Transcript Tools for Health Policy

Government Regulation
and Intervention
Part 1
Vivian Ho
Health Economics
This material draws heavily from Santerre & Neun, Health Economics,
Theories, Insights, and Industry Studies, Dryden Press.
Introduction
Causes and consequences of
government intervention in health care.
 Types of government intervention.
 Case studies

– Cigarette taxes.
– Price ceilings on health care services.
– Hospital antitrust litigation.
Why Government Intervention?

Perfectly competitive markets lead to
efficient outcomes. Why?

Recall that the demand curve for any
given product has a negative slope.
– If consumers are visiting the doctor 2 times
per year when the price of a visit is $100,
the price must fall below $100 in order to
encourage consumers to see the doctor
more often.
Why Government Intervention?

Thus, the demand curve reflects the
consumer’s marginal benefit from
consumption.
– The marginal utility from the third visit to
the doctor is lower than the marginal
benefit from the second visit.

Similarly, we can define a demand
curve for society’s preferences as a
whole, which reflects the marginal social
benefit of medical services.
Why Government Intervention?
Price
MSB
Quantity of
medical services
Why Government Intervention?

Recall that the supply curve for any
given product slopes upwards.
– If a pharmacy is being paid $30 per
prescription to fill 300 prescriptions per
day, it must be paid more than $30 per unit
to fill 400 orders per day.

This reflects the fact that the marginal
costs of production usually rise as
output increases.
Why Government Intervention?

At the societal level, the marginal social
costs of providing services will also rise
as output increases.
– e.g. The marginal cost of achieving an
infant mortality rate of 20 per 100,000 live
births may be fairly low, but the marginal
cost of reducing the rate to 5 per 100,000
will be much higher.
Why Government Intervention?
Price
MSC
Quantity of
medical services
Why Government Intervention?

Equilibrium is reached where
MSB=MSC
Price
MSC
P0
MSB
Q0
Quantity
Why Government Intervention?

In equilibrium, all services are
exchanged at the price P0.
– But for all services less than Q0 (e.g. the 1st
and 2nd physician visit), the marginal social
benefit exceeds P0.
– The difference between marginal social
benefit and the equilibrium price is called
consumer surplus.
Why Government Intervention?
Price
MSC
Consumer
Surplus
P0
MSB
Q0
Quantity
Why Government Intervention?

For all services less than Q0, the
marginal social cost is lower than P0.
– The difference between marginal social
cost and the equilibrium price is called
producer surplus.
Why Government Intervention?
Price
MSC
P0
Producer
Surplus
MSB
Q0
Quantity
Why Government Intervention?

Perfect competition is considered efficient,
because it maximizes social welfare =
consumer surplus + producer surplus.
Price
Consumer
Surplus
S
Producer
Surplus
D
Quantity
Criteria for perfect
competition
All firms and consumers are price
takers.
 Consumers and firms have perfect
information.
 All firms produce an identical product.
 Firms can freely enter an exit an
industry.

Market imperfections may lead to inefficient
or inequitable distribution of resources.
Imperfect consumer information
 Monopoly
 Externalities

 Government
intervenes to restore
efficiency and/or equity.
• “Public interest theory.”
An opposing theory: The amount and types
of government intervention are determined
by supply and demand.
Vote-maximizing politicians “supply”
legislation.
 Wealth maximizing special interest
groups are the buyers.
 Successful politicians stay in office by
satisfying special interest groups.

“Special interest group theory”
Examples:

Extended patent protection for brand
name drugs.

Rejection of national health insurance in
favor of private insurance companies.
Special interest group theory claims that special
interest groups gain at the expense of the general
public.
Consumers are diverse, fragmented,
more costly for them to organize.
 Inefficient, inequitable resource
allocation by government.

Which theory do you believe?
 C-B analysis is needed to identify
winners and losers.

Types of Government Intervention

Provide public goods.
 Fund medical research.

Correct for externalities
 Tax cigarettes, pollution.

Impose regulations.
Enforce antitrust laws.
Sponsor redistribution
programs.
Operate public
enterprises.
 FDA
 Bar hospital mergers.
 Medicare and Medicaid.



 VA hospitals
Public Goods

>1 individual simultaneously receives
benefits from the good.
 i.e.,
no rivalry in consumption.
Costly to exclude nonpayers from
consumption of the good.
 Private firms unwilling to produce and sell
public goods.
 Are most medical services public goods?

Externalities
Definition: An unpriced byproduct of
production or consumption that adversely
affects another party not directly involved
in the market transaction.
 Cigarette
smoking
 Pollution
 Medical
treatment for cyclists who don’t
wear helmets
 Drunk drivers
Demand-side externality:
 Marginal Social Benefit  Marginal
Private Benefit

Supply-side externality:
 Marginal Social Cost  Marginal Private
Cost

Cigarette smoking is an example of a
(negative) demand-side externality.
Smokers impose work-related costs on
nonsmokers.
 Health insurance, pensions, sick leave,
disability, group life insurance financed
collectively by smokers and
nonsmokers.

 But
smokers, die earlier, pay less taxes,
premiums.
Smokers also impose health care
costs on nonsmokers.

Smokers usually incur higher health
care costs.
 But
nonsmokers die prematurely from
passive smoking, smoking-related fires.

The total external costs of cigarette
smoking are estimated to be 15¢ per
pack.
(Manning et al., 1991)
Keep in mind:
The problem which calls for government
intervention is external costs, not
internal costs.
 The full extent of external costs must be
measured using a lifetime approach.

Manning et al.’s methods
Lifetime external costs
154 
# packs smoked

Numerator takes into account life
expectancy for smokers and the costs
(savings due to early death) incurred
each year.
External Cost Components
Covered medical costs.
 Covered work loss and disability.
 Group life insurance.
 Widow’s social security bonus.
 Covered nursing home costs.
 Pensions.
 Taxes on earnings.
 Fires.

$ per
S=MPC=MSC
pack
MSC0
D=MPB
MSB0
MSB
Q1

Q0
Cigarette Packs
At Q0 MSC0 > MSB0
Cigarettes are being over-consumed.
Government can use taxes and subsidies to
alter economic incentives, correct for
externalities.

Charge a tax on cigarettes that reduces
consumption to the socially optimal level
Q 1.
 Levy
a per-unit tax T on cigarette
makers equal to vertical distance
between MPB and MSB at Q1.
$ per
pack
MPC0+ T
MPC0=MSC
P1
P0
P2
D=MPB
MSB
Q1
Q0
Cigarette packs
With tax:
Market price of cigarettes = P1
 Cigarette manufacturers receive P2 per
pack.


Tax burden
 Consumer
pays P1 - P0
 Seller pays P0 - P2
The relative tax burden on consumers vs.
producers depends on price elasticities for
supply and demand.

If demand for cigarettes is inelastic,
consumers bear a larger?/smaller?
Share of the tax burden.
Further issues
The current tax per pack exceeds
external costs. Is this “OK”?
 Should smokers or cigarette companies
be responsible for the external costs of
smoking?
 “Thank you for smoking.” Is this
moral??

Regulations

Government can attempt to control
price, quantity, or quality of health care
products.

Example: Price Ceilings in The
Canadian Health Care System.
– Consumers are fully insured by the
government.
– The government fixes the price the
physician receives for each visit.
Regulations

Because consumers are fully insured,
they will demand the number of visits as
if the price per visit = 0.

Assume that the government sets a
reimbursement rate for physician visits
equal to PC.
Price
S
PC
D
QS QD
Physician visits
With full insurance, consumers want QD
visits.
 But the government has fixed the price
of visits at PC.

– Only QS visits will be provided.
 Shortage
of physician visits = QD - QS.
Consequences
1)Physicians may treat patients on 1stcome, 1st-served basis, regardless of
severity/urgency.
2)Patients will have to queue for care/not
receive care.
3)Unethical doctors may take bribes from
patients trying to jump the queue.
Lesson: There is no free lunch under cost
containment. Price ceilings can lead to:
1) Shortages.
2) Longer waiting lines.
3) Nonprice rationing.
4) Poorer health outcomes.
The FDA and Drug Advertising

Fine Print in Drug Ads Sparks a Debate
– WSJ 4/1/97

What does the new advertising of drugs on
TV say about special interest vs. public
interest theory?
– Who are the special interest groups?
– What is in the public’s best interest?

Do drug companies all agree?
THE NEW YORK TIMES
Editorial: The Need
for Regulation:
For All of the
Nation’s Imports
9/16/2007