Feldstein Chapter 2: How much should we spend on healthcare?
Three questions:
1. Efficiency criteria
2. Efficiency in US healthcare
3. Why does it matter?
Main Topics Covered
Consumer Sovereignty
Economic Efficiency
Efficiency in Providing Medical Services
Efficiency in the Use of Medical Services
Government and Employer Concerns over Rising Medical Expenditures
Approaches to Limiting Increases in Medical Expenditures
How do we compare to other countries?
1. Background: United States spends a greater portion of its Gross National Product (GDP) on
medical care than any other country (17% of GDP). Health care spending rising much faster than
inflation. Rapidly rising costs is also main reason why US has so many uninsured (17%).
2. How does a competitive market efficiently determine the types of goods and services to be
produced, how much it costs to produce those goods, and who receives them?
Consumer sovereignty generates allocative efficiency. Purchasing one thing generates
opportunity cost in terms of others. Balance MB vs. MC which maximizes total utility
Consumer decisions to purchase communicate to producers what they should produce.
Competition maximizes technological efficiency resulting in min ATC production thereby
maximizing total output.
Higher incomes have more “votes” in the marketplace, as do consumers with better insurance
3. Efficiency problems in Healthcare
A. Demand Side Problems
 Patients lack information and have limited ability to judge needs for medical treatment.
Concern also exists about the quality of care patients receive and how much care is
appropriate. Rely on providers, insurers & government for info.
 Given the lack of consumer information, some physicians have been able to increase the
demand for their services to increase their incomes. When advising patients, providers have
historically had no incentive to provide a cost-efficient level of care, because consumers
normally do not pay the full cost of the service.
 Tax free employer paid insurance premiums subsidy leads to overpurchase of insurance,
especially by high income persons. Tax advantage also to employer (no Social Security)
leads to overinsurance leading to over spending on health care. MB not >= MC because full
cost not paid by employee
 Inefficiencies in the demand for medical services occur when individuals do not have to pay
the full cost of their choices; they consume “too much” medical care because their use of
services is based on the out-of-pocket price they pay, which is less than the cost of producing
the service. Studies have shown that patients who pay less out-of-pocket have more hospital
admissions, physician visits, and use of outpatient services than patients who pay higher
prices. The reason use inefficiency is important in medical care is that the price of care has
been artificially lowered to many consumers of medical services. This at times results in
inefficient use—for example, when the patient uses the more expensive emergency room
rather than a physician’s office in a non-emergent situation.
B. Supply Side Problems
In past, cost-plus led to providers increasing costs to get paid more.
Fee-for-service still norm for doctors, so incentive to prescribe more care.
Hospitals and ambulatory surgeries now on DRG/APG prospective payment per case.
Efficiency on the supply side is increasing because competition between providers and
insurers is intensifying. Therefore, inefficiency on the supply side from the provision of
medical services is not the main cause for concern with the rise in medical expenditures.
Even if administrative costs of private insurers were halved, drug company profits halved and
MD incomes reduced by 25%, the savings would amount to only 9% which is equal to how
much med spending increases every two years.
4. Employers and Governments are very concerned about health care spending increases
For large employers, spending on health insurance premiums has risen rapidly over time,
both as a percentage of total employee compensation and as a percentage of business profits.
Health premiums increase costs which reduce competitiveness versus companies that don’t
provide insurance (domestically) or pay for it (international competitors)
Financial Accounting Standards Board (FASB) 106 requires, starting in 1993, employers lists
promised retiree medical benefits as a liability on their balance sheet. Employers previously
paid their retiree medical expenses only as they occurred and did not set aside funds as they
do with pensions.
o net worth of many large corporations declined by many billions of dollars
o reported earnings declined, because part of liability has to be expensed each year,
thereby lowering reported profits.
o Lower health care premiums will increase profits so companies very interested
Government is concerned about rising medical expenditures because federal health spending,
as a proportion of total federal spending, is increasing rapidly, from 12.4 percent of total
federal expenditures in 1985 to 26.4 percent in 2012 to a projected 30 percent in 2018.
o As the baby boomers begin to retire and become eligible for Medicare in 2011,
Medicare expenditures are expected to dramatically increase.
o Unless the federal government can reform Medicare and reduce its growth rate, the
Medicare Social Security tax on the working population will be sharply increased to
prevent the Medicare trust fund from going bankrupt.
o Funding Medicare Part B will require increased income taxes, a very large federal
deficit, or reductions in other popular federal programs. Each of these options carries
significant political cost.
o Government spending on Medicaid and subsidies for near-poor will also increase
rapidly with Affordable Care Act (ACA)
Summarizing concerns
o Whereas growth in expenditures in other industries is generally considered good,
concern exists that growth in medical expenditures is a sign of inefficiencies and
wastefulness in the healthcare system.
o Are we receiving value for our money; namely, that the additional medical services
and technologies are worth their cost.
o Employers faced with lower profits and competitive pressure
o State and federal governments must raise additional taxes or spend less on other
programs to pay for Medicaid and Medicare.
5. Health Care Market is Becoming More Efficient but Public is Unhappy
The public wants cheaper but more comprehensive insurance (unlimited choice and access) =
impossible. Some tradeoff is necessary.
Some politicians have led the public to believe that these trade-offs are not necessary; they
claim that by eliminating waste in the health system, universal coverage can be achieved and
everyone can have all the medical care they need, and at a lower cost. Such rhetoric merely
postpones the time when the public realizes it must make the unpleasant choice between
spending and access to care.
Employer and individual insurance plans are reducing options to hold premiums down, thru
either higher out-of-pocket payments, restricting enrollees to using only participating
physicians, specialists, and hospitals, requiring evidenced based medicine.
These measures are not enough. Services and technology will have to become less available
to many to contain costs.
6. Relative to other countries, US (go to PowerPoint slides)
Spends a lot more but infant mortality and life expectancy not better
Have differing mix of death causes
After surgery, US survives longest
If you get to 80, don’t live longer
Spend a lot less time in hospitals and have less doctors