for used Yugo limos 1,201 > 1,200 Plum owners sell to dealer 1,201 > 100 Lemon owners sell to dealer
Profit if all 100 are bought Total value = 25 3,000 + 75 250 =
$93,750 Total cost of buying Yugos = 100 1,201 =
$120,100 Total profit = $93,750 - $120,100 = –$26,350
Notice here that the dealer will never offer $1,201
Why? Profits are negative Profits can be zero by not attempting
to buy Yugo limos
What should the used car dealer offer for Yugo limos?
Offer a price below $1,200 only the lemon owners would sell their cars Profit if $101 was offered 75 (250
– 101) = $11,175 Offer $101 to maximize profit
What else could the car dealer do?
The dealer could hire a mechanic to try to determine if the Yugo limos are lemons or plums Will do it if MB of information exceeds
MC
Summary: Asymmetric information
The Lemons model Under what conditions will plums
never enter the market?
Wednesday Other topics E-mail me by tonight if you want to see
any of the following topics covered Public goods Labor markets (value of work; human
capital; more on unions; discrimination; income distribution)
Government failure Taxation The internet and information
Sick? lemons are good (Vitamin C)Driving? lemons are bad