Health Economics: Core Concepts and Essential Tools

By Steph Bernell

Instructor Resources: PowerPoint slides, sample exercises, and course lesson plans.

The healthcare landscape is shifting rapidly. A solid grounding in economics enables healthcare managers to make informed and thoughtful decisions in the face of changing market and regulatory demands.

Health Economics: Core Concepts and Essential Tools takes a unique, streamlined approach to explaining the building blocks of health economics. Rather than interweaving technical information with introductory content, each chapter is divided into two main sections: Core Concepts and Technical Material. This treatment allows students to gain an intuitive understanding of each chapter topic before delving into advanced graphs, equations, and other technical details.

Health Economics: Core Concepts and Essential Tools focuses on nine topics that are essential to understanding health economics and its connection to health policy:

The purpose of health economics The relationship between health and wealth The production of health The production of health-related goods and services The demand for healthcare Perfect competition and other market structures Physician behavior The insurance market Cost-effectiveness analysis

The Core Concepts section in each chapter provides learning objectives and a straightforward but comprehensive overview of the chapter topic. The Technical Material section allows for deeper examination of the chapter topic through discussion of relevant literature as well as graphical examples and mathematical techniques.

Like the other titles in Health Administration Press's Gateway to Healthcare Management series, this book is written at an introductory level and suitable for use by undergraduates and other students new to healthcare management. Examples and anecdotes bring concepts to life, learning aids reinforce key concepts, review questions boost comprehension, and a running glossary introduces essential terminology.

• Language: English
• Publisher: Health Administration Press
• Release date: Feb 3, 2017
• ISBN: 9781567937978

Book preview

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CHAPTER 1

THINKING LIKE A HEALTH ECONOMIST

LEARNING OBJECTIVES

Studying the core and technical sections of this chapter will help you with the following:

Core

Explain the types of relationships studied by health economists.

Describe how health economics is used to evaluate public policy.

Identify health policy topics that can benefit from economic analysis.

Technical

Explain essential microeconomic assumptions related to the consumer, producer, and payer.

CORE CONCEPTS

Although most people do not think they use economics in their everyday life, they actually do. For example, many people wait in line for hours (if not days) to be among the first to buy a much-anticipated and much-publicized new cell phone. To the average observer, this phenomenon is just a typical representation of techies flocking to the trendiest gadgets. But to the trained economist, it is an example of economics at work.

An economist is a social scientist who studies specific kinds of relationships. She is trained to assume that changes in factors, such as income, tastes and preferences, and quality, can be a catalyst for an increase in demand (see Exhibit 1.1). Thus, the behavior of techie consumers is not surprising to an economist. Conversely, an economist also knows that a lot of factors are at play that can decrease demand, such as the economy spiraling into a recession.

Economics provides a toolkit that allows us to anticipate or predict how a change in one factor will influence something else. This toolkit is like a Magic 8 Ball—a popular fortune-telling toy that answers your questions with a possible outcome—only the toolkit prediction is based on theoretical reasoning rather than merely chance.

Economists frequently use mathematical and statistical techniques to test theories; evaluate the appropriateness of specific assumptions; and understand the relationship between subjects, such as the price of a good and the quantity demanded of that good. The discipline of using such techniques is called econometrics.

Econometrics

A subspecialty of economics that applies appropriate mathematical and statistical techniques to analyze relationships

ECONOMIC RELATIONSHIPS

Economic analysis examines the relationship between two (or more) subjects. Typically, economic relationships involve consumers, producers, and payers (or distributors), and a subject is not evaluated in isolation. In health economics, the list of subjects is very long and includes (but is not limited to) the following:

Physicians and other providers, such as nurses, dentists, and physician assistants

Patients or a particular group of patients, such as children, those with physical or mental limitations, and the elderly

Health-related goods and services, such as surgery, preventive care, and diagnostic testing

Hospitals and other types of facilities, such as nursing homes, ambulatory surgical centers, and birthing centers

Private or public insurance, such as Medicare or Medicaid

Examples of relationships that a health economist might look at include those between

type of health insurance and mental health service use,

average wage and the purchase of health insurance, and

economic downturns and health status.

After specifying the subjects of inquiry, the health economist formulates a question that he or she wants to answer. Examples of these kinds of questions are as follows:

Do physicians increase the supply of health services to increase their income?

What is the effect of Medicare payments on the financial condition of rural hospitals?

How is employment related to the incidence of heart disease?

Does increasing copayments change consumers’ health service use?

In addition, a health economist might study subjects that at first blush might not appear to be health related. Examples of these are housing, transportation, agriculture, and the environment (see Exhibit 1.2).

LINKING ECONOMIC ANALYSIS TO HEALTH POLICY

Economic analysis is crucial to the evaluation of health policy. When a new health policy is introduced, the health economist’s mind spins with questions. For example, the economist might want to explore whether the Affordable Care Act’s (ACA’s) individual mandate (which requires American citizens to obtain health insurance or pay a tax penalty) leads to a decrease in the price of health insurance. Economic theory suggests that greater competition for consumers purchasing health insurance will bring down prices. However, because the individual mandate has been in effect for only a few years (at the time of this writing), the impact of the ACA on competition in the health insurance market remains to be seen.

Identifying the essential economic questions related to a health policy is an important part of the policymaking process. Economic analysis helps policymakers evaluate whether a policy is working as planned or if a policy revision of some type is needed. Following are examples of recent health policies that lend themselves to economic analysis.

The Medicare Payment Advisory Commission (MedPAC 2014) advised Congress to lower payments to physicians for hospital services that can be performed in doctors’ offices. The discrepancy in payments between these two settings (hospital and doctor’s office) may encourage behavior that a health economist would deem worthy of investigation. Numerous questions come to an economist’s mind, including the following:

Does the pricing differential give physicians an incentive to admit patients to hospitals for care?

Do patients reduce their use of health services because of the price differential or the location of services?

To promote cost-effective health services, the ACA included a provision often referred to as the Cadillac tax—a 40 percent tax on health insurance plans that cost more than $10,200 annually for individuals and $27,500 for families (IRS 2015). The overarching goal of the Cadillac tax is to give employers an incentive to select less expensive health insurance plans. Of course, policymakers want to know if the quantity of Cadillac plans sold decreases. However, many other questions have to be considered, such as the following:

Do taxable wages increase as employers substitute Cadillac plans with lower-premium plans?

What are the health impacts on employees as employers switch from Cadillac plans to lower-premium plans?

Does the Cadillac tax disproportionately affect small businesses more than it does large businesses?

The Great Recession (which began in 2007 and officially ended in 2009, although its effects were felt for many years after) has been the subject of much discussion by policymakers and economists. Health economists, specifically, are interested in determining the answers to questions such as these:

Does the transition to unemployment result in a decrease in health status, and if so, does the change differ by socioeconomic status?

Does the transition to unemployment affect mental health and physical health in a similar manner?

Are there negative health effects for individuals who remained employed, perhaps as a result of added responsibilities or stress?

Simply put, economic analysis allows for a deeper understanding of a health policy, its issues, and its intended and unintended consequences. To identify the policies that may benefit from critical economic analysis, an economist may read various print and online publications. Health policy topics are discussed in newspapers and magazines, such as the Washington Post, The New York Times, The Economist, and The Atlantic. Peer-reviewed academic journals, such as Health Affairs, Inquiry, and Milbank Quarterly, are equally helpful as they provide in-depth analysis of policy topics, as do reputable health policy blogs and other web-based resources.

CORE CONCEPTS TAKEAWAYS

An economist is a social scientist who studies specific kinds of relationships. These relationships typically involve producers, consumers, and payers (or even distributors).

Health economics typically covers a wide range of topics related to healthcare consumers (e.g., patients), providers (e.g., physicians), and payers (e.g., Medicare).

Economic analysis allows for a deeper understanding of a health policy, its issues, and its intended and unintended consequences.

TECHNICAL ELEMENTS

Health economics is rooted in microeconomics theory. For this reason, a basic understanding of microeconomics is recommended for readers of this book. This section reviews microeconomics concepts to help readers begin to think like a health economist.

FUNDAMENTAL ASSUMPTIONS

As mentioned earlier, economics typically involves consumers, producers, and payers. In health economics, consumers are those who use health-related goods and services (e.g., patients), producers are those who provide or deliver the goods and services (e.g., doctors, nurses, clinical staff, facilities), and payers are those that pay the bills for the goods and services rendered (e.g., individuals insurance companies, government entities such as Medicare or Medicaid).

Economists think about consumers, producers, and payers in a fairly systemized manner. That is, most economists make some fundamental assumptions about consumers, producers, and payers to begin their economic analysis.

ASSUMPTIONS 1, 2, AND 3: ABOUT CONSUMERS

One of the first ideas that microeconomics students are introduced to is the concept of utility. Utility is a theoretical concept that represents satisfaction or happiness. The greater the utility, the more satisfaction or happiness the individual has.

Utility

A measure of satisfaction for a good or service

A general health economics assumption is that total utility for an individual is determined by health and the amount of other things the individual has. This leads to Assumption 1: Utility is a function of an individual’s health and other goods and services one has. Another general assumption is that individuals prefer more to less utility, which brings us to Assumption 2: Individuals want to maximize utility.

The general implication of both Assumptions 1 and 2 is that individuals want to purchase more health-related goods and services to achieve better health status and thus maximize utility. This is where things get a bit confusing.

At some point, more health-related goods or services do not make individuals feel more satisfied. Perhaps the reason for this diminished satisfaction is that the goods or services have lost the impact they initially had on the health or condition of the individual. Maybe other factors—such as the travel time required to visit a doctor’s office or the wages lost from missing work for a doctor’s appointment—are what prevent consumers from getting as much satisfaction. In addition, people (and institutions) usually have limited resources. This leads to Assumption 3: Individuals maximize utility subject to their budget constraint.

Assume that people live within their personal budget (i.e., take credit cards out of the picture). These people make purchasing decisions based on the utility they gain from the goods and services, the prices of those goods and services, and the amount of money they can spend on those goods and services. In other words, consumers choose the combination of goods and services that will bring them the most utility while taking into account their own income and the prices of goods and services.

ASSUMPTION 4: ABOUT PRODUCERS

All producers must bring in money to stay in business. Supplies need to be purchased; wages need to be paid; and, in the case of for-profit businesses, shareholders’ return on investment needs to be distributed. Not-for-profit businesses also must make a profit to meet their obligations. Unlike for-profits, however, not-for-profits do not distribute funds to shareholders; instead, they reinvest profits back into the business—in the form of higher wages, program or building expansions, technology updates or installations, and so on.

Economists typically start with the idea that producers want to maximize profit. If that is the case, producers want to pay as little as possible for supplies and other resources without skimping on quality. Low quality could dissuade consumers from purchasing the good or service, which in turn could mean a reduction in profit. This leads to Assumption 4: Producers want to minimize the cost of production.

Even though in healthcare many producers (e.g., hospitals) want to maximize either the quality of goods and services or the quantity of individuals who seek those goods and services, it is reasonable to begin with the assumption that producers want to minimize the cost of production so that they can maximize their profit.

ASSUMPTION 5: ABOUT PAYERS

Traditionally, buyers and sellers engage in an informal dance in the marketplace. This dance is what determines equilibrium price and equilibrium quantity. It works like this:

Equilibrium price

The market price agreed on by buyers and sellers of a good or service

Equilibrium quantity

The total amount of a good or service sold in the market at the equilibrium price

Healthy You (a seller) wants to make as much money as possible, so it sets a very high price for its good—ibuprofen. The price is $25 for a bottle of 30 pills. This price is much higher than the price set by other sellers. As a result, consumers (buyers) do not purchase ibuprofen from Healthy You. Because Healthy You really wants to get in the business of selling ibuprofen, it lowers the price to $20 per bottle. Still, no one buys the good. Only when the seller reduces the price to $4 a bottle do individuals start buying its ibuprofen.

This explanation brings us to Assumption 5: In a perfectly competitive market, individual sellers take the price from the market. This means that when a market is perfectly competitive, individual sellers do not determine the price of their goods or services—the market does. Healthcare markets, however, work a bit different than other markets. In healthcare markets, prices are not determined by consumers or producers. Rather, prices are often determined by payers—insurance companies (which draw up insurance contracts), Medicare, Medicaid, and some other institutions. Even with the kind of pricing mechanism used in healthcare, the informal dance between suppliers and demanders in the market is a decent starting place for economic analysis.

TECHNICAL ELEMENTS TAKEAWAYS

An economist thinks about consumers, producers, and payers in a fairly systemized manner, and most economists make some fundamental assumptions.

Assumptions typically used as a starting place for economic analysis include the following:

Utility is a function of an individual’s health and the other goods and services one has.

Individuals want to maximize utility.

Individuals maximize utility subject to their budget constraint.

Producers want to minimize the cost of production.

In a perfectly competitive market, individual sellers take the price from the market.

REVIEW QUESTIONS

Other than the relationships identified in this chapter, identify three different health policy relationships (e.g., food stamps, business cycles). Why is it important for policymakers to understand the complexity of the relationship?

Select a health policy–related article from a national newspaper (e.g., The New York Times). Write down two thoughtful questions about the article that are worthy of more in-depth economic analysis. Why do you think your questions are best answered using economic analysis as opposed to another type of analysis?

The Affordable Care Act has ushered in many changes. Select three specific changes, and for each change, formulate two questions that a health economist might ask. Discuss how the questions are related to economics. Your answer may incorporate economic concepts and theories beyond those related to consumers, producers, and payers.

RECOMMENDED READINGS

Birkmeyer, J., C. Gust, O. Baser, J. B. Dimick, J. M. Sutherland, and J. S. Skinner. 2010. Medicare Payments for Common Inpatient Procedures: Implications for Episode-Based Payment Bundling. Health Services Research 45 (6 Pt 1): 1783–95.

Gruber, J. 2014. Growth and Variability in Health Plan Premiums in the Individual Insurance Market Before the Affordable Care Act. Issue Brief (Commonwealth Fund) 11: 1–12.

Holahan, J. 2011. The 2007–09 Recession and Health Insurance Coverage. Health Affairs 30 (1): 145–52.

Mechanic, M. 2012. Seizing Opportunities Under the Affordable Care Act for Transforming the Mental and Behavioral Health System. Health Affairs 31 (2): 376–82.

Rice, T., and R. Labelle. 1989. Do Physicians Induce Demand for Medical Services? Journal of Health Politics, Policy and Law 14 (3): 587–600.

Sen, B., J. Blackburn, M. A. Morrisey, M. L. Kilgore, D. J. Becker, C. Caldwell, and N. Menachemi. 2012. Did Copayment Changes Reduce Health Service Utilization Among CHIP Enrollees? Evidence from Alabama. Health Services Research 47 (4): 1603–20.

REFERENCES

Internal Revenue Service (IRS). 2015. Section 4980I—Excise Tax on High Cost Employer-Sponsored Health Coverage. Accessed August. www.irs.gov/pub/irs-drop/n-15-16.pdf.

MedPAC. 2014. Report to the Congress: Medicare Payment Policy. Published March. www.medpac.gov/documents/reports/mar14_entirereport.pdf.

CHAPTER 2

THE RELATIONSHIP BETWEEN HEALTH AND WEALTH

LEARNING OBJECTIVES

Studying the core and technical sections of this chapter will help you with the following:

Core

Describe the relationship between health and wealth.

Identify the ways in which income can affect health.

Summarize the absolute income hypothesis and relative income hypothesis.

Explain how income-related policies can influence health.

Technical

Compare and contrast the theories on the health–wealth relationship.

Demonstrate the health–wealth relationship in mathematical form.

Evaluate the health–wealth relationship theories using real-world studies.

Use a graphical tool to illustrate the relationship between gross national product and aggregate health.

CORE CONCEPTS

Many factors contribute to a person’s health status, such as genetics, smoking, diet and exercise, insurance coverage, and wealth or income. This chapter focuses on the wealth or income factor—not because it is more important than other factors but because of its deep connection to taxation and other governmental policies. (The term wealth is used in this chapter to mean income plus the value of assets; it does not necessarily mean an abundance of money.)

THE RELATIONSHIP BETWEEN HEALTH AND WEALTH

Lack of wealth can have a tremendous impact on an individual’s well-being. Wealth can enable people to purchase quality health insurance, needed health-related goods and services, and access to a healthier lifestyle (Exhibit 2.1). All of these can lead to better health outcomes.

Necessary health-related goods and services. Individuals with money are more likely to fill or refill needed prescriptions and seek routine care from providers, which may result in early detection and treatment of disease. Earning more money, however, does not always translate to purchasing more medical services. At some point, a person will reach the upper limit on the number of times he wishes to go to a healthcare provider, or he will reach the upper limit on how much healthier he can get.

Healthier lifestyle. Individuals with more income have the means to take advantage of available goods and services that encourage healthy living, such as nutritious foods, organic products, gym memberships, fitness trainers, yoga, and various sports and physical activities.

In addition, having wealth gives people advantages that contribute to their well-being, such as the following:

Educational background and health literacy. People with monetary resources have greater access to quality education. Furthermore, those with more education may be more inclined to keep up with news, trends, and other information about health and nutrition, or they may have the ability to understand basic medical language and health-related research.

A safe environment in which to live. Certain neighborhoods have high crime rates, easy access to illegal drugs and alcohol, few or no stores that sell nutritious foods, and scarce healthcare facilities or clinics. Individuals with a greater amount of wealth typically avoid such areas, opting instead to live in places that, although more expensive, are safe and full of various conveniences.

A safe environment in which to work. The risk of work-related injuries and accidents is greater in workplaces that are usually associated with low-income employees (e.g., construction sites) than in workplaces usually associated with high-income workers (e.g., offices). On the flip side, an argument could be made that more affluent individuals work in highly stressful, competitive