Post on 21-Oct-2015
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Presentation Outline
I. Introduction: Scope and MethodsII. A Survey of the Special Characteristics of the Medical-Care
Marketa. The nature of demandb. Expected behavior of physicianc. Product uncertaintyd. Supply conditionse. Pricing practices
III. Comparisons with the competitive model under certaintya. Nonmarketable Commoditiesb. Increasing returnsc. Entryd. Pricing
IV. Comparisons with the ideal competitive model under uncertaintya. Introductionb. The Theory of Ideal Insurancec. Problems of Insuranced. Uncertainty of effects of treatment
I. Introduction: Scope and Methods
• Focus on medical care industry not “health”
• Focus on the way the operation of medical-care industry and the efficacy with which it satisfies the needs of society differ from the “norm”.
1. Introduction
• The interest in the competitive model stems partly from its presumed descriptive power and partly from its implications for economic efficiency.
First Optimality Theorem
• If a competitive equilibrium exists at all, and all commodities relevant to costs or utilities are in fact priced in the market, then the equilibrium is necessarily optimal: There is no other allocation of resources to services which will make all participants in the market better off (Pareto Optimality)
First Optimality Theorem
• Competitive equilibrium achieved depends on the initial distribution of purchasing power
• Transfer of purchasing power from the well to the ill will increase the demand for health services
• This in turn will lead to short-term increases in the price of medical services
• In the long-term it will lead to an increase in the amount of services provided
Second Optimality Theorem
• If there are no increasing returns in production then every optimal state is a competitive equilibrium corresponding to some initial distribution of purchasing power
• What the two optimality theorems state is that if they hold then all one needs to worry about is altering the distribution of purchasing power
• Competitive markets will take care of the rest• If the optimality theorem does not hold the separation of
allocative and distributional procedures becomes difficult
Actual Health Market and Competitive Markets
• Milton Friedman– Market models should be tested solely on
their ability to predict– Prices and quantities are the only relevant
data
• Arrow argues that institutional organization and observable practices of the medical profession should also be included
Competitive Markets
• Three conditions need to be satisfied– The existence of a competitive equilibrium– The marketability of all goods and services relevant to
costs and utilities– Non-increasing returns
• The first two conditions ensure that the competitive equilibrium is optimal
• The third condition states that every optimal competitive equilibrium corresponds to some distribution of income
Social Costs and Benefits (Externality case)• Social benefits refers to the fact that the market does not
require an individual to pay for costs that she imposes on others as a result of her action or does not permit her to be paid for benefits/services provided
• Example is spread of communicable diseases– Person who does not get immunized not only risks own life but
also that of others– In an ideal pricing system she would have to pay to anyone
whose health is endangered (the price will need to be high enough to ensure they feel adequately compensated) or else she will have to be paid enough to get immunized
• This is clearly not practical. Therefore collective intervention occurs – either a subsidy, tax or compensation
Non-Marketability and Risk Bearing
• Illness is an unpredictable phenomenon• Ability to shift the risks of illness is a price that
many are willing to pay• Because of pooling and of superior willingness
and ability other are willing to bear the risks.• When one introduces risk bearing into the
equation it means there is an element of uncertainty. This in turn means that information or knowledge becomes a commodity
Information as a Commodity
• If information is a commodity then– There is a cost to producing it– There is a cost to making it available– Therefore it will not be uniformly distributed across the
entire population but rather concentrated amongst those who can profit from it
• Note that we are actually buying information from health providers – they have the knowledge and skills to deal with health problems
• Therefore “information” departs from the usual marketability assumptions about other commodities
Information as a Commodity
• Arrow mentions that one form of knowledge is research– Knowledge tends to be increasingly used once it is
available– It is used over and over without “being consumed”– Cost of reproduction is much less than the cost of
production– Therefore either a free enterprise economy will under
invest in research or patents will restrict access to it
Failure of Preconditions• When one or more of the preconditions does not
hold it means– There will be a failure to reach Pareto
Optimality– This means that there will be a loss in welfare– Society if it recognizes this problem will take
actions to redress it– Action typically will tend to be nonmarket
social institutions trying to bridge this welfare loss gap
2. A Survey of the Special Characteristics of the Medical-Care Market
A. The nature of individual demand• Not steady in origin• Irregular and unpredictable• Illness is not only risky but a costly risk in
itself, apart from the cost of medical care
B. Expected behavior of the physician
• Advertising and overt price competition are virtually eliminated among physicians
• Advice given by physicians is supposed to be completely divorced from self-interest
• Treatment is dictated by objective needs of the case and not limited by financial considerations---in theory
• The Physician is relied upon as an expert in certifying the existence of illness
C. Product uncertainty
• Uncertainty as to the quality of the product
• Recovery from disease is as unpredictable as its incidence
• The uncertainty is very different on the two sides of the transaction
D. Supply Conditions
• Entry to the profession is restricted by licensing (USMLE is only one example)
• The cost of medical education in the US is a reflection of the quality standards imposed by AMA.
• Both licensing laws and standards of medical-school training have limited possibilities of alternative qualities of medical care.
E. Pricing Practices
• Extensive price discrimination by income
• Formerly, strong insistence on fee-for-services as against alternatives as pre-payment.
• Problems of implicit and explicit price-fixing.
• Price competition is not welcome
Important to keep in mind that this was the situation when Arrow wrote the paper
3. Comparisons with the competitive model under certainty
A. Non-marketable goods:• Example: diffusion of communicable diseases
• Beyond the “public health” area, there is a more general interdependence, the concern of individuals for the health of others.--- manifestations are donations and government responsibilities
• There is a case for collective action if each participant derives satisfaction from the contribution of all
B. Increasing returns
• Hospitals show increasing returns to scale up to a point
• Problems associated with increasing returns play some role in allocation of resources---- particularly in low density and low income areas.
C. Entry
• Most striking departure from competitive behavior is restriction on entry to the field.
• Why entry restrictions important:– Additional entrants would be, in general, of low
quality?– To achieve genuinely competitive conditions, it would
be necessary not only to remove numerical restrictions but also to remove subsidy in medical education.
– To some extent, the effect of making tuition carry the full cost education will be to create too few entrants, rather than too many
C. Entry
• If entry were governed by ideal competitive conditions, it may be that the quantity on balance would be increased, though this conclusion is not obvious.
• Entry restrictions exclude many imperfect substitutes for physicians.
C. Entry
“In the competitive model without uncertainty, consumers are presumed to be able to distinguish qualities of commodities they buy. Under this hypothesis, licensing would exclude those from whom consumers would not buy anyway; but it might exclude too many.”
D. Pricing
• Pricing practices part sharply from competitive norms
• Not only is price discrimination incompatible with the competitive model, but its preservation in the face of a large number of physicians is equivalent to a collective monopoly
D. Pricing
• Price discrimination is designed to maximize profits along the lines of discriminating monopoly
• Organized medical opposition to pre-payment was motivated by desire to protect these profits. Arrow is not convinced that there is sufficient evidence for this in reality. Price-discrimination by income in the extreme case of charity for example shows that social and ethical factors should be considered
• Resistance to pre-payment is also because of its relation to closed-panel plans where the physician assumes the risks.
D. Pricing • Price discrimination, for whatever cause, is a
source of non-optimality:
– Hypothetically, it means that everyone would be better off if prices were made equal for all, and the rich compensated the poor for the changes in relative positions.
– The importance of this welfare loss depends on the actual amount of discrimination and on the elasticities of demand for medical services by different income groups.
4. Comparisons with the ideal competitive model under uncertainty
A. Introduction:
- in this section, assume that insurance policies against all conceivable risks are available
- There are two risks involved in medical care:
1. Risk of becoming ill
2. Risk of total or incomplete or delayed recovery
A. Introduction
• The loss due to illness is only partially the cost of medical care. It consists of:– Discomfort– Loss of productivity– Possibly death or prolonged deprivation of normal
function
• From the point of view the welfare economics of uncertainty, both losses are risks against which individuals would like to insure. The nonexistence of suitable insurance policies for either risk implies a loss of welfare.
B. The Theory of Ideal Insurance
Assumptions:• Each individual acts so as to maximize the expected
value of a utility function
• Utility is attached to income. Costs of medical care act as a random deduction from income
• Illness itself is not a source of satisfaction, therefore it should enter the utility function as a separate variable
• Individuals are assumed to be risk averters which means that they have diminishing marginal utility of income (wealth)
• The expected utility hypothesis is plausible and the most analytically manageable hypotheses that have been proposed to explain behavior under uncertainty.
B. The Theory Ideal Insurance
• If an individual is given the choice between a probability of distribution of income, with a given mean “m” and the certainty of the income “m”, he would prefer the latter
• Suppose an agency is willing to offer insurance on an actuarially fair basis; that is, if the costs of medical care are a random variable with “m” mean and the company will charge “m”.
B. The Theory Ideal Insurance
• Under the assumption that medical risks on different individuals are basically independent, the pooling of them reduces the risk involved to the insurer to relatively small proportions.
• In this limit, the welfare loss even assuming risk aversion on the part of the insurer, would disappear and there is net social gain.
B. The Theory Ideal Insurance
C. Problems of insurance
1. Moral hazard
2. Alternative methods of insurance payment. Three main methods:
• Prepayment• Indemnities according to a fixed schedule• Insurance against costs, whatever they may be
In a hypothetically perfect market, these 3 forms would be equivalent but in reality they do not work in health insurance market easily
3. Third-party control over payments:Provider and patient moral hazard shows itself here
4. Administrative costs- There are several types of operating costs such as commissions and acquisition costs and selling costs.
- Not only does this mean that insurance policies must be sold for considerably more than actuarial value, but it also means there is a great differential among different types of insurance
- Expenses constitute 51.6% of total premium for individual policies vs. 9.5% for group policies.
- This implies economies of scale. A strong case for widespread plans, including in particular compulsory ones (think of a huge social insurance pool)
C. Problems of insurance
5. Predictability and insurance– From the risk aversion point of view,
insurance is more valuable, the greater the uncertainty in the risk being insured against.
6. Pooling of unequal risks– Hypothetically, insurance requires for its full
social benefit a maximum possible discrimination of risks.
7. Gaps and coverage
C. Problems of insurance
D. Uncertainty effects of treatment
1. There are two major aspects of uncertainty for a person already suffering from illness:
- Uncertain about the effectiveness of medical treatment
- Uncertainty on the part of the physician which is different because of knowledge level differences
2. Ideal insurance- This will involve insurance against a failure to
benefit from medical care
3. The concepts of trust and delegation- The information inequality which leads to the setting up of a relationship of trust and confidence, one which the physician has a social obligation to live up to.
Consequences of the information asymmetry:- The physician cannot act, or at least appear to act, as if he is profiting maximizing his income at every moment of the time.- The patient must delegate to the physician much of his
freedom of choice
D. Uncertainty effects of treatment
4. Licensing and educational standardsThe social demand for quality can be met in more than one way. There are 3 attitudes:– The occupation can be licensed, nonqualified
entrants being simply excluded– The State or other agency can certify or label
without compulsory exclusion– Nothing at all may be done; consumers make
their own choices
D. Uncertainty effects of treatment