Lecture Health economics - Chapter 13: Government regulation and intervention (Part 1)

Chapter 13 - Government regulation and intervention (Part 1). This chapter presents the following content: Introduction, criteria for perfect competition, types of government intervention, public goods, externalities, smokers also impose health care costs on nonsmokers,...

Government Regulation

and Intervention

Part 1

Vivian HoHealth Economics

This material draws heavily from Santerre & Neun: Health Economics, Theories Insights and  Industry Studies, Southwestern Cengate 2010

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.

Criteria for perfect

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”

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.

Correct for externalities

 Fund medical research.

 Tax cigarettes, pollution.

 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?

Definition: An unpriced byproduct of

production or consumption that adversely affects another party not directly involved

in the market transaction

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

Manning et al.’s methods

Numerator takes into account life

expectancy for smokers and the costs (savings due to early death) incurred each year

smoked packs

osts c

external

Lifetime

# 154

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

At Q0 MSC0 > MSB0

Cigarettes are being over-consumed.

Cigarette Packs

$ per pack

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 Q1

Levy a per-unit tax T on cigarette

makers equal to vertical distance

between MPB and MSB at Q1

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??

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.

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.

With full insurance, consumers want QDvisits.

But the government has fixed the price

of visits at PC

– Only QS visits will be provided.

Shortage of physician visits = QD - QS

1)Physicians may treat patients on

1st-come, 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:

Antitrust: Sherman Antitrust Act

Section 1:

Every contract, combination in the form

of trust or otherwise, or conspiracy, in

restraint of trade or commerce among the several states or with foreign nations, is hereby declared illegal

The Act prohibits anticompetitive business practices that promote inefficiency and

inequity in the marketplace, such as:

Price fixing - when business rivals enter

a collusive agreement to refrain from

price competition; fix the price of a good

or service

Hospitals in a given city cannot jointly

establish the price of various hospital

services.

Boycott - agreement among competitors not to deal with a supplier or a

customer

Physicians in an area can’t collectively

agree to deny services to a particular

managed care organization.

Market allocation - when competitors

agree to compete with one another in

specific market area

Hospitals in the same city can’t collectively set geographic service boundaries.

Price fixing, boycotting, and market

allocations are illegal per se

The plaintiff must only prove these actions took place for the defendant to be in

violation of the Act.

In contrast, rule of reason doctrine is

used to evaluate horizontal mergers

under the Act

While horizontal mergers may force price above the competitive level, they may also create benefits which could be passed on

to the customer.

The government often taxes one group and uses the revenues to subsidize

another Why?

Interdependent utility functions

Donors get utility from increasing the

welfare of recipients.

Why is the government involved?

“free rider” problem.

Two notions of equity in redistribution

programs

Vertical equity

“Unequals should be treated unequally.” People who earn more should pay higher taxes.

Horizontal equity

“Equals should be treated equally.”

Two persons with the same income level should pay the same in net taxes.

Vertical equity in practice

How much more in taxes should higher income people pay?

Suppose high income households pay

$4,000 in taxes on average, and low

income households pay $2,000 Is this equitable?

If the high income household makes

$100,000, they pay a 4% tax

If the low income household makes

$10,000, they pay a 20% tax

The notion of equity in taxation depends not just on total tax revenues, but on

income levels and tax rates as well

In practice, vertical equity is achieved when the net tax system is sufficiently

Other forms of redistribution

Subsidy to a public hospital.

Tuition for nurses or doctors.

Potentially violates notion of vertical

equity

if all persons have equal access to the

subsidized product.

Demand-side subsidies - government

funding for consumers

In-kind: vouchers or reimbursements for specific services

Food stamps, Medicare, Medicaid

Cash: government-provided income that people can use at their own discretion

AFDC, Supplemental Security Income

Keep in mind: It is difficult to guarantee horizontal equity with multiple programs

in operation

Consumer Groups Accuse U.S of Negligence on Food Safety

– The New York Times, October 15, 2002

Back to the Start

Does government intervention correct

for market imperfections, or is it ruled by special interest groups?

A Final Caveat

Market failure is a necessary, but not sufficient condition for government

intervention

It may cost the government $10m to

correct a problem in the marketplace, which imposes $8m in damages

While markets may fail and impose

societal costs, the costs of government intervention may be greater