Deck 21: Pure Competition

Question 1

Suppose that the price elasticity for hip replacement surgeries is 0.2. Further suppose that hip replacement surgeries are originally not covered by health insurance and that at a price of $50,000 each, 10,000 such surgeries are demanded each year.
a. Suppose that health insurance begins to cover hip replacement surgeries and that everyone interested in getting a hip replacement has health insurance. If insurance covers 50 percent of the cost of the surgery, by what percentage would you expect the quantity demanded of hip replacements to increase? What if insurance covered 90 percent of the price? (Hint: Do not bother to calculate the percentage changes using the midpoint formula given in Chapter 4. If insurance covers 50 percent of the bill, just assume that the price paid by consumers 50 percent.)
b. Suppose that with insurance companies covering 90percent of the price, the increase in demand leads to a jump in the price per hip surgery from $50,000 to $100,000. How much will each insured patient now pay for a hip replacement surgery? Compared to the original situation, where hip replacements cost $50,000 each but people had no insurance to help subsidize the cost, will the quantity demanded increase or decrease? By how much?

Answer 1

a)
Insurance covers only 50% :
Price or cost of a hip replacement surgery = $50,000
Percentage cost of the surgery covered by insurance = 50%
Fall in price due to insurance cover =
= $25,000
Price elasticity for hip replacement surgery = 0.2
To recall, price elasticity =
Therefore,
0.2 =
% change in quantity demanded = 0.2×50% =
Now if the percentage cost of the surgery covered by insurance = 90%
So, 0.2 =
% change in quantity demanded = 0.2×90% =
______________________________________________________________________________
(b)
If insurance companies cover 90% of the surgery;
New price of hip replacement surgery due to increased demand = $100,000
90% coverage by insurance = $90,000
Price to be paid by patient = $10,000
In payment terms, % of new price with actual price=
= 20%
Percentage change in price (from $50,000 to $10,000) = 80%
Therefore,
0.2 =
% change in quantity demanded = 0.2×80% =
Number of surgeries demanded in a year = 10,000
Therefore, the quantity of surgeries demanded increases =
=
Change in quantity demanded for surgeries = 11,600 - 10,000 =

Question 2

Why would increased spending as a percentage of GDP on, say, household appliances or education in a particular economy be regarded as economically desirable? Why, then, is there so much concern about rising expenditures as a percentage of GDP on health care?

Answer 2

Increasing expenditures on goods such as household appliances or education is regarded as desirable because production is expanding under relatively competitive market conditions.  Thus, not only are output and employment expanding, but presumably these are happening because of allocative efficiency.  Consumers are choosing to buy appliances or education because they are willing to pay the price for these goods.
?There is concern about the same rising expenditures in the health care industry because of the unique factors that characterize the market for health care services.  On the demand side, there is imperfect competition in that buyers do not have good information about the services needed or the fees that will be charged for the services; doctors control much of this information and, in fact, order the services for the consumer in most cases.  Third-party insurance companies pay the direct costs of most health care on a fee-for-service basis, and therefore the consumer pays less than the full price at the time of consumption, leading to overconsumption; overconsumption by the insured may also be encouraged by the "moral hazard" problem.  On the supply side, technology is encouraged without much regard for its cost by insurance providers; doctors also control much of the provision of health care in an imperfectly competitive supply structure, since they really don't compete on the basis of price.  In other words, many of the unique factors of the health care market lead economists to believe that overconsumption is occurring and that society is losing because resources are not being allocated efficiently in a way that maximizes society's welfare.

Question 3

The Federal tax code allows businesses but not individuals to deduct the cost of health insurance premiums from their taxable income. Consider a company named HeadBook that. could either spend $5000 on an insurance policy for an employee named Vanessa or could increase her annual salary by $5000 instead.
a. As far as the tax code is concerned, HeadBook will increase its expenses by $5000 in either case. If it pays for the policy, it incurs a $5000 health care expense. If it raises Vanessa's salary by $5000, it incurs $5000 of salary expense. If HeadBook is profitable and pays corporate profit taxes at a marginal 35 percent rate, by how much will HeadBook's tax liability be reduced in either case?
b. Suppose that Vanessa pays personal income tax at a marginal 20 percent rate. If HeadBook increases her salary by $5000, how much ofthat increase will she have after paying taxes on that raisel If Vanessa can only devote what remains after paying taxes on the $5000 to purchasing health insurance, how much will she be able to spend on health insurance for herself?
c. If HeadBook spends the $5000 on a health insurance policy for Vanessa instead of giving it to her as araise, how many more dollars will HeadBook be able to spend on Vanessa's health insurance than if she had to purchase it herself after being given a $5000 raise and paying taxes on that raise?
d. Would Vanessa prefer to have the raise or to have HeadBook purchase insurance for her? Would HeadBook have any profit motive for denying Vanessa her preference?
e. Suppose the government changes the tax law so that individuals can now deduct the cost of health insurance from their personal incomes. If Vanessa gets $5000 raise and then spends all of it on health insurance, how much will her tax liability change? How much will she be able to spend on health insurance? Will she now have a preference for HeadBook to buy insurance on her behalf?

Answer 3

(a) The firms will pay $1750 less in taxes.
(b) $4000; $4,000
(c) $1000
(d) Vanessa would prefer to have HeadBook purchase insurance for her. Headbook would not have any profit motive to deny Vanessa's preference.
(e) Vanessa's tax liability will not change. She will have $5000 to spend on health insurance. She will no longer have a preference for HeadBook to buy insurance.
Feedback: Consider the following example. The Federal tax code allows businesses but not individuals to deduct the cost of health insurance premiums from their taxable income. Consider a company named HeadBook that could either spend $5000 on an insurance policy for an employee named Vanessa or could increase her annual salary by $5000 instead.
Part a:
a. As far as the tax code is concerned, HeadBook will increase its expenses by $5000 in either case. If it pays for the policy, it incurs a $5000 health care expense. If it raises Vanessa's salary by $5000, it incurs a $5000 of salary expense. If HeadBook is profitable and pays corporate profit taxes at a marginal 35 percent rate, by how much will HeadBook's tax liability be reduced in either case?
Corporate profit tax is paid on accounting profit, which is the difference between revenue and expenses. Since either option will increase the firm's expenses by $5000, it will lower the firm's accounting profit by $5000. This means that the firms will pay 0.35*$5000 = $1750 less in taxes in either case.
Part b:
b. Suppose that Vanessa pays personal income tax at a marginal 20 percent rate. If HeadBook increases her salary by $5000, how much of that increase will she have after paying taxes on that raise? If Vanessa can only devote what remains after paying taxes on the $5000 to purchasing health insurance, how much will she be able to spend on health insurance for herself?
Since her marginal tax rate is 20 percent, Vanessa will pay $1000 of taxes on her $5000 raise (=0.2 x$5000). That will leave her with only $4000 to spend on health insurance.
Part c:
c. If HeadBook spends the $5000 on a health insurance policy for Vanessa instead of giving it to her as a raise, how many more dollars will HeadBook be able to spend on Vanessa's health insurance than if she had to purchase it herself after being given a $5000 raise and paying taxes on that raise?
If HeadBook uses the $5000 to purchase health insurance for Vanessa, it will be able to spend $1000 more than Vanessa would after paying income taxes on a $5000 raise. Recall from part b, Vanessa only had $4000 after taxes to purchase insurance.
Part d:
d. Would Vanessa prefer to have the raise or to have HeadBook purchase insurance for her? Would HeadBook have any profit motive for denying Vanessa her preference?
Vanessa would prefer to have HeadBook purchase insurance for her rather than receiving the raise and having to pay 20 percent of it as taxes before spending the remainder on health insurance. Since HeadBook's profit is the same in either case, it would not have any profit motive to deny Vanessa's preference.
Part e:
e. Suppose the government changes the tax law so that individuals can now deduct the cost of health insurance from their personal incomes. If Vanessa gets the $5000 raise and then spends all of it on health insurance, how much will her tax liability change? How much will she be able to spend on health insurance? Will she now have a preference for HeadBook to buy insurance on her behalf?
Since individuals can now deduct the cost of health insurance, Vanessa's taxable income will not change. She will therefore owe exactly as much income tax as before (so that her taxes paid will increase by zero dollars.) She will spend $5000 on health insurance. She will no longer have a preference for HeadBook to buy insurance for her as she can now buy just as much if HeadBook gives her the $5000 raise as if HeadBook spends the $5000 directly buying her health insurance.

Question 4

What are the "twin problems" of the health care industry as viewed by society? How are they related?

Question 5

Preventive care is not always cost effective. Suppose that it costs $100 per person to administer a screening exam for a particular disease. Also suppose that if the screening exam finds the disease, the early detection given by the exam will avert $1000 of costly future treatment.
a. Imagine giving the screening test. to 100 people How much will it cost to give those 100 tests? Imagine a case in which 15 percent of those receiving the screening exam test positive. How much in future costly treatments will be averted? How much is saved by setting up a screening system?
b. Imagine that everything is the same as in part a except that now only 5 percent of those receiving the screening exam test positive. In this case, how much in future costly treatments will be averted? How much is lost by setting up a screening system?

Question 6

Briefly describe the main features of Medicare and Medicaid, indicating how each is financed

Question 7

What are the implications of rapidly rising health care prices and spending for ( a ) the growth of real wage rates, ( b ) government budgets, and ( c ) offshoring of U.S. jobs? Explain

Question 8

What are the main groups without health insurance?

Question 9

List the special characteristics of the U.S. health care market and specify how each affects health care problems.

Question 10

What are the estimated income and price elasticities of demand for health care? How does each relate to rising health care costs?

Question 11

Briefly discuss the demand and supply factors that contribute to rising health costs. Specify how ( a ) asymmetric information, ( b ) fee-for-service payments, ( c ) defensive medicine, and ( d ) medical ethics might cause health care costs to rise.

Question 12

How do advances in medical technology and health insurance interact to drive up the cost of medical care?

Question 13

Using the concepts in Chapter 6's discussion of consumer behavior, explain how health care insurance results in an overallocation of resources to the health care industry. Use a demand and supply diagram to specify the resulting efficiency loss.

Question 14

How is the moral hazard problem relevant to the health care market?

Question 15

What is the rationale for exempting a firm's contribution to its workers' health insurance from taxation as worker income? What is the impact of this exemption on allocative efficiency in the health care industry?

Question 16

What are ( a ) preferred provider organizations and ( b ) health maintenance organizations? In your answer, explain hi each is designed to alleviate the overconsumption of healthcare.

Question 17

What are health savings accounts (HSAs)? How might they reduce the overconsumption of health care resulting from traditional insurance? How might they introduce an element of price competition into the health care system?

Question 18

Why is the PPACA's attempt to extend insurance coverage to all Americans so costly? How does the PPACA attempt to obtain the funds needed to extend insurance coverage to all Americans?

Question 19

How does the PPACA attempt to ensure affordable insurance for the poor?

Question 20

What were the objections made by opponents of the PPACA?

Question 21

LAST WORD What are the three major cost-reducing features of the Singapore health care system? Which one do you think has the largest effect on holding down the price of medical care in Singapore? What element of the Singapore system is shared by the Whole Foods and State of Indian systems? What elements are missing? How difficult do you think it would be to implement those missing elements in the United States? Explain.