CHAPTER
9
The Health Care Market
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
U.S. Expenditures of Selected Goods and
Services as Share of GDP (1960-2007)
Source: US Bureau of the Census [2009, pp. 95, 425], and National Income and Product Accounts
9-2
Social Insurance
• Social insurance - government programs that
provide insurance to protect against adverse
events
• Examples
–
–
–
–
Medicaid
Medicare
Social Security
Unemployment Compensation
9-3
How Health Insurance Works
• Insurance premium
• Expected Value
– Expected value (EV) = probability of outcome 1) *
(Payout in outcome 1) + probability of outcome
2)*(Payout in outcome 2) + … + (probability of
outcome n)*(Payout in outcome n)
9-4
Expected Value Computation
Draw cards from deck of cards
Draw heart and receive $12
Draw spade, diamond or club and lose $4
Probability of drawing heart = 13/52 = ¼
Probability of drawing spade, diamond or club = 39/52 = ¾
EV = (1/4)($12) + (3/4)(-$4) = $0
9-5
Why Buy Insurance?
(A)
Insurance
Options
Income
Probability
of Staying
Healthy
Probability
of Getting
Sick
Option 1: No
Insurance
$50,000
9 in 10
Option 2: Full
Insurance
($3,000
premium to
cover $30,000 in
losses
$50,000
9 in 10
Income
if She
Stays
Healthy
(B)
(C)
Income if
She Gets
Sick
Expected
Value
1 in 10
Lost
Income if
She Gets
Sick
$30,000
$50,000
$20,000
$47,000
1 in 10
$30,000
$47,000
$47,000
$47,000
Actuarially Fair Insurance Policy
9-6
Utility
Why People Buy Insurance
B
UB
UD
UC
D
C
• Expected
Utility
A
• Risk
Smoothing
UA
20,000
47,000 50,000
Income
9-7
Do People Buy Insurance with Loading Fees?
• Risk Aversion
• Risk Premium
• Loading Fee
9-8
The Role of Risk Pooling
• Insurance in a small population
• Insurance in a large population
• Law of large numbers
9-9
Adverse Selection in the Health Insurance
Market
• Asymmetric information
9-10
Asymmetric Information and Adverse Selection
(A)
Insurance Buyer
(B)
(C)
(D)
(E)
(F)
Expected Benefit
Expected Benefit
Expected Benefit
Probability of
Lost Income
Expected
Minus Premium
Minus Premium
Minus Premium
Getting Sick
if Sick
Lost Income
(Differential
Premiums)
(Premium = $3,000)
(Premium = $4,500)
Emily
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Jacob
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Emma
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Michael
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Madison
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Joshua
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Olivia
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Matthew
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Hannah
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Ethan
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
$0
-$15,000
$0
Insurer's Net Profits
9-11
Does Adverse Selection Justify
Government Intervention?
• Experience rating
• Experience rating and equity
• Community rating
9-12
Insurance and Moral Hazard
•
•
•
•
Moral hazard
Deductible
Co-payment
Co-insurance
9-13
Price per unit
Moral Hazard
Flat-of-the-curve medicine
deadweight loss
P0
a
b
h
.2P0
0
Sm
Dm
M0
M1
Medical services per year
9-14
Additional Considerations
• The Elasticity of Demand for Medical Services
• Does Moral Hazard Justify Government
Intervention?
– Third Party Payment
9-15
Other Market Failures in the Health Care Market
• Information Problems
• Externalities
9-16
Do We Want Efficient Provision of Health Care?
• Paternalism
• The Problem of the Uninsured
– Who are the uninsured?
– Does health insurance improve health?
9-17
High Health Care Costs
Source: Organization for Economic Cooperation and Development [2008a].
9-18
Causes of Health Care Cost
Inflation
•
•
•
•
The Graying of America
Income Growth
Improvements in Quality
Commodity Egalitarianism
9-19