WHY HEALTH ECONOMICS

Instructor Manual For Health Economics Sixth Edition Charles E. Phelps 1 / 4

CHAPTER 1

WHY HEALTH ECONOMICS

Chapter Outline Why Health Economics

Important (if not Unique) Aspects of Health Economics Government Intervention Uncertainty Asymmetric Information Externalities How Markets Interrelate in Medical Care and Health Insurance Fixed Technology (Figure 1.1) Dynamic Issues (changes through Time Income Aging Technological Change Price changes and their meaning (quality and consumer surplus) Spending Patterns over time Summary Related Chapters in Handbook of Health Economics Problems

Teaching Tips from the Author

As a general rule for the entire Health Economics Course, I tend to emphasize the roles of uncertainty and information throughout the course. Indeed, I proposed a title for the book to my first editor of “Uncertainty and the Economics of Health Care,” He thought it sounded too specialized, and I now agree with him, but you will find an emphasis on uncertainty throughout the book. I always look for ways to bring uncertainty into the discussion, and point out whenever possible how uncertainty rests as the basis for much of what we know in health economics as different and interesting compared with (say) the market for sugar or salt. While I will not point out these opportunities everywhere, I urge you to take this task on (for me, if you will): help your students recognize the role of uncertainty, 2 / 4

information asymmetry, and the social rules and institutions that have emerged as a result of the uncertainty that’s omnipresent in health care.

When I taught using this book (ECO 236, an upper division undergraduate course at the University of Rochester), I went through Chapter 1 fairly rapidly, without detailed reference to specific items in the text. I used a lot of questions to the class here: it’s a great way to get the class used to answering questions I pose when the questions have no “right” answer.The “important (if not unique) aspects of health care section in Chapter 1 sets the stage for what comes later, so it’s worth a bit of time to emphasize these issues.None of them are wholly distinctive to health care markets, but the extent to which they matter exceeds that found in almost any other sector of the economy.

Government intervention of course is not novel to health care. The government regulates airline safety (in more ways than when I wrote the first edition), food safety, traffic safety, and (an issue more prominent in recent times!) safety of money you have entrusted to the banking system. Of course the government takes primary responsibility for safety from foreign invasion (the military), as well as air and water quality. Note the common thread of much of earlier government intervention – safety. The logic for government intervention there is similar to the logic in health care – possible harm or death to humans that is irreparable if it occurs, coupled with either major informational problems for individual consumers in achieving the same level of safety or obvious economics of scale in producing the safety (public goods).

This leads naturally into two other areas that demand constant attention in health care – uncertainty and informational asymmetry (which are obviously first cousins intellectually). In few other areas of the economy can you find such an overriding emphasis on uncertainty. The institutions we have in modern societies to deal with uncertainty span a huge array of topics – health insurance and managed care, malpractice insurance, FDA regulation of drugs, enormous regional variation in medical treatment rates for specific therapies (diagnostic and therapeutic uncertainty by providers), and now, “clinical outcomes assessment” activities.These all are manifestations of uncertainty.

Asymmetric information also turns up commonly, most often in doctor-patient interaction, but also in the knotty problem of possible market failure in health insurance. The emphasis on professional ethics (e.g., as in Arrow 1963) emphasizes the importance of informational asymmetry, and the societal norms 3 / 4

and rules we have (“professionalization,” licensure) are societal responses to these issues.

I like to use these discussions to involve the students in answering questions I pose.This works particularly well in the “important aspects of health care economics,” where the students’ own experiences in life help to illuminate some of the key ideas. How many have been to a doctor in the last year? What was the first thing they were asked by the receptionist? (It’s usually something about insurance

coverage!) Some questions can be deliberately whimsical: How many of you have

worked on your own car, or do repairs around the home? OK, now how many of you have done surgery on yourselves or removed a tooth? (This emphasizes the information gap between providers and consumers of health care.)

The material on technological change and prices is essential for later discussions about the future health care system. I view it as vitally important that students of health economics learn to parse out the implications of increasing prices. First, the measures of prices are poor, often omitting quality improvements. Second, and more important, it is quite possible (as the chapter shows) to have a welfare- enhancing price increase if comes with sufficient quality improvement. This comes back full-force in Chapter 16 when the discussion turns to universal health insurance (and the PPACA) and questions of “how much can we afford to spend” in health care? Box 1.1 provides the key discussion.

There’s a simple way to work through the tables at the end of Chapter 1 showing spending patterns through time. The tables “nest” in a very specific way that you can illuminate by focusing on the numbers at the lower left corner of the table.Look at Table 1.5 to start out. The annual total spending in 1960 was $23 billion, and grew to $3206 billion in 2015. The ratio of those two years is 138, the number in the lower left hand corner of the table. The same ratios are calculated for components of health care spending as well as the “total” figure.

Now look at Table 1.6. This corrects for general inflation, so the ratio of 138 becomes 20.9. In other words, almost 7/8ths of the increase in spending (about 85 percent) is just simple inflation over the past half century. The “real” increase of 21-fold is still important, however.

Table 1.7 takes the next step, correcting for changes in population levels. The “real per capita” increase is now down to “merely” a factor of 11.8. Table 1.8 takes a more specious step by correcting not only for general inflation but for relative price increases (using the “medical CPI” component). This step is fraught

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