Lecture Principles of economics (Brief edition, 2e): Chapter 10 - Robert H. Frank, Ben S. Bernanke

Chapter 10 - Using economics to make better policy decisions. After completing this chapter, students will be able to: Describe how the Scarcity Principle applies to choices involving health, use the incentive principle to explain why health care costs have been rising so rapidly, discuss pollution taxes and effluent permits as a means to reduce the cost of improved air quality,...

Chapter 10: Using Economics to Make Better Policy Decisions

1 Describe how the Scarcity Principle applies to

choices involving health

2 Use the Incentive Principle to explain why health

care costs have been rising so rapidly

3 Discuss pollution taxes and effluent permits as a

means to reduce the cost of improved air quality

4 Illustrate why free trade is often politically

controversial even though it promises to increase total income

5 Assess the economic pros and cons of various

components of the social safety net

Health Care Delivery

• Health care spending has grown faster than income

– Up from 4% of national income in 1940 to 16% in 2010

– Part of the increase is due to improved quality of tests,

procedures, drugs, etc.

– Part is due to the third-party payment system

• Growth in use of insurance for payments ( Employer-provided and government-provided)

• Cost-benefit test assures efficient allocation of health care

– Perform a service only if the benefit exceeds the cost

• Costs are easy to measure

• Benefits are complicated

– Usual measure is willingness to pay marginal cost

• Some patients are unable to pay for basic services ( government-provided insurance)

Health Care for Employed

• Employer pays insurance

on behalf of employee

– Employees pay part of

the insurance premiums

• Medical provider cares for

patient / employee

– Patient co-pay

• Medical provider bills insurance

– Insurance company pays provider

• Insurance company periodically reviews employer's

policy and adjusts rates

Medical Provider

Patient / Employee

Employer

Insurance Company

Insurance, Demand, and Waste

• Amount of waste from full insurance depends on the price elasticity of demand for medical

services

• Research compared patients with first dollar

coverage to those with $1,000 deductibles

– First-dollar coverage pays all expenses for the

insured's health care

– $1,000 deductible pays all expenses after the

patient has paid $1,000

– Deductible patients spent 40 – 50% less on health care and had the same health outcomes

Policy Implications

• Research shows that when individuals pay for

their health care, they consume less

• A more efficient system can be designed

– Adopt a system of high deductible health insurance– Use stipend payments for the poor

• An efficient policy will increase the size of the

health care pie

Health Maintenance

Organization (HMO)

• A Health Maintenance Organization is a group

of physicians that provides health services for a fixed annual fee

– Reduced incentives to prescribe expensive tests

• The doctor receives no additional fee for prescribing and interpreting tests

• In most cases, diagnoses and treatment will be

the same with conventional health insurance and with an HMO

– HMO costs less than conventional health insurance

US Health Insurance

• In 2007, 47 million Americans had no health insurance

– Cost of a policy for a family of 4 generally exceeds annual health spending for the family

– Stigma of being irresponsible is fading

– Adverse selection problem

• If the healthy opt for no insurance, the insured are those with known health problems or risks (Raises costs for remaining insured)

• A possible solution

– Government payment of $5,000 to each family

– Health care market efficiency increases

• Patients decide, not insurance companies

– Cost to government would be $350 billion per year

• Higher taxes offset by higher salaries and reductions in cost care for the uninsured

high-Price Incentives and the

Environment

• Goods with negative externalities tend to be

overproduced

• Social objective is to reduce pollution by half

from its unregulated level

– The most efficient solution is one where the

marginal cost of pollution abatement is the same for all polluters

• Cost data are not available to government

– One solution is to have all reduce pollution by the

same proportion

• Uneven distribution of costs

Taxing Pollution

• If tax is $T per ton, the firms will reduce pollution

as long as the cost of reductions is less than $T

• A tax of $101 moves Sludge to B and NW Lumber

Price Incentives and the

Environment

• Taxing pollution concentrates pollution reduction

in firms that can accomplish it at the least cost

– Cost – Benefit Principle

– Cost of the last ton of smoke removed is the same for all firms

• It can be difficult to determine the optimal tax

rate

– Set the tax too high and you get too little reduction

– Set the tax too low and you get too much reduction

• Marginal cost exceeds marginal benefit to society

Auctioning Pollution Permits

• Set a target level for total pollution allowed

– Auction 4 permits to allow 4 tons/day

• Determine price of a permit, who buys them, and the total cost of pollution reductions

Auctioning Pollution Permits

Process

(smoke)

A (4 T/day)

B (3 T / day)

C (2 T/day)

D (1 T/day)

E (0 T/day)

Resistance to International Trade

• International trade benefits both exporting country and importing country

– Exporter gets a higher price abroad than he could

get at home

– Importer pays less than he would pay for the same product made domestically

• Blockades and sanctions limit a country's trade

– Civil War blockade of the South

– Current trade sanctions against Iran

• Opposition focuses on groups who lose from free

trade and ignores the benefit to the economy as a

whole

Resistance to International Trade

• Suppose Brazil has a comparative advantage in coffee and the US has a comparative advantage in

computers

– If Brazil allows the free importation of computers,

Brazilians get more computers and pay a lower

price

– Brazilian computer manufacturers are harmed

• Price has decreased, so inefficient firms fail

• Surviving firms earn lower profits

• In general

– Consumers are helped by imports

– Domestic producers of imported goods are hurt by

Resistance to International

Trade

• Suppose Brazil exports coffee to the US

– Price of coffee in Brazil increases, hurting domestic consumers

– Producers of coffee benefit from a higher price and

a larger market

• In general

– Consumers are hurt by exports

– Domestic producers of exported goods benefit from free trade

Restricting Trade

• Protectionism is the view that free trade is

injurious and should be restricted

• "Protecting" domestic markets is achieved in

several ways

– A tariff is a tax on an imported good

• Raises the price of the import and reduces quantity imported

– A quota is a legal limit on the quantity of a good

that can be imported

• Reduces supply of imports and increases the market price for the good compared to free trade

Income Redistribution

• Raising incomes of the needy reduces the

incentive to work

– Difficulty distinguishing between needy and others

• Risk takers may appear "needy"

• People who prefer not to work ineligible

• Hurricane victims

• No perfect solution

– Choose among imperfect alternatives

Welfare Payments and In-kind

• From mid 1960s to 1996, Aid to Families with

Dependent Children (AFDC) provided cash

– Sometimes required no adult male in the household

• Destabilizing for families

– Created persistent dependence on AFDC

Means-Tested Benefit Programs

• A means-tested program decreases benefits as

the recipient's other income increases

– Intends to avoid paying benefits to those who can

support themselves

• Administrative structure discourages work

– If benefits are reduced by $1 for each $2 earned,

participants in multiple programs may lose more

benefits than the income they earn

• Administrative costs are high

– Simplify the program and distribute the cost savings

to the needy

Earned Income Tax Credit

(EITC)

• An earned-income tax credit is a policy under

which low-income workers receive credits on

their federal taxes

• A family of four earns $15,000

– EITC is $4,750

– Federal taxes are reduced by $4,750

• If taxes are less than EITC, a refund is issued

• EITC does not interfere with market incentives

– Affects only people who work

– Allows labor markets to reach equilibrium

Public Employment for the Poor

• Overcomes the shortcomings of the EITC and

NIT

– EITC does not help the unemployed

– NIT reduces the incentive to work

• Government could employ the poor

– If wages are the same as the private sector, some

workers will prefer government jobs

• Increases the cost of the program

– Make-work programs are not productive

– Increases size of government

NIT + Public Job

NIT + Private Job Poverty

threshold