Economics 330
Economics of Health Care
Dr. Greg Delemeester
Spring 2010
National Health Care Expenditures
Year
Total
Spending
(in billions)
Percent
change
Percent of
GDP
Per capita
spending
1950
$ 13
--
4.5
$ 82
1960
28
8.8
5.2
148
1970
75
10.5
7.2
356
1980
254
13.0
9.1
1,100
1990
714
10.9
12.3
2,814
2000
1,353
5.9
13.6
4,789
2005
1,982
7.9
15.7
6,701
2006
2,113
6.7
15.8
7,071
2007
2,240
5.6
15.9
7,423
2008
2,339
4.3
16.2
7,681
Source: http://www.cms.hhs.gov/NationalHealthExpendData/
Why do Americans spend so much on
medical care?
 Aaron (1991)




Expansion of 3rd party payment system
Aging of the population
Expanded medical malpractice litigation
Increased use of medical technology
 Other factors
 Physician-induced demand
 Entry restrictions
 Predominance of not-for-profit providers
Personal Health Care Expenditures
(in billions of dollars)
Private Spending
Year
Out of
pocket
Public Spending
Private
Insurance
Federal
State
1960
$ 12.9
$ 5.9
$ 2.0
$ 2.9
1970
24.9
14.0
14.4
7.8
1980
58.1
61.2
62.3
23.9
1990
136.1
204.7
172.8
63.5
2000
192.6
402.8
369.8
117.1
2005
247.5
599.8
562.3
176.9
2006
254.9
634.6
620.1
178.7
2007
270.3
665.0
661.3
188.7
2008
277.8
691.2
718.0
189.8
Source: http://www.cms.hhs.gov/NationalHealthExpendData/
2008 National Health Care Dollar…
…Where it Came From
…Where it Went
Private vs Public Spending
on Personal Health Care Expenditures
90%
80%
70%
% of PHCE
60%
50%
Private
Public
40%
30%
20%
10%
0%
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Spending as % of Personal Health Care Expenditues
60%
50%
% of PHCE
40%
Out of pocket
Health Ins
30%
Fed
State
20%
10%
0%
1960
1970
1980
1990
2000
2010
Changes in Hospital Usage
Short-Stay Community Hospital Characteristics, United States
Category
1970
1980
1990
2000
Beds
4.17
4.38
3.73
2.93
(per 1,000 population)
Admissions
144.0
159.6
125.4
117.6
(per 1,000 population)
Average length of stay
7.7
7.6
7.2
5.8
(days)
Outpatient visits
657.2
893.2
1,211.6 1,882.8
(per 1,000 population)
Outpatient visits per
4.6
5.6
9.7
15.8
admission
Percent occupancy
78.0
75.4
66.8
63.9
Source: Health United States, various years.
2003
2.79
2004
--
2005
2.71
119.4
119.3
118.9
5.7
5.6
5.6
1,933.4
1,943.7
1,972.0
16.2
16.3
16.6
66.2
--
67.3
Changes in Medical Care Delivery
Shift from private to public financing
Shift to 3rd party financing
Changes in hospital usage and pricing
Deregulation and growth in managed care
Payment Structure
Traditional fee structure
 Fee for service
 Retrospective payment
 Incentive to overspend
Managed care
 Capitation and risk sharing
 Prospective payment
 Incentive to limit care
Health Care As a Commodity
 Demand is irregular
 Asymmetric information problems
 Widespread uncertainty
 Reliance on not-for-profit providers
 Insurance as the primary means of payment
Health System Goals
Access to care
 Who’s covered?
 What’s covered?
Quality of care
Cost of care
Private Health Insurance Coverage
(under age 65, numbered in millions)
With Health Insurance*
Without Health Insurance
Year
Number
Percent
Number
Percent
1999
161.2
68.3
38.5
16.1
2000
160.8
67.1
41.4
17.0
2001
162.4
67.0
40.3
16.4
2002
159.4
65.3
41.7
16.8
2003
157.5
64.4
41.6
16.5
2004
159.5
64.0
42.1
16.6
2005
160.1
63.6
42.1
16.4
2006
155.8
61.5
43.9
17.0
2007
157.9
61.6
43.3
16.6
* Employer-based.
Source: Health, United States, 2008, http://www.cdc.gov/nchs/hus/updatedtables.htm, Table 138 and 140.
Health System Goals
Access to care
 Who’s covered?
 What’s covered?
Quality of care
 Medical outcomes
 Medical efficacy
Cost of care
 Who pays?
 How much?
Review of Economic
Methodology
Economic Fundamentals
Optimization
Marginal Analysis
Supply and Demand
 Equilibrium
What are the likely consequences of the
following events in the U.S market for cosmetic
surgery?
1) Health insurance coverage is expanded to cover all
elective procedures, such as tummy tucks, nose
jobs, and liposuction
2) The FDA (Food and Drug Administration) takes all
silicone-based implants off the market fearing a
connection with certain connective-tissue diseases
3) Personal finance companies start a nationwide
lending program for cosmetic procedures not
covered by health insurance
4) Medical malpractice insurance premiums increase
for plastic surgeons
5) Medical schools announce that residents in plastic
surgery can be licensed after only five years instead
of the current seven years
Economic Fundamentals
Optimization
Marginal Analysis
Supply and Demand
 Equilibrium
 Elasticity
 Welfare analysis
 Effects of government intervention
Suppose the market for lasik eye surgery can be
described by the following equations:
Qd = 5100 – 6P
Qs = - 400 + 5P
a)
b)
c)
d)
Solve for the market equilibrium price and quantity.
Calculate consumer and producer surplus.
Calculate the elasticity of demand at the equilibrium.
Suppose the government imposes an excise tax of $100
per surgery on eye surgeons. What is the new equilibrium
price and quantity? What happens to social welfare?
Competitive Market Model
 Many buyers/sellers
 Homogeneous product
 No entry barriers
 Perfect information
$
MC
ATC
Profit max rule: P = MC
AVC
P1
MR1
LR Equil: π = 0
q1
quantity
Market Failures
 Market Power
 Monopoly
 Restricted entry (AMA, CON)
 EOS
 Monopsony
 Externalities
 Communicable diseases/immunizations
 Uninsured and cost shifting
 Public goods
 Free-riders
 R&D
Imperfections in Medical Markets
Imperfect/Asymmetric information
 Agency problem (induced demand)
 Adverse selection
 Moral hazard
Third-party payers
Hospitals:
3¢ per $1
Physicians: 20¢ per $1
Dealing with Market Failure
Collective provision
 Medicare
 Medicaid
Government regulation
 Price controls
 Entry restrictions
 FDA
Tax Policy
 Tax exemptions
Government Failure?
Economic Evaluation in
Health Care
The Inevitability of Trade-Offs
The value of a medical intervention
The inclusion of a drug on the formulary
Paying for an experimental procedure
Investing in new technology
Is it worth it? How do we measure value to insure
we get value for spending?
Options for colorectal cancer screening
 Fecal blood test
($20)
 Sigmoidoscopy
($150 - $300)
 Barium enema
($250 - $500)
 Virtual Colonoscopy
($500 - $900)
 Colonoscopy
($800 - $1200)
Is it worth the
extra money?
Types of Economic Evaluation
 Cost of illness studies
 Cost-benefit analyses
 Cost-effectiveness studies
Cost of Illness Studies
 What does it cost?
 Burden of 5 chronic conditions in US (Druss et al., 2001)
 Mood disorders, diabetes, heart disease, asthma, and hypertension
 Direct cost of treatment: $62 billion
 Cost of treating coexisting conditions: $208 billion
 Lost productivity: $36 billion
 Role in analysis – increased awareness
$306 billion
Cost-Benefit Analysis
Benefits
today
Costs
 Net PV =
time
Bt
B1
B2
 C0 


1
2
(1  r ) (1  r )
(1  r )t
The higher the discount rate, r, the lower the PV
Cost-Benefit Criterion
 If net benefit stream is positive, project is acceptable
n
NPV  
t 1
Bt  Ct
t
(1  r )
 If ratio is greater than one, project is acceptable
n
B/C  
t 1
n
Bt
Ct
/
t 
t
(1  r ) t 1 (1  r )
 Examples
 Clarke (1998): mobile mammographic screening and travel cost method
 Ginsberg and Lev (1997): riluzole and ALS
Challenges of Cost-Benefit Analysis
Valuing benefits
 How do you place a value on a human life?
 Willingness-to-pay approach
wealth
life expectancy
current health status
possibility of substituting current consumption for future
consumption
Choosing a discount rate
Cost-Effectiveness Analysis
Measures health benefit by health outcome, not the
dollar value of life
Using the decision makers’ approach
 Maximize the level of health for a given population subject
to a budget constraint
 Practical guide for choosing between programs or treatment
options when budgets are limited
Cervical Cancer Screening
The medical evidence is clear: Cervical cancer screening
saves lives. Much of the focus of cost-effectiveness
research addresses issues concerning the appropriate
screening interval.
D.M. Eddy (Screening for cervical cancer, Annals of
Internal Medicine 113, 214-226, 1990) studied the issue
and estimated that annual screening for a hypothetical
cohort of 1,000 22-year-old women screened until age
75 would cost $1,093,000 and would save 27.6 life
years. If screened every three years instead, the cost
would be $467,000 and 26.8 life years would be saved.
Is annual screening cost effective?
Incremental Cost-Effectiveness Ratio
CB  C A
ICER 
EB  E A
If CA > CB and EA < EB, B dominates.
If CA < CB and EA > EB, A dominates.
If, however, CB > CA and EB > EA, choice is
not obvious. Use CE.
ICER Curve: 2 Treatments
Effectiveness
Large ICER = flat slope
B
EB
EA
ICER 
A
CA
CB
CB  C A
EB  E A
Cost
Cervical Cancer Screening: Redux
 D.M. Eddy (Screening for cervical cancer, Annals of Internal
Medicine 113, 214-226, 1990) studied the issue and
estimated that annual screening for a hypothetical cohort of
1,000 22-year-old women screened until age 75 would cost
$1,093,000 and would save 27.6 life years. If screened
every three years instead, the cost would be $467,000 and
26.8 life years would be saved.
 What is the ICER?
1,093,000  467,000
ICER 
 $782,500
27.6  26.8
ICER Curve: Multiple Treatments
Effectiveness
“flat of the curve”
G
F
D
B
A
E
C
Treatments C and E are dominated
Cost
Measuring Costs
Direct – associated with use of resources
 Medical
 Non-medical
Indirect – related to lost productivity
Intangible – associated with pain and suffering, grief,
anxiety, and disfigurement
Measuring Effectiveness
Improvements in Health
Surrogate measures stated in terms of clinical efficacy
 Blood pressure, cholesterol levels, bone mass density, or
tumor size
Intermediate measures stated in terms of clinical
effectiveness
 Events (heart attack, stroke, cancer), scores on exams
Final outcomes measure economic effectiveness
 Events avoided, disease-free days, life-years saved,
quality-adjusted life years saved
Problem Set 1: #16
Survival Measures
Improved Life Expectancy Due to Clinical Treatment
Life expectancy = area under survival function
Survival
probability
100%
LE w/o treatment = ½(1.00-0.0)6.5
A
B
90%
77%
= 3.25 yrs
Gain in LE during trial = ½(.90-.77)1.5 = 0.0975 yrs
Gain in LE after trial = ½(.90-.77)5
= 0.325 yrs
Total Gain in LE
= 0.4225 yrs
C
Survival function for
treatment group
Survival function for
control group
D
1.5
6.5
Time (years)
Quality of Life Measures: QALY
Quality-Adjusted Life Year
 Measured on a preference scale anchored by
death (0) and perfect health (1)
Calculating a QALY
Utility
Normal 55-yr old male has LE of 25 more yrs
Diabetic 55-yr old male has LE of 15 more yrs
U(H1)
x = healthy years
t = chronic health years
U(HD)
6
15
Value of one year in chronic health state is x/t
Utility value of 15 years = 6/15 = 0.40
QALY of remaining 15 years = (.40)(15) = 6 years
Time (years)
Decision Trees
Handout
Mortality Rate
Life Expectancy for
Survivors
Initial Treatment Cost
Follow up cost, year 1
Annual follow up costs,
all subsequent years
Treatment A
2%
20 years
Treatment B
5%
10 years
$10,000
$5,000
$1,000
$3,000
$1,000
$500