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A Lecture Presentation in PowerPoint to accompany Exploring Economics Second Edition by Robert L. Sexton Copyright © 2002 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting EXPLORING ECONOMICS, Second Edition by Robert L. Sexton as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the written permission of the publisher. Printed in the United States of America ISBN 0030342333 Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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) Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. 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 Copyright © 2002 by Thomson Learning, Inc. 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 Copyright © 2002 by Thomson Learning, Inc. 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 Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. A Quantity of other Goods Sacrificed B Additional Medical Services PPC1 Quantity of Healthcare Copyright © 2002 by Thomson Learning, Inc. 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. Copyright © 2002 by Thomson Learning, Inc. The Market for Healthcare Dollars per Physician Service S2 $350 S1 250 D 0 Copyright © 2002 by Thomson Learning, Inc. 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.