The Economics of Health Care: Microeconomics Study Notes

The Economics of Health Care

Introduction

This chapter explores the microeconomic principles underlying the health care sector, focusing on health outcomes, health care systems, information problems, externalities, and policy debates. Health care is a major component of the U.S. economy, and its unique characteristics make it a rich field for economic analysis.

7.1 The Improving Health of People in the United States

Trends in U.S. Health Over Time

• Health care refers to goods and services intended to maintain or improve a person’s health, including prescription drugs, doctor consultations, and surgeries.

• U.S. health care expenditure is higher than anywhere else in the world, due to high quality, payment systems, and high demand.

• Life expectancy and health outcomes have improved dramatically, especially in the twentieth century.

• Key factors: improvements in nutrition, public health, sanitation, and food distribution.

• Feedback loop: better health leads to higher incomes, which further improves health.

Health Outcomes: Historical Comparison

• Advances in medical prevention and treatment have reduced death rates, especially from cardiovascular disease.

• Obesity-related illnesses have increased in recent years.

7.2 Health Care Around the World

Comparing Health Care Systems

• Health care systems differ in who provides care and who pays for it.

• In the U.S., most health care is provided by private firms and paid for through health insurance.

• Health insurance: A contract where buyers pay premiums in exchange for coverage of medical bills.

• Insurance payments: Fee-for-service (payment per service) vs. Health Maintenance Organizations (HMOs) (flat fee per patient).

Sources of Health Insurance in the U.S.

• About 49% receive insurance through employers, 35% through government programs, and 9% are uninsured (2016 data).

• The Affordable Care Act (ACA) reduced the uninsured rate by providing subsidies and penalties.

• Reasons for being uninsured: perceived unaffordability or unnecessary due to good health.

Health Care Systems in Other Countries

• Canada: Single-payer system; government provides insurance, private firms provide care, funded by taxes.

• Japan: Universal health insurance; residents enroll in nonprofit societies or government programs, with copayments.

• UK: Socialized medicine; government owns hospitals and employs doctors, with some private insurance supplementation.

Health Care as a Normal Good

• Higher income leads to higher health care expenditure.

• The U.S. spends a greater proportion of income on health care than other countries.

Health Outcomes in High-Income Countries

• Life expectancy, health risks, diagnostic equipment, and cancer rates vary across countries.

• Comparisons are complicated by data collection methods, lifestyle choices, and consumer preferences.

7.3 Information Problems and Externalities in the Market for Health Care

Asymmetric Information

• Asymmetric information: One party in a transaction has less information than the other, leading to market failure.

• Two main forms: Adverse selection and Moral hazard.

Adverse Selection

• Occurs when one party takes advantage of knowing more than the other.

• In health insurance, those most likely to use insurance are most likely to buy it, raising premiums and excluding moderate-risk individuals.

• Mitigation: Excluding pre-existing conditions, mandating insurance (e.g., ACA individual mandate).

Moral Hazard

• Occurs when actions after entering a transaction make the other party worse off.

• Patients may overuse health care when not paying full cost; doctors may order unnecessary procedures (principal-agent problem).

• Mitigation: Deductibles, coinsurance, standardized payments.

Externalities in Health Care

• Positive externalities: Vaccinations benefit others, healthy populations benefit employers.

• Negative externalities: Poor health choices increase costs for others.

• Market failure occurs when external costs or benefits are not reflected in prices.

Positive Externality Example: Vaccinations

• Marginal social benefit exceeds marginal private benefit, leading to underconsumption and deadweight loss.

• Subsidies can reduce this problem.

7.4 The Debate Over Health Care Policy in the United States

Major Issues in U.S. Health Care Policy

• The ACA aimed to increase coverage and regulate insurance, but remains controversial.

• The U.S. spends more per person on health care than other countries, with rising costs.

Reasons for Rising Health Care Costs

• Paperwork, malpractice lawsuits, and uninsured patients contribute, but are not the main drivers.

• Cost disease: Service sector productivity gains lag behind manufacturing, but wages rise to retain workers.

• Aging population increases demand for health care.

• Third-party payer system distorts incentives, leading to overconsumption and deadweight loss.

Policy Responses and Debate

• Attempts at universal coverage have failed multiple times.

• The ACA included mandates, marketplaces, Medicaid expansion, and tax changes.

• Debate continues over government vs. market-based reforms.

Tax Treatment of Health Insurance

• Employer-provided health insurance is tax-exempt, favoring generous plans.

• Removing this tax preference could reduce spending by 33% for those enrolled.

Medicare for All: Pros and Cons

• Pros: Universal coverage, less paperwork, cost savings.

• Cons: High cost, reduced flexibility, less innovation, increased moral hazard.

• Intermediate reforms include expanding Medicare or Medicaid eligibility.

Conclusion

Health care expenditure is projected to consume nearly 20% of national income by 2025. Policymakers must balance cost control with maintaining quality and access. The debate over health care policy is ongoing and complex, involving economic, social, and political considerations.

Key Terms and Concepts

• Health care: Goods and services to maintain or improve health.

• Health insurance: Contract for coverage of medical expenses.

• Adverse selection: Market failure due to asymmetric information.

• Moral hazard: Risk of overuse or risky behavior due to insurance.

• Externalities: Costs or benefits not reflected in market prices.

• Cost disease: Rising costs in service sectors due to lagging productivity.

Important Formulas

• Deadweight Loss from Externalities: $DWL = \frac{1}{2} \times (Q_{social} - Q_{private}) \times (P_{social} - P_{private})$

• Marginal Social Benefit: $MSB = MPB + Externality$

• Coinsurance Payment: $Payment = Total\ Cost \times Coinsurance\ Rate$

Table: Comparison of Health Care Systems

Country	System Type	Provider	Payment
United States	Mixed (Private/Public)	Private Firms	Insurance (Employer, Government, Individual)
Canada	Single-Payer	Private Firms	Government Insurance (Taxes)
Japan	Universal Insurance	Private Firms	Nonprofit Societies/Government, Copayments
UK	Socialized Medicine	Government	Government (Taxes), Some Private Insurance

Table: Key Information Problems in Health Care

Problem	Description	Example	Mitigation
Adverse Selection	High-risk individuals buy insurance	Health insurance premiums rise	Mandates, Exclusions, ACA reforms
Moral Hazard	Overuse after insurance purchase	Unnecessary doctor visits	Deductibles, Coinsurance, Standardized payments
Principal-Agent Problem	Doctors act in own interest	Ordering extra tests	Standardized payments, Regulation

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