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Exploring Economics
Second Edition
by Robert L. Sexton
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Chapter 15
Income Distribution, Poverty,
and Health Care
Copyright © 2002 by Thomson Learning, Inc.
15.1 Income Distribution



The ultimate purpose of producing
goods and services is to satisfy the
material wants of people.
But for whom does society produce
consumer goods and services?
Why are some people able to consume
much more than others?
Copyright © 2002 by Thomson Learning, Inc.
Income Distribution in The United States
Family Income
Under $15,000
$15,000–$24,999
$25,000–$34,999
$35,000–$49,999
$50,000–$74,999
$75,000–$99,999
$100,000 and over
SOURCE: U.S. Bureau of the Census, 2000.
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Distribution
10.5%
12.0
11.9
16.5
21.2
12.7
15.2
15.1 Income Distribution


While there have been changes in the
distribution of measured income, there
remains substantial income inequality.
Inequality might be overstated due to
failure to consider differences in




age,
certain demographic factors,
institutional factors,
and government redistributive activities.
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Before-Tax Income Shares
Lowest Second
Fifth
Year Fifth
Third
Fifth
1935
1950
1960
1970
1980
1990
1999
14.1%
17.4
17.8
17.6
17.6
16.6
15.6
4.1%
4.5
4.8
5.4
5.3
4.6
4.3
9.2%
12.0
12.2
12.2
11.6
10.8
9.9
SOURCE: U.S. Bureau of Census.
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Fourth Highest Highest
Fifth
Fifth
5%
20.9%
23.4
24.0
23.8
24.4
23.8
23.0
51.7%
42.7
41.3
40.9
41.1
44.3
47.2
26.5%
17.3
15.9
15.6
14.6
17.4
20.3
15.1 Income Distribution

At any moment in time, middle-age
persons tend to have higher incomes
than younger and older persons
because


they are at an age when their productivity
is at a peak and
they are participating in the labor force to a
greater extent.
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15.1 Income Distribution


Even if every individual earned exactly
the same income over his or her
lifetime, there would still be inequality at
any given moment in time, so that
inequality resulting from this overstates
the true inequality in the lifetime
earnings of people.
The increased proportion of Americans
that are either very young or very old
has tended to increase the observed
inequality in the distribution of income.
Copyright © 2002 by Thomson Learning, Inc.
15.1 Income Distribution

Other demographic trends have also
caused the measured distribution of
income (measured in terms of
household or family income) to appear
more unequal.



increased number of divorced couples
rise of two-income families
DINKS (Double Income, No Kids)
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15.1 Income Distribution


A family that decides to have two bread
winners instead of one would move into
a higher income quintile and create
greater apparent income inequality.
At the same time, divorces create two
households instead of one, lowering
income per household for divorced
couples; thus, they move into lower
income quintiles, also creating greater
apparent income inequality.
Copyright © 2002 by Thomson Learning, Inc.
15.1 Income Distribution



The impact of increased government
activity should be considered in
evaluating the measured income
distribution.
Government-imposed taxes burden
different income groups differently.
Also, many government programs
benefit some groups of income
recipients more than others.
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15.1 Income Distribution

When taxes and in-kind income are
included, many economists conclude
that they have served to reduce levels
of inequality significantly from the levels
suggested by aggregate income
statistics.
Copyright © 2002 by Thomson Learning, Inc.
15.1 Income Distribution

The evidence suggests



inequality of money income in the United
States declined from 1935 to 1950,
then remained rather stable until 1980;
since then, the distribution of income has
become less equal.
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15.1 Income Distribution

However, if we consider age
distribution, institutional factors, and inkind transfer programs, it is safe to say
that the income distribution is
considerably more equal than it
appears.
Copyright © 2002 by Thomson Learning, Inc.
15.1 Income Distribution

While the distribution of current income
is an important piece of information, it is
also critical to know how much
movement goes on between different
income levels.

The people that make up a given income
group are not always the same people
because there is substantial movement
between income groups.
Copyright © 2002 by Thomson Learning, Inc.
15.1 Income Distribution

Reasons people make more income

age
Wages generally increase up to the age of 50
and fall dramatically at retirement age.
 Younger people tend to make little income
when they begin their working careers.





skill
education
training
preferences toward risk and leisure.
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15.1 Income Distribution




As productivity increases, workers can
command higher wages.
Some workers are just more productive
than others, as a result of both innate
skills and training and education.
Some workers’ skills are just more in
demand than others.
Those that work longer hours or more
intensely earn more.
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15.1 Income Distribution



Those who prefer more amenities at
work or more time for leisure earn less.
Those who work in riskier or more
unpleasant jobs earn more as
compensation.
Despite difficulties in measurement,
international comparisons of income
distribution have been made.
Copyright © 2002 by Thomson Learning, Inc.
15.1 Income Distribution


Income inequality is greater in the
United States and United Kingdom than
in Sweden and Japan.
However, many developed countries
have more equal distributions of income
than developing countries.
Copyright © 2002 by Thomson Learning, Inc.
Global Income Inequalities as a Percent of
Total Nation Income
Countries
Japan
Sweden
Germany
India
Canada
France
United Kingdom
China
United States
Russian Federation
Mexico
Chile
Brazil
Lowest
Fifth
Second
Fifth
Third
Fifth
Fourth
Fifth
10.6%
9.6
8.2
8.1
7.5
7.2
6.6
5.9
5.2
4.4
3.6
3.5
2.5
14.2%
14.5
13.2
11.6
12.9
12.6
11.5
10.2
10.5
8.6
7.2
6.6
5.5
17.6%
18.1
17.5
15.0
17.2
17.2
16.3
15.1
15.6
13.3
11.8
10.9
10.0
22.0%
23.2
22.7
19.3
23.0
22.8
22.7
22.2
22.4
20.1
19.2
18.1
18.3
Highest
Fifth
SOURCE: World Bank, World Development Report 2000/2001.
NOTE: The income inequality differences are approximations, because the data vary according to survey year and
different methods are used for computing the distribution of income in different countries
Copyright © 2002 by Thomson Learning, Inc.
35.7%
34.5
38.5
46.1
39.3
40.2
43.0
46.6
46.4
53.7
58.2
61.0
63.8
15.1 Income Distribution


While income inequality within nations is
often substantial, it is far less than
income inequality among nations.
A majority of income inequality reflects
differences in living standards among
countries rather than disparities within
nations.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality


Because of the difficulty of measuring
welfare, it is impossible to "prove" that a
given income distribution is better than
another.
Political and social changes in the past
century or two have generally worked to
reduce income inequality.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality

The economic theory that supports
income redistribution is derived from the
principle of diminishing marginal utility:


where increases in income generate less
additional happiness (utility) at higher
levels of income.
Taking from the rich and giving to the
poor could increase society's total utility
if the rich family loses less utility than
the poor family gains from the
redistribution.
Copyright © 2002 by Thomson Learning, Inc.
Marginal Utility
Diminishing Marginal Utility of Income
Utility gain from
receiving $30,000
Utility loss from
losing $30,000
MU
0
10 40
270 300
Income per Year
(thousands of dollars)
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality


The theoretical argument favoring
income redistribution is based on the
assumption that people are alike in how
they experience diminishing marginal
utility from increasing income, a
proposition impossible to prove.
If you believe society should try to
equalize happiness among its
members, some income redistribution
could arguably make sense.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality


The principal disagreement over income
redistribution is not over whether we
should have some redistribution, but
rather over at what point we should stop
in our redistributive efforts.
Some believe we should go further than
we have, while others think we have
already gone too far in attempts to alter
the distribution of income in favor of the
poor and less affluent.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality

Arguments against a radical
redistribution of income to eliminate
virtually all inequality include the equity
argument:

It is not “fair” to take most of the income of
hard-working, talented persons who earn
high incomes, particularly when some of it
is given to persons who perhaps are
shiftless and lazy.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality

Other arguments against redistribution:


Some income inequality would seem
desirable because consumption needs
may well vary with family size, age of
family members, and other factors.
Radical redistribution would reduce
economic growth and future real income.
Copyright © 2002 by Thomson Learning, Inc.
Marginal Utility of Income
Differences Marginal Utility of Income
Utility gain from
gaining $30,000
Utility loss from
losing $30,000
MUPOOR
0
Y´POOR Y´POOR
Y´POOR Y´POOR
Income (Y´) per Year
Copyright © 2002 by Thomson Learning, Inc.
MURICH
15.2 The Pros and Cons of Income
Equality



At some level of taxation, substantial
disincentive effects develop.
At some higher tax rate, people will tend
to produce, save, and invest less.
To the extent that this is the case,
nations may face a trade-off between
more equality now and less growth over
time.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality

It is possible that the poorest of the poor
in a high-growth, high-inequality
economy might be far better off in a few
generations than the middle class would
be in a low-growth, but low-inequality
country.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality


Where income is very unequally
distributed, a move to increase income
equality through redistribution of income
might be made without sacrificing very
much economic growth.
Economic growth might actually
increase as the redistribution to lower
income groups raises their productivity
via improved health and education.
Copyright © 2002 by Thomson Learning, Inc.
15.2 The Pros and Cons of Income
Equality


At some point however, increased
redistribution of income might create
increasing disincentive effects, and
reduce the rate of savings, retarding
capital formation.
Ultimately, the cost of more current
income equality is less income growth.
Copyright © 2002 by Thomson Learning, Inc.
Rate of Economic Growth
Income Redistribution and Economic
Growth—A Possible Relationship
B
A
C
Low Equality
High Equality
Degree of Income Equality
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination

Job-entry discrimination


A worker is denied employment on the
basis of some factor without regard to the
productivity of the worker.
Wage discrimination

Workers are given employment at wages
lower than that of other workers on some
basis other than productivity differences.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination



In a world where sex and race have
absolutely no bearing whatsoever on
the employment circumstances of
persons (e.g. talent, education,
willingness to work, move, ...),
every occupation would, apart from
random variations, have a workforce
with the same sex and race proportions
as the population at large.
However, that is not the case.
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15.3 The Economics of
Discrimination

A strong statistical correlation exists
between lifetime earnings and years of
schooling.

High-school graduates earn roughly twothirds of the salary of college graduates.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination

While a major reason women and
nonwhites earn less than white males is
that they occupy jobs that are lower
paying, it is possible also that they earn
less because of wage discrimination—
being paid less for a job strictly because
of their race or sex.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination


Merely demonstrating that wages are
lower for blacks and females does not in
itself prove wage discrimination,
although it is consistent with the notion
that discrimination occurs.
If occupational and wage differentials
are not caused by discrimination, what
are the causes?
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination


Several scholars have developed
statistical models that argue that a great
deal of the earnings differentials across
the sexes and races can be explained
by differences in productivity.
Employers hire and pay workers roughly
an amount equal to their perceived
contributions (marginal revenue
product).
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination

One explanation for higher productivity
among Caucasian males than others is
that various environmental factors have
prevented blacks and women from
gaining the training, skills and
experience necessary to achieve high
productivity.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination

This environmental explanation of
productivity differences does not rule
out discrimination, but rather argues
that past discrimination's perverse
influences on the environment of
women and nonwhites has caused them
to have an inferior endowment of
human capital now, even if present-day
employers were color- and sex-blind in
terms of paying workers.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination


It might appear that discrimination is
totally inconsistent with rational utilitymaximization.
To maximize profits, a firm should
minimize costs by hiring the best
persons available per dollar of wage
expenditure, regardless of the age, sex,
race, or other attribute of the worker.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination


To some extent, discrimination may
reflect information costs.
Based on past experience, race or sex
may be used as a screening device, to
narrow the list of job candidates,
because it costs money and time to
evaluate the prospects of every
applicant.
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15.3 The Economics of
Discrimination

The information cost reduction from
hiring on the basis of color or sex may
exceed the perceived benefits from the
identification of good workers of a
particular color or sex.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination


It is a fact that some people prefer to
associate with persons with certain
racial and/or sexual attributes.
In such cases, the utility gained from
having the desired racial or sexual mix
might exceed the loss in income from
not having the best employees.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination

In competitive industries, firms that
discriminate may lose out.


The nondiscriminating firm hires the
unfavored but equally competent workers
and has a cost advantage, allowing it to
undercut discriminating competitors’ prices
and either force them out of business or
make them change their hiring practices.
In the long run, competition has the
potential to reduce discrimination.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination

The primary means used to address
economic discrimination in our country
is affirmative action programs, in which
employers are strongly encouraged to
hire more minority group workers in
occupations where those groups are
now relatively under-represented and to
correct wage and salary inequities.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination



Some environmental causes of
productivity differences have also been
attacked.
There is some evidence that these
various efforts have met with some
success.
Still, the economic differences between
different races and sexes are rather
large.
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15.3 The Economics of
Discrimination


Affirmative action job hiring programs
are controversial.
The establishment of what are, in effect,
quotas on the hiring of minorities
increases the probability that some
persons will be hired on some basis
other than productivity.
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15.3 The Economics of
Discrimination


While this may be desirable from the
standpoint of equalizing opportunities
between demographic groups, it also
can serve to lower the output of society
as a whole and profits to firms.
Also, the "reverse discrimination" equity
argument is raised.
Copyright © 2002 by Thomson Learning, Inc.
15.3 The Economics of
Discrimination

An alternative approach to one using
implicit quotas would be to subsidize
employers for hiring minority workers,
which would provide employers with
greater incentive to increase minority
job opportunities.
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15.4 Poverty

Our concern over income distribution
largely arises because of a feeling that
people with low incomes (“the poor”)
suffer in a material sense relative to
other persons.
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15.4 Poverty

Economic growth can have important
effects on poverty and welfare.

Strong economic growth since 1993 has
helped
raise median household income,
 lower the poverty rate, and
 lower the number of welfare recipients.

Copyright © 2002 by Thomson Learning, Inc.
Household Income Poverty Rate
and Welfare Recipients
Improvements in Household Income, Poverty
and Welfare
15.1 percent
Number of Welfare
Recipients
$40,816
14.1million
Poverty Rate
11.8 percent
$35,539
1993
Real Median
Household Income
(1999 dollars)
5.8 million
1994 1995 1996 1997 1998 1999 2000
Year
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15.4 Poverty

The federal government measures
poverty by using a set of money income
thresholds that vary by family size and
are adjusted for inflation.


If the family’s total income is less than the
established threshold—the poverty line—it
is considered poor.
The poverty rate is the proportion of
persons who fall below that absolute
standard.
Copyright © 2002 by Thomson Learning, Inc.
15.4 Poverty


The poverty rate for the United States is
currently set at three times the cost of
providing a nutritionally adequate diet—
slightly less than $20,000 for a family of
four.
The poverty rate may overstate the level
of poverty because it does not include
noncash benefits, such as public
housing, Medicaid, and food stamps.
Copyright © 2002 by Thomson Learning, Inc.
Number of Poor and Poverty: 1939 to 1999
Recession
45
40
35
30
25
20
15
10
5
0
1959
Number in poverty
32.3 million
11.8 percent
Poverty rate
1964
1969
1974
1979
Year
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1984
1989
1994
1999
15.4 Poverty

With a definition of poverty that is
determined at some fixed, real income
level, poverty over time should decline
and, indeed, largely disappear, unless
lower income groups do not share at all
in rising incomes because real incomes
generally rise over time with economic
growth.
Copyright © 2002 by Thomson Learning, Inc.
15.4 Poverty


Thus, one cure for poverty, as defined
by some absolute income or standard of
living criterion, is economic growth.
The greater the rate of economic
growth, the more rapidly poverty will be
eradicated.
Copyright © 2002 by Thomson Learning, Inc.
15.4 Poverty


Many “poor” individuals in the United
States, using the official definition,
would be considered well off, even “rich”
in many less-developed countries.
Rather than being classified by an
ability to buy some specific basket of
goods and services, poverty is often
thought of as a relative income concept.
Copyright © 2002 by Thomson Learning, Inc.
15.4 Poverty

A person is “poor” if his or her income is
low relative to the incomes of most
other persons in the same geographical
area.
Copyright © 2002 by Thomson Learning, Inc.
15.4 Poverty


Using definitions of poverty based on
relative income measures, as economic
growth proceeds, the income necessary
to avoid being considered poor by this
measure increases.
Using this definition, then, poverty
cannot be eradicated by economic
growth, but only by income
redistribution.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare


Like the production of any other good or
service, however, healthcare involves
the utilization of scarce resources.
Not only must the healthcare sector
compete with other sectors for
resources, but those resources must be
allocated across patients facing vastly
different circumstances.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare


The United States spends more money
on healthcare per person and as a
percentage of national income than any
other industrialized nation.
Medical expenditures comprise
approximately 13.5 percent of GDP.
Copyright © 2002 by Thomson Learning, Inc.
U.S. Healthcare Expenditures as a Percentage
of GDP Since 1960
Percent of GDP
16
14
12
10
8
6
4
2
1960
1965
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1970
1975
1980
Year
1985
1990
1995
1999
15.5 Healthcare

The utilization of medical care involves
trade-offs.

Scarce resources allocated toward the
production of health services cannot be
used in the production of other goods and
services.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare


Investment in healthcare bears
similarities to investment in human or
physical capital.
By promoting health and removing
disabilities, medical care may


improve the productivity of workers on the
job and reduce missed workdays;
extend the average number of years of
participation by people in the labor force.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Increases in the quality and quantity of
labor available due to better healthcare
will shift an economy’s production
possibilities curve outward.
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A
Quantity
of other
Goods
Sacrificed
B
Additional
Medical
Services
PPC1
Quantity of Healthcare
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Quantity of All Other Goods
Quantity of All Other Goods
PPC Between Healthcare and All
Other Goods
PPC2
PPC1
Quantity of Healthcare
15.5 Healthcare


Both the demand for and supply of
healthcare have increased over the last
several decades.
Demand for medical coverage has been
significant due to changes in:



income
insurance coverage
population demographics
Copyright © 2002 by Thomson Learning, Inc.
The U.S. Health Dollar: 1999
Other Public1
15.7¢
Medicaid
15.7¢
Medicare
17.6¢
Other
Private2
15.7¢
Private
Insurance
32.3¢
Program
Administration and
Net Cost 32.3¢
Prescription Drugs
32.3¢
Nursing Home
Care 32.3¢
Other Spending
32.3¢
Physician Services
Hospital Care
Care 32.3¢
32.3¢
Out-of-pocket
15.4¢
1
2
3
“Other Public” Includes programs such as workers’ compensation, public health activity, Department of Defense, Department of Veteran Affairs, Indian health
services, and State and local hospital and school health.
“Other Private” Includes industrial inplant, privately funded construction, and non-patient revenues including philanthropy.
Other Spending includes dentist services, other professional services, home health, durable medical products, over-the-counter medicines and sundries, public
health, research, and construction.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Consequently, the price of medical care
has risen at the same time the utilization
of services has increased.
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The Market for Healthcare
Dollars per
Physician Service
S2
$350
S1
250
D
0
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300,000 500,000
Quantity of
Physician Services
15.5 Healthcare


Rising U.S. real income has contributed
to the increase in demand for medical
services.
Most healthcare services are normal
goods.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare


Estimates of the price elasticity of
demand for healthcare generally range
between 0.2 and 1.0, indicating
significant inelasticity of demand for
medical services.
The quantity of medical care demanded
appears to be quite insensitive to
changes in price.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Healthcare is considered a necessity
with few good substitutes, particularly
when it comes to serious illness.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

The health services market differs from
many others in that, due to insurance,
the consumer often pays only a fraction
of the direct cost of care.

Third-party payers, such as insurance
companies or health maintenance
organizations, play significant roles in this
industry, which have important incentive
effects and alter the behavior of both
patients and providers.
Copyright © 2002 by Thomson Learning, Inc.
Type of Health Insurance and Coverage
Status in the U.S., All People 1999
Individual
8.2%
Military/
Veterans
3.1%
Uninsured
15.5%
Medicaid
10.2%
Medicare
62.8%
Copyright © 2002 by Thomson Learning, Inc.
Employment-based
insurance 62.8%
15.5 Healthcare

In addition to increasing the quantity of
healthcare demanded by reducing price,
insurance alters the incentive of patients
in other ways.



Insurance reduces the cost to the insured
of undertaking risky activities.
In an accident or illness, the healthcare
costs are borne by the insurer.
This creates what economists call a “moral
hazard” problem.
Copyright © 2002 by Thomson Learning, Inc.
Demand for Physician Services
Dollars per
Physician
Office Visit
$150
Paid by
Insurance 100
Provider
Paid by
Consumer
20
0
S = MC
Overallocation
of
Resources
to the
Healthcare
Sector
D = MB
1,000,000 1,600,000
Quantity of Office Visits
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Moral hazard in healthcare exists
whenever insurance makes a person
more likely to engage in risky behavior
(which could lead to an accident or
illness) and less likely to undertake
preventative measures against illness.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Insurance companies or third-party
payers attempt to reduce moral hazard
problems by requiring patients to pay
higher deductibles and/or co-payments,
thereby compelling the insured to share
a greater proportion of incurred costs.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Insurance may pose additional
problems for the healthcare industry.

A situation of asymmetric information exists
whenever patients know more about their
own health status than prospective
insurers.

This is known as "adverse selection" because
the chronically ill are more likely to demand
health insurance than are those in good health.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

An insurance company inviting
voluntary participation in a plan may find
that it has insured an adverse selection
of largely ill patients and would be
forced to increase insurance premiums
to stave off losses.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare


As insurance premiums increase,
however, healthy enrollees are more
likely to drop out of the plan (opting
instead for cheaper, less generous
health insurance plans or for selfinsurance).
This further exacerbates the adverse
selection problem.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Insurers can reduce adverse selection
risk by



limiting the period of open enrollment in
health insurance plans,
requiring physical exams (so that an
individual cannot purchase insurance after
serious illness strikes), and
insuring entire groups (such as all
members of a large employer or union) in
order to ensure a diversity of health
statuses.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

The aging of the U.S. population is an
additional factor that explains the
increase in demand for healthcare.

The elderly consume a disproportionate
share of healthcare services (three to four
times as much as the rest of the
population).
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare



The supply of healthcare has increased
slowly since 1960.
The number of providers has increased
but has not kept up with the demand for
medical services.
There has been an increase in the cost
of medical education and training as
well as a greater use of high-cost
technological equipment in the
healthcare industry.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Escalating healthcare costs over the
last decade, however, have led to a
greater emphasis on cost containment.

“Managed care,” including health
maintenance organizations (HMOs) and
preferred provider organizations (PPOs)
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Medical research and technological
progress has vastly improved the quality
of medical care.



Innovative therapies help reduce disability,
improve health, and prolong life.
Some innovations undoubtedly reduce the
overall cost of healthcare.
Other innovations, however, significantly
add to the cost of healthcare.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Technological advances have led not
only to an increase in the supply of
healthcare, but through its interaction
with insurance, also a significant
increase in the demand for medical
care.

Insured patients who bear a small fraction
of healthcare costs naturally desire the
best possible care, contributing to a rise in
healthcare costs that far exceeds the
average level of inflation.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Healthcare markets are imperfectly
competitive for several reasons,
including




the presence of legal or administrative
barriers to entry,
economies of scale,
collusion, and
restrictions on advertising.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Compulsory licensing



Restricts entry into the healthcare market.
Licensing requirements and limitations on
hospital privileges are justified as
protecting patients from inferior-quality
medical care by certifying that physicians
possess a certain level of competency.
Restricting the supply of physicians,
licensing and hospital privilege
requirements limit the quantity of services
provided and lead to higher medical prices.
Copyright © 2002 by Thomson Learning, Inc.
Dollars per
Physician Service
Leftward Supply Curve Shift
S2
S1
$350
250
D
300,000 500,000
0
Quantity of Physician Services
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Healthcare economies of scale




Specialty services may be utilized
infrequently requiring large populations be
served by only a few providers.
Cities and towns are often unable to
support a large number of hospitals.
Only in densely populated metropolitan
areas may it be economical for numerous
hospitals to compete.
Conditions may be such that "natural
monopolies" exist in many areas.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare

Healthcare providers possess
significant market power, making price
discrimination and collusive behavior
(such as price-fixing) more likely to
occur.
Copyright © 2002 by Thomson Learning, Inc.
15.5 Healthcare


In Canada, where a national healthcare
program controls prices and strictly
rations care, conditions of excess
demand for surgery prevail.
Likewise, shortages prevail in the
market for organ transplants.
Copyright © 2002 by Thomson Learning, Inc.
Dollars per
Heart Transplant
Excess Demand for Organs
S
$200,000
100,000
Shortage
of
Hearts
D
3,000 3,500 5,000
0
Quantity of Heart Transplants
Copyright © 2002 by Thomson Learning, Inc.