Income, poverty and healthcare

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A Lecture PresentationA Lecture Presentation


Income, Poverty, Income, Poverty, and Healthcareand Healthcare

Chapter 15Chapter 15


15.1 Income Distribution15.1 Income Distribution

The ultimate purpose of producing The ultimate purpose of producing goods and services is to satisfy the goods and services is to satisfy the material wants of people.material wants of people.

But for whom does society produce But for whom does society produce consumer goods and services? consumer goods and services?

Why are some people able to Why are some people able to consume much more than others?consume much more than others?


The Record Since 1935The Record Since 1935 While there have been changes in While there have been changes in

the distribution of measured income, the distribution of measured income, there remains substantial income there remains substantial income inequality.inequality.

Inequality might be overstated due Inequality might be overstated due to failure to consider differences in to failure to consider differences in ageage certain demographic factorscertain demographic factors institutional factorsinstitutional factors and government redistributive activitiesand government redistributive activities


Are We Overstating the Disparity Are We Overstating the Disparity in the Distribution of Income?in the Distribution of Income?

At any moment in time, middle-age At any moment in time, middle-age persons tend to have higher incomes persons tend to have higher incomes than younger and older persons than younger and older persons because because they are at an age when their they are at an age when their

productivity is at a peak productivity is at a peak they are participating in the labor force they are participating in the labor force

to a greater extentto a greater extent


Even if every individual earned exactly Even if every individual earned exactly the same income over his or her lifetime, the same income over his or her lifetime, there would still be inequality at any given there would still be inequality at any given moment in time, so that inequality moment in time, so that inequality resulting from this overstates the true resulting from this overstates the true inequality in the lifetime earnings of inequality in the lifetime earnings of people.people.

The increased proportion of Americans The increased proportion of Americans that are either very young or very old has that are either very young or very old has tended to increase the observed tended to increase the observed inequality in the distribution of income.inequality in the distribution of income.


Other demographic trends have also Other demographic trends have also caused the measured distribution of caused the measured distribution of income (measured in terms of income (measured in terms of household or family income) to household or family income) to appear more unequal. appear more unequal. increased number of divorced couples increased number of divorced couples rise of two-income familiesrise of two-income families DINKS (Double Income, No Kids)DINKS (Double Income, No Kids)


A family that decides to have two bread A family that decides to have two bread winners instead of one would move into a winners instead of one would move into a higher income quintile and create greater higher income quintile and create greater apparent income inequality.apparent income inequality.

At the same time, divorces create two At the same time, divorces create two households instead of one, lowering households instead of one, lowering income per household for divorced income per household for divorced couples; thus, they move into lower couples; thus, they move into lower income quintiles, also creating greater income quintiles, also creating greater apparent income inequality. apparent income inequality.


The impact of increased government The impact of increased government activity should be considered in activity should be considered in evaluating the measured income evaluating the measured income distribution. distribution.

Government-imposed taxes burden Government-imposed taxes burden different income groups differently. different income groups differently.

Also, many government programs Also, many government programs benefit some groups of income benefit some groups of income recipients more than others. recipients more than others.


Food stamps, school lunch Food stamps, school lunch programs, housing subsidies, programs, housing subsidies, Medicaid, and several other Medicaid, and several other programs provide recipients with programs provide recipients with in-kind transfersin-kind transfers..

In-kind transfers are given in the In-kind transfers are given in the form of goods and services rather form of goods and services rather than money.than money.


When taxes and in-kind transfers are When taxes and in-kind transfers are included, many economists conclude included, many economists conclude that they have served to reduce that they have served to reduce levels of inequality significantly from levels of inequality significantly from the levels suggested by aggregate the levels suggested by aggregate income statistics.income statistics.


The evidence suggests that The evidence suggests that inequality of money income in the inequality of money income in the United States declined from 1935 United States declined from 1935 to 1950 and then remained rather to 1950 and then remained rather stable until 1980.stable until 1980.

Since then, the distribution of Since then, the distribution of income has become less equal.income has become less equal.


However, if we consider age However, if we consider age distribution, institutional factors, distribution, institutional factors, and in-kind transfer programs, it and in-kind transfer programs, it is safe to say that the income is safe to say that the income distribution is considerably more distribution is considerably more equal than it appears.equal than it appears.


How Much Movement is There How Much Movement is There on the Economic Ladder?on the Economic Ladder?

A study of income mobility during A study of income mobility during the decade of 1985-1995 found that the decade of 1985-1995 found that less than 50 percent of individuals less than 50 percent of individuals who began in the poorest quintile who began in the poorest quintile ended up there a decade later, and ended up there a decade later, and almost 30 percent of those in the almost 30 percent of those in the poorest quintile moved up to the top poorest quintile moved up to the top three quintiles.three quintiles.


While the distribution of current While the distribution of current income is an important piece of income is an important piece of information, it is also critical to know information, it is also critical to know how much movement goes on how much movement goes on between different income levels. between different income levels. The people that make up a given The people that make up a given

income group are not always the same income group are not always the same people because there is substantial people because there is substantial movement between income groups.movement between income groups.


Most Americans experience Most Americans experience significant fluctuations in their significant fluctuations in their economic well-being from one year economic well-being from one year to the next.to the next.

Economic well-being can be affected Economic well-being can be affected by changes in personal and family by changes in personal and family circumstances, such as work circumstances, such as work experience, marital status, and experience, marital status, and household composition, as well as household composition, as well as changes in earnings.changes in earnings.


Why Do Some Earn More Why Do Some Earn More Than Others?Than Others?

Age Age Wages generally increase up to the age of Wages generally increase up to the age of

50 and fall dramatically at retirement age. 50 and fall dramatically at retirement age. Younger people tend to make little income Younger people tend to make little income

when they begin their working careers. when they begin their working careers. Skill Skill Education and trainingEducation and training Preferences toward risk and leisurePreferences toward risk and leisure


As productivity increases, workers can As productivity increases, workers can command higher wages.command higher wages.

Some workers are just more productive Some workers are just more productive than others, as a result of both innate than others, as a result of both innate skills and training and education. skills and training and education.

Some workers’ skills are just more in Some workers’ skills are just more in demand than others. demand than others.

Those that work longer hours or more Those that work longer hours or more intensely earn more.intensely earn more.


Those who prefer more amenities at Those who prefer more amenities at work or more time for leisure earn less. work or more time for leisure earn less.

Those who work in riskier or more Those who work in riskier or more unpleasant jobs earn more as unpleasant jobs earn more as compensation. compensation.

Despite difficulties in measurement, Despite difficulties in measurement, international comparisons of income international comparisons of income distribution have been made.distribution have been made.


Income inequality is greater in the Income inequality is greater in the United States and United Kingdom United States and United Kingdom than in Sweden and Japan.than in Sweden and Japan.

However, many developed countries However, many developed countries have more equal distributions of have more equal distributions of income than developing countries.income than developing countries.

Income Distribution in Income Distribution in Other CountriesOther Countries


While income inequality While income inequality withinwithin nations is often substantial, it is far nations is often substantial, it is far less than income inequality less than income inequality amongamong nations. nations.

A majority of income inequality A majority of income inequality reflects differences in living reflects differences in living standards standards amongamong countries rather countries rather than disparities than disparities withinwithin nations. nations.


15.2 The Pros and Cons of 15.2 The Pros and Cons of Income Equality Income Equality

Because of the difficulty of Because of the difficulty of measuring welfare, it is impossible to measuring welfare, it is impossible to "prove" that a given income "prove" that a given income distribution is better than another.distribution is better than another.

Political and social changes in the Political and social changes in the past century or two have generally past century or two have generally worked to reduce income inequality.worked to reduce income inequality.


The economic theory that supports The economic theory that supports income redistribution is derived from the income redistribution is derived from the principle of diminishing marginal utility:principle of diminishing marginal utility: where increases in income generate less where increases in income generate less

additional happiness (utility) at higher levels of additional happiness (utility) at higher levels of income income

Taking from the rich and giving to the Taking from the rich and giving to the poor could increase society's total utility if poor could increase society's total utility if the rich family loses less utility than the the rich family loses less utility than the poor family gains from the redistribution.poor family gains from the redistribution.

The Case for Income RedistributionThe Case for Income Redistribution


The theoretical argument favoring income The theoretical argument favoring income redistribution is based on the assumption redistribution is based on the assumption that people are alike in how they that people are alike in how they experience diminishing marginal utility experience diminishing marginal utility from increasing income, a proposition from increasing income, a proposition impossible to prove.impossible to prove.

If you believe society should try to If you believe society should try to equalize happiness among its members, equalize happiness among its members, some income redistribution could some income redistribution could arguably make sense.arguably make sense.


The Case Against Income RedistributionThe Case Against Income Redistribution

The principal disagreement over income The principal disagreement over income redistribution is not over whether we redistribution is not over whether we should have some redistribution, but should have some redistribution, but rather over at what point we should stop rather over at what point we should stop in our redistributive efforts. in our redistributive efforts.

Some believe we should go further than Some believe we should go further than we have, while others think we have we have, while others think we have already gone too far in attempts to alter already gone too far in attempts to alter the distribution of income in favor of the the distribution of income in favor of the poor and less affluent.poor and less affluent.


Arguments against a radical Arguments against a radical redistribution of income to eliminate redistribution of income to eliminate virtually all inequality include the virtually all inequality include the equity argument:equity argument: It is not “fair” to take most of the income It is not “fair” to take most of the income

of hard-working, talented persons who of hard-working, talented persons who earn high incomes, particularly when earn high incomes, particularly when some of it is given to persons who some of it is given to persons who perhaps are shiftless and lazy.perhaps are shiftless and lazy.


Other arguments against Other arguments against redistribution: redistribution: Some income inequality would seem Some income inequality would seem

desirable because consumption needs desirable because consumption needs may well vary with family size, age of may well vary with family size, age of family members, and other factors.family members, and other factors.

Radical redistribution would reduce Radical redistribution would reduce economic growth and future real income.economic growth and future real income.


At some point however, increased At some point however, increased redistribution of income might create redistribution of income might create increasing disincentive effects, and increasing disincentive effects, and reduce the rate of savings, retarding reduce the rate of savings, retarding capital formation. capital formation.

Ultimately, the cost of more current Ultimately, the cost of more current income equality is less income income equality is less income growth. growth.


15.3 The Economics of 15.3 The Economics of Discrimination Discrimination

Job-entry discriminationJob-entry discrimination A worker is denied employment on the A worker is denied employment on the

basis of some factor without regard to basis of some factor without regard to the productivity of the worker.the productivity of the worker.

Wage discriminationWage discrimination Workers are given employment at Workers are given employment at

wages lower than that of other workers wages lower than that of other workers on some basis other than productivity on some basis other than productivity differences.differences.


Job Entry DiscriminationJob Entry Discrimination

In a world where sex and race have In a world where sex and race have absolutely no bearing whatsoever on absolutely no bearing whatsoever on the employment circumstances of the employment circumstances of persons (e.g. talent, education, persons (e.g. talent, education, willingness and ability to work, move, willingness and ability to work, move, etc.), every occupation would, apart etc.), every occupation would, apart from random variations, have a from random variations, have a workforce with the same sex and race workforce with the same sex and race proportions as the population at large.proportions as the population at large.


Wage DiscriminationWage Discrimination

A strong statistical correlation exists A strong statistical correlation exists between lifetime earnings and years between lifetime earnings and years of schooling.of schooling.

High-school graduates earn roughly High-school graduates earn roughly two-thirds of the salary of college two-thirds of the salary of college graduates.graduates.


While a major reason women and While a major reason women and nonwhites earn less than white nonwhites earn less than white males is that they occupy jobs that males is that they occupy jobs that are lower paying, it is possible also are lower paying, it is possible also that they earn less because of wage that they earn less because of wage discrimination—being paid less for a discrimination—being paid less for a job strictly because of their race or job strictly because of their race or sex.sex.


Discrimination or Differences Discrimination or Differences in Productivity?in Productivity?

Merely demonstrating that wages are Merely demonstrating that wages are lower for blacks and females does not lower for blacks and females does not in itself prove wage discrimination, in itself prove wage discrimination, although it is consistent with the although it is consistent with the notion that discrimination occurs. notion that discrimination occurs.

If occupational and wage differentials If occupational and wage differentials are not caused by discrimination, are not caused by discrimination, what are the causes?what are the causes?


Several scholars have developed Several scholars have developed statistical models that argue that a great statistical models that argue that a great deal of the earnings differentials across deal of the earnings differentials across the sexes and races can be explained by the sexes and races can be explained by differences in productivity.differences in productivity.

Employers hire and pay workers roughly Employers hire and pay workers roughly an amount equal to their perceived an amount equal to their perceived contributions (marginal revenue contributions (marginal revenue product). product).


One explanation for higher One explanation for higher productivity among white males than productivity among white males than others is that various environmental others is that various environmental factors have prevented blacks and factors have prevented blacks and women from gaining the training, women from gaining the training, skills and experience necessary to skills and experience necessary to achieve high productivity. achieve high productivity.


This environmental explanation of This environmental explanation of productivity differences does not rule productivity differences does not rule out discrimination, but rather argues out discrimination, but rather argues that past discrimination's perverse that past discrimination's perverse influences on the environment of women influences on the environment of women and nonwhites has caused them to have and nonwhites has caused them to have an inferior endowment of human capital an inferior endowment of human capital now, even if present-day employers now, even if present-day employers were color- and sex-blind in terms of were color- and sex-blind in terms of paying workers.paying workers.


Why Do People Discriminate?Why Do People Discriminate? It might appear that discrimination is It might appear that discrimination is

totally inconsistent with rational totally inconsistent with rational utility-maximization.utility-maximization.

To maximize profits, a firm should To maximize profits, a firm should minimize costs by hiring the best minimize costs by hiring the best persons available per dollar of wage persons available per dollar of wage expenditure, regardless of the age, expenditure, regardless of the age, sex, race, or other attribute of the sex, race, or other attribute of the worker.worker.


To some extent, discrimination may To some extent, discrimination may reflect information costs. reflect information costs.

Based on past experience, race or Based on past experience, race or sex may be used as a screening sex may be used as a screening device, to narrow the list of job device, to narrow the list of job candidates, because it costs money candidates, because it costs money and time to evaluate the prospects and time to evaluate the prospects of every applicant.of every applicant.


The information cost reduction from The information cost reduction from hiring on the basis of color or sex hiring on the basis of color or sex may exceed the perceived benefits may exceed the perceived benefits from the identification of good from the identification of good workers of a particular color or sex.workers of a particular color or sex.


It is a fact that some people prefer to It is a fact that some people prefer to associate with persons with certain associate with persons with certain racial and/or sexual attributes. racial and/or sexual attributes.

In such cases, the utility gained from In such cases, the utility gained from having the desired racial or sexual having the desired racial or sexual mix might exceed the loss in income mix might exceed the loss in income from not having the best employees. from not having the best employees.


The Costs of DiscriminationThe Costs of Discrimination In competitive industries, firms that In competitive industries, firms that

discriminate may lose out. discriminate may lose out. The nondiscriminating firm hires the unfavored The nondiscriminating firm hires the unfavored

but equally competent workers and has a cost but equally competent workers and has a cost advantage, allowing it to undercut advantage, allowing it to undercut discriminating competitors’ prices and either discriminating competitors’ prices and either force them out of business or make them force them out of business or make them change their hiring practices. change their hiring practices.

In the long run, competition has the In the long run, competition has the potential to reduce discrimination.potential to reduce discrimination.


Remedying DiscriminationRemedying Discrimination The primary means used to address The primary means used to address

economic discrimination in our economic discrimination in our country is affirmative action country is affirmative action programs, in which employers are programs, in which employers are strongly encouraged to hire more strongly encouraged to hire more minority group workers in occupations minority group workers in occupations where those groups are now relatively where those groups are now relatively under-represented and to correct under-represented and to correct wage and salary inequities. wage and salary inequities.


Some environmental causes of Some environmental causes of productivity differences have also productivity differences have also been attacked. been attacked.

There is some evidence that these There is some evidence that these various efforts have met with some various efforts have met with some success. success.

Still, the economic differences Still, the economic differences between different races and sexes between different races and sexes are rather large. are rather large.


Affirmative action job hiring programs Affirmative action job hiring programs are controversial. are controversial.

The establishment of what are, in The establishment of what are, in effect, quotas on the hiring of effect, quotas on the hiring of minorities increases the probability minorities increases the probability that some persons will be hired on that some persons will be hired on some basis other than productivity. some basis other than productivity.


While this may be desirable from the While this may be desirable from the standpoint of equalizing standpoint of equalizing opportunities between demographic opportunities between demographic groups, it also can serve to lower the groups, it also can serve to lower the output of society as a whole and output of society as a whole and profits to firms. profits to firms.

Also, the "reverse discrimination" Also, the "reverse discrimination" equity argument is raised. equity argument is raised.


An alternative approach to one using An alternative approach to one using implicit quotas would be to subsidize implicit quotas would be to subsidize employers for hiring minority employers for hiring minority workers, which would provide workers, which would provide employers with greater incentive to employers with greater incentive to increase minority job opportunities. increase minority job opportunities.


15.4 Poverty15.4 Poverty

Our concern over income distribution Our concern over income distribution largely arises because of a feeling largely arises because of a feeling that people with low incomes (“the that people with low incomes (“the poor”) suffer in a material sense poor”) suffer in a material sense relative to other persons.relative to other persons.


Defining PovertyDefining Poverty The federal government measures poverty The federal government measures poverty

by using a set of money income thresholds by using a set of money income thresholds that vary by family size and are adjusted that vary by family size and are adjusted for inflation.for inflation. If the family’s total income is less than the If the family’s total income is less than the

established threshold—the established threshold—the povertypoverty lineline—it is —it is considered poor. considered poor.

The The poverty ratepoverty rate is the proportion of is the proportion of persons who fall below that absolute persons who fall below that absolute standard.standard.


The poverty rate for the United States The poverty rate for the United States is currently set at three times the cost is currently set at three times the cost of providing a nutritionally adequate of providing a nutritionally adequate diet—slightly less than $20,000 for a diet—slightly less than $20,000 for a family of four.family of four.

The poverty rate may overstate the The poverty rate may overstate the level of poverty because it does not level of poverty because it does not include noncash benefits, such as include noncash benefits, such as public housing, Medicaid, and food public housing, Medicaid, and food stamps.stamps.


With a definition of poverty that is With a definition of poverty that is determined at some fixed, real determined at some fixed, real income level, poverty over time income level, poverty over time should decline and, indeed, largely should decline and, indeed, largely disappear, unless lower income disappear, unless lower income groups do not share at all in rising groups do not share at all in rising incomes because real incomes incomes because real incomes generally rise over time with generally rise over time with economic growth. economic growth.


Thus, one cure for poverty, as Thus, one cure for poverty, as defined by some absolute income defined by some absolute income or standard of living criterion, is or standard of living criterion, is economic growth. economic growth.

The greater the rate of economic The greater the rate of economic growth, the more rapidly poverty growth, the more rapidly poverty will be eradicated.will be eradicated.


An Alternative Definition of An Alternative Definition of PovertyPoverty

Many “poor” individuals in the United Many “poor” individuals in the United States, using the official definition, States, using the official definition, would be considered well off, even “rich” would be considered well off, even “rich” in many less-developed countries.in many less-developed countries.

Rather than being classified by an ability Rather than being classified by an ability to buy some specific basket of goods to buy some specific basket of goods and services, poverty is often thought and services, poverty is often thought of as a relative income concept.of as a relative income concept.


A person is poor if his or her income A person is poor if his or her income is low relative to the incomes of is low relative to the incomes of most other persons in the same most other persons in the same geographical area.geographical area.


Using definitions of poverty based on Using definitions of poverty based on relative income measures, as economic relative income measures, as economic growth proceeds, the income growth proceeds, the income necessary to avoid being considered necessary to avoid being considered poor by this measure increases. poor by this measure increases.

Using this definition, then, poverty Using this definition, then, poverty cannot be eradicated by economic cannot be eradicated by economic growth, but only by income growth, but only by income redistribution. redistribution.


Income RedistributionIncome Redistribution

There are a variety of programs There are a variety of programs designed to reduce poverty and designed to reduce poverty and redistribute income:redistribute income: TaxesTaxes Transfer PaymentsTransfer Payments Government SubsidiesGovernment Subsidies Minimum WageMinimum Wage


One way to redistribute income to One way to redistribute income to reduce disparities among individuals reduce disparities among individuals is through federal income tax.is through federal income tax.

The federal income tax is designed The federal income tax is designed to be a to be a progressive taxprogressive tax systemsystem——one that imposes higher marginal one that imposes higher marginal tax rates on higher incomes.tax rates on higher incomes.


A second means by which income A second means by which income redistribution can be carried out by redistribution can be carried out by the government is through direct the government is through direct transfer payments to the lower part transfer payments to the lower part of the income distribution.of the income distribution.

Transfer payments are payments Transfer payments are payments made to individuals for which goods made to individuals for which goods or services are exchanged.or services are exchanged.


There are in-kind transfers—direct There are in-kind transfers—direct transfers of goods or services like transfers of goods or services like food stamps, housing subsidies, and food stamps, housing subsidies, and Medicaid—and Medicaid—and cash transferscash transfers like like welfare, Social Security, and welfare, Social Security, and unemployment compensation.unemployment compensation.


Supplemental Security Income Supplemental Security Income (SSI)(SSI) is a program designed for the is a program designed for the most needy, elderly, disabled, and most needy, elderly, disabled, and blind.blind.

Temporary Assistance for Needy Temporary Assistance for Needy Families (TANF)Families (TANF) is designed to is designed to help families that have few financial help families that have few financial resources.resources.


The The Earned Income Tax Credit Earned Income Tax Credit (EITC)(EITC) is a program that allows the is a program that allows the working poor to receive income working poor to receive income refunds than can be greater than the refunds than can be greater than the taxes they paid during the last year.taxes they paid during the last year.

It is a It is a means-tested income means-tested income transfer programtransfer program like food stamps, like food stamps, Medicaid, and housing subsidies.Medicaid, and housing subsidies.


Government can help the less affluent Government can help the less affluent by using government revenues to by using government revenues to provide low-cost public services:provide low-cost public services: Inexpensive public housingInexpensive public housing Subsidized public transportSubsidized public transport Public parksPublic parks ““Free” public educationFree” public education


Federal government subsidies to Federal government subsidies to commuter railroads primarily lower commuter railroads primarily lower the cost to affluent suburbanites of the cost to affluent suburbanites of getting to work in the central city.getting to work in the central city.

Support for public universities may Support for public universities may help the middle or even upper help the middle or even upper income groups more than the poor.income groups more than the poor.


There are agricultural subsidies that There are agricultural subsidies that often provide large benefits to often provide large benefits to farmers who already have large farmers who already have large incomes.incomes.


Can a higher minimum wage ease Can a higher minimum wage ease the burden on the poor?the burden on the poor?

Almost all economists would agree Almost all economists would agree that a large increase in the minimum that a large increase in the minimum wage, to say $20, would have a wage, to say $20, would have a devastating effect on the unskilled devastating effect on the unskilled labor market.labor market.


There is some debate among There is some debate among economists over the elasticity of the economists over the elasticity of the demand curve for labor.demand curve for labor.

If the demand curve for labor is If the demand curve for labor is relatively inelastic, an increase in relatively inelastic, an increase in the minimum wage leads to only a the minimum wage leads to only a small reduction in employment.small reduction in employment.


However, if the demand curve for However, if the demand curve for labor is relatively elastic, the labor is relatively elastic, the reduction in employment is larger.reduction in employment is larger.

Critics of a higher minimum wage Critics of a higher minimum wage argue that it is poorly targeted, if its argue that it is poorly targeted, if its object is to reduce poverty, because object is to reduce poverty, because many of the recipients of the many of the recipients of the minimum wage are teenagers living minimum wage are teenagers living in households that are not facing in households that are not facing poverty.poverty.


Some argue that a policy focusing on Some argue that a policy focusing on subsidizing the wages of the poor subsidizing the wages of the poor would go a lot further in reducing would go a lot further in reducing poverty.poverty.

That is, society needs to find more That is, society needs to find more effective policy for low-wage workerseffective policy for low-wage workers—perhaps job training programs.—perhaps job training programs.


15.5 Healthcare15.5 Healthcare Like the production of any other Like the production of any other

good or service, however, healthcare good or service, however, healthcare involves the utilization of scarce involves the utilization of scarce resources.resources.

Not only must the healthcare sector Not only must the healthcare sector compete with other sectors for compete with other sectors for resources, but those resources must resources, but those resources must be allocated across patients facing be allocated across patients facing vastly different circumstances.vastly different circumstances.


The Rising Cost of HealthcareThe Rising Cost of Healthcare

The United States spends more The United States spends more money on healthcare per person and money on healthcare per person and as a percentage of national income as a percentage of national income than any other industrialized nation.than any other industrialized nation.

In 2001, healthcare expenditures In 2001, healthcare expenditures comprised approximately 14 percent comprised approximately 14 percent of GDP.of GDP.


Spending on healthcare has Spending on healthcare has increased significantly over the last increased significantly over the last several decades, averaging over 14 several decades, averaging over 14 percent of GDP throughout the percent of GDP throughout the 1990s compared with only 5.1 1990s compared with only 5.1 percent in 1960.percent in 1960.


The utilization of medical care The utilization of medical care involves trade-offs. involves trade-offs.

Scarce resources allocated toward Scarce resources allocated toward the production of health services the production of health services cannot be used in the production cannot be used in the production of other goods and services.of other goods and services.


Investment in healthcare bears Investment in healthcare bears similarities to investment in human or similarities to investment in human or physical capital.physical capital.

By promoting health and removing By promoting health and removing disabilities, medical care candisabilities, medical care can improve the productivity of workers on improve the productivity of workers on

the job and reduce missed workdaysthe job and reduce missed workdays extend the average number of years of extend the average number of years of

participation by people in the labor participation by people in the labor forceforce


The Demand for HealthcareThe Demand for Healthcare

Increases in the quality and quantity Increases in the quality and quantity of labor available due to better of labor available due to better healthcare will shift an economy’s healthcare will shift an economy’s production possibilities curve production possibilities curve outward.outward.

Both the demand for and supply of Both the demand for and supply of healthcare have increased over the healthcare have increased over the last several decades.last several decades.


IncomeIncome

Estimates of the price elasticity of Estimates of the price elasticity of demand for healthcare generally demand for healthcare generally range between 0.2 and 1.0, range between 0.2 and 1.0, indicating significant inelasticity indicating significant inelasticity of demand for medical services. of demand for medical services.

The quantity of medical care The quantity of medical care demanded appears to be quite demanded appears to be quite insensitive to changes in price.insensitive to changes in price.


Healthcare is considered a necessity Healthcare is considered a necessity with few good substitutes, with few good substitutes, particularly when it comes to serious particularly when it comes to serious illness. illness.


InsuranceInsurance The health services market differs from The health services market differs from

many others in that, due to insurance, the many others in that, due to insurance, the consumer often pays only a fraction of the consumer often pays only a fraction of the direct cost of care.direct cost of care.

Third-party payers, such as insurance Third-party payers, such as insurance companies or health maintenance companies or health maintenance organizations, play significant roles in this organizations, play significant roles in this industry, which have important incentive industry, which have important incentive effects and alter the behavior of both effects and alter the behavior of both patients and providers.patients and providers.


In addition to increasing the quantity of In addition to increasing the quantity of healthcare demanded by reducing price, healthcare demanded by reducing price, insurance alters the incentive of patients insurance alters the incentive of patients in other ways.in other ways. Insurance reduces the cost to the Insurance reduces the cost to the

insured of undertaking risky activities. insured of undertaking risky activities. In an accident or illness, the healthcare In an accident or illness, the healthcare

costs are borne by the insurer.costs are borne by the insurer. This creates what economists call a This creates what economists call a

“moral hazard” problem.“moral hazard” problem.


Moral hazard in healthcare exists Moral hazard in healthcare exists whenever insurance makes a person whenever insurance makes a person more likely to engage in risky more likely to engage in risky behavior (which could lead to an behavior (which could lead to an accident or illness) and less likely to accident or illness) and less likely to undertake preventative measures undertake preventative measures against illness. against illness.


Insurance companies or third-party Insurance companies or third-party payers attempt to reduce moral payers attempt to reduce moral hazard problems by requiring hazard problems by requiring patients to pay higher deductibles patients to pay higher deductibles and/or co-payments, thereby and/or co-payments, thereby compelling the insured to share a compelling the insured to share a greater proportion of incurred costs.greater proportion of incurred costs.


Insurance may pose additional Insurance may pose additional problems for the healthcare industry.problems for the healthcare industry. A situation of asymmetric information A situation of asymmetric information

exists whenever patients know more exists whenever patients know more about their own health status than about their own health status than prospective insurers.prospective insurers.

This is known as "adverse selection" This is known as "adverse selection" because the chronically ill are more likely because the chronically ill are more likely to demand health insurance than are to demand health insurance than are those in good health. those in good health.


An insurance company inviting An insurance company inviting voluntary participation in a plan may voluntary participation in a plan may find that it has insured an adverse find that it has insured an adverse selection of largely ill patients and selection of largely ill patients and would be forced to increase would be forced to increase insurance premiums to stave off insurance premiums to stave off losses.losses.


As insurance premiums increase, As insurance premiums increase, however, healthy enrollees are more however, healthy enrollees are more likely to drop out of the plan (opting likely to drop out of the plan (opting instead for cheaper, less generous instead for cheaper, less generous health insurance plans or for self-health insurance plans or for self-insurance).insurance).

This further exacerbates the adverse This further exacerbates the adverse selection problem.selection problem.


Insurers can reduce adverse selection risk by Insurers can reduce adverse selection risk by limiting the period of open enrollment in limiting the period of open enrollment in

health insurance plans health insurance plans requiring physical exams (so that an requiring physical exams (so that an

individual cannot purchase insurance after individual cannot purchase insurance after serious illness strikes)serious illness strikes)

insuring entire groups (such as all insuring entire groups (such as all members of a large employer or union) in members of a large employer or union) in order to ensure a diversity of health order to ensure a diversity of health statusesstatuses


Demographic ChangesDemographic Changes The aging of the U.S. population is The aging of the U.S. population is

an additional factor that explains the an additional factor that explains the increase in demand for healthcare. increase in demand for healthcare.

The elderly consume a The elderly consume a disproportionate share of healthcare disproportionate share of healthcare services (three to four times as services (three to four times as much as the rest of the population).much as the rest of the population).


The Supply of HealthcareThe Supply of Healthcare The supply of healthcare has increased The supply of healthcare has increased

slowly since 1960. slowly since 1960. The number of providers has increased The number of providers has increased

but has not kept up with the demand for but has not kept up with the demand for medical services. medical services.

There has been an increase in the cost of There has been an increase in the cost of medical education and training as well as medical education and training as well as a greater use of high-cost technological a greater use of high-cost technological equipment in the healthcare industry.equipment in the healthcare industry.


Doctors as GatekeepersDoctors as Gatekeepers Healthcare services may be provided Healthcare services may be provided

through through independent physiciansindependent physicians nonprofit hospitalsnonprofit hospitals for-profit hospitalsfor-profit hospitals health maintenance organizationshealth maintenance organizations preferred provider organizationspreferred provider organizations nursing homesnursing homes hospiceshospices home health providershome health providers other healthcare agents and agenciesother healthcare agents and agencies


Traditional health insurance in the Traditional health insurance in the United Sates provides United Sates provides indemnity indemnity coveragecoverage (security in the event of (security in the event of illness or injury) on a fee-for-service illness or injury) on a fee-for-service basis.basis.


Escalating healthcare costs over the Escalating healthcare costs over the last decade, however, have led to a last decade, however, have led to a greater emphasis on cost greater emphasis on cost containment.containment.

There has been a proliferation of There has been a proliferation of organizations offering managed organizations offering managed care, including health maintenance care, including health maintenance organizations and preferred provider organizations and preferred provider organizations.organizations.


Health maintenance Health maintenance organizations (HMOs)organizations (HMOs) combine tow combine tow traditionally separated functions: the traditionally separated functions: the provision of comprehensive provision of comprehensive healthcare and its financing.healthcare and its financing.


A A preferred provider organization preferred provider organization (PPO)(PPO) is a network of doctors who is a network of doctors who agree to provide services to a health agree to provide services to a health plan’s enrollees at discounted fees.plan’s enrollees at discounted fees.


Technological Progress and Technological Progress and Quality of CareQuality of Care

Medical research and technological Medical research and technological progress has vastly improved the quality progress has vastly improved the quality of medical care.of medical care.

Innovative therapies help reduce disability, Innovative therapies help reduce disability, improve health, and prolong life. improve health, and prolong life.

Some innovations undoubtedly reduce the Some innovations undoubtedly reduce the overall cost of healthcare. overall cost of healthcare.

Other innovations, however, significantly Other innovations, however, significantly add to the cost of healthcare.add to the cost of healthcare.


Technological advances have led not only Technological advances have led not only to an increase in the supply of healthcare, to an increase in the supply of healthcare, but through its interaction with insurance, but through its interaction with insurance, also a significant increase in the demand also a significant increase in the demand for medical care.for medical care.

Insured patients who bear a small fraction Insured patients who bear a small fraction of healthcare costs naturally desire the of healthcare costs naturally desire the best possible care, contributing to a rise in best possible care, contributing to a rise in healthcare costs that far exceeds the healthcare costs that far exceeds the average level of inflation.average level of inflation.


Imperfect CompetitionImperfect Competition

Healthcare markets are imperfectly Healthcare markets are imperfectly competitive for several reasons, competitive for several reasons, includingincluding the presence of legal or administrative the presence of legal or administrative

barriers to entrybarriers to entry economies of scaleeconomies of scale collusioncollusion restrictions on advertisingrestrictions on advertising


Compulsory licensingCompulsory licensing Restricts entry into the healthcare market.Restricts entry into the healthcare market. Licensing requirements and limitations on Licensing requirements and limitations on

hospital privileges are justified as protecting hospital privileges are justified as protecting patients from inferior-quality medical care by patients from inferior-quality medical care by certifying that physicians possess a certain certifying that physicians possess a certain level of competency.level of competency.

Restricting the supply of physicians, licensing Restricting the supply of physicians, licensing and hospital privilege requirements limit the and hospital privilege requirements limit the quantity of services provided and lead to higher quantity of services provided and lead to higher medical prices.medical prices.


Healthcare economies of scaleHealthcare economies of scale Specialty services may be utilized infrequently Specialty services may be utilized infrequently

requiring large populations be served by only requiring large populations be served by only a few providers. a few providers.

Cities and towns are often unable to support a Cities and towns are often unable to support a large number of hospitals.large number of hospitals.

Only in densely populated metropolitan areas Only in densely populated metropolitan areas may it be economical for numerous hospitals may it be economical for numerous hospitals to compete.to compete.

Conditions may be such that "natural Conditions may be such that "natural monopolies" exist in many areas.monopolies" exist in many areas.


Healthcare providers possess Healthcare providers possess significant market power, making significant market power, making price discrimination and collusive price discrimination and collusive behavior (such as price-fixing) more behavior (such as price-fixing) more likely to occur.likely to occur.


ShortagesShortages

In Canada, where a national In Canada, where a national healthcare program controls prices healthcare program controls prices and strictly rations care, conditions and strictly rations care, conditions of excess demand for surgery of excess demand for surgery prevail. prevail.

Likewise, shortages prevail in the Likewise, shortages prevail in the market for organ transplants.market for organ transplants.

Income, poverty and healthcare

Education

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