Government Regulation and Intervention Part 1

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Government Regulation and InterventionPart 1

• Vivian Ho
• Health Economics

This material draws heavily from Santerre Neun,
Health Economics, Theories, Insights, and
Industry Studies, Dryden Press.
2
Introduction

• 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.

3
Why Government Intervention?

• Perfectly competitive markets lead to efficient
  outcomes. Why?
• Recall that the demand curve for any given
  product has a negative slope.
• If consumers are visiting the doctor 2 times per
  year when the price of a visit is 100, the price
  must fall below 100 in order to encourage
  consumers to see the doctor more often.

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Why Government Intervention?

• Thus, the demand curve reflects the consumers
  marginal benefit from consumption.
• The marginal utility from the third visit to the
  doctor is lower than the marginal benefit from
  the second visit.
• Similarly, we can define a demand curve for
  societys preferences as a whole, which reflects
  the marginal social benefit of medical services.

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Why Government Intervention?
Price
MSB
Quantity of medical services
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Why Government Intervention?

• Recall that the supply curve for any given
  product slopes upwards.
• If a pharmacy is being paid 30 per prescription
  to fill 300 prescriptions per day, it must be
  paid more than 30 per unit to fill 400 orders
  per day.
• This reflects the fact that the marginal costs of
  production usually rise as output increases.

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Why Government Intervention?

• At the societal level, the marginal social costs
  of providing services will also rise as output
  increases.
• e.g. The marginal cost of achieving an infant
  mortality rate of 20 per 100,000 live births may
  be fairly low, but the marginal cost of reducing
  the rate to 5 per 100,000 will be much higher.

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Why Government Intervention?
Price
MSC
Quantity of medical services
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Why Government Intervention?

• Equilibrium is reached where MSBMSC

Price
MSC
P0
MSB
Q0
Quantity
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Why Government Intervention?

• In equilibrium, all services are exchanged at the
  price P0.
• But for all services less than Q0 (e.g. the 1st
  and 2nd physician visit), the marginal social
  benefit exceeds P0.
• The difference between marginal social benefit
  and the equilibrium price is called consumer
  surplus.

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Why Government Intervention?
Price
MSC
Consumer Surplus
P0
MSB
Q0
Quantity
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Why Government Intervention?

• For all services less than Q0, the marginal
  social cost is lower than P0.
• The difference between marginal social cost and
  the equilibrium price is called producer surplus.

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Why Government Intervention?
Price
MSC
P0
Producer Surplus
MSB
Q0
Quantity
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Why Government Intervention?

• Perfect competition is considered efficient,
  because it maximizes social welfare consumer
  surplus producer surplus.

Price
S
Consumer Surplus
Producer Surplus
D
Quantity
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Criteria for perfect competition

• All firms and consumers are price takers.
• Consumers and firms have perfect information.
• All firms produce an identical product.
• Firms can freely enter an exit an industry.

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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.

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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.

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Special interest group theoryExamples

• Extended patent protection for brand name drugs.
• Rejection of national health insurance in favor
  of private insurance companies.

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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.

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Types of Government Intervention

• Provide public goods.
• Correct for externalities
• Impose regulations.
• Enforce antitrust laws.
• Sponsor redistribution programs.
• Operate public enterprises.

• Fund medical research.
• Tax cigarettes, pollution.
• FDA
• Bar hospital mergers.
• Medicare and Medicaid.
• VA hospitals

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Public Goods

• gt1 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?

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Externalities

• Definition An unpriced byproduct of production
  or consumption that adversely affects another
  party not directly involved in the market
  transaction.
• Cigarette smoking
• Pollution
• Medical treatment for cyclists who dont wear
  helmets
• Drunk drivers

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• Demand-side externality
• Marginal Social Benefit ? Marginal Private
  Benefit
• Supply-side externality
• Marginal Social Cost ? Marginal Private Cost

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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.

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Smokers also impose health care costs on
nonsmokers.

• Smokers usually incur higher health care costs.
• But nonsmokers die prematurely from passive
  smoking, smoking-related fires.
• The total external costs of cigarette smoking are
  estimated to be 15 per pack.
  (Manning et al., 1991)

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Keep in mind

• The problem which calls for government
  intervention is external costs, not internal
  costs.
• The full extent of external costs must be
  measured using a lifetime approach.

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Manning et al.s methods

• Numerator takes into account life expectancy for
  smokers and the costs (savings due to early
  death) incurred each year.

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External Cost Components

• Covered medical costs.
• Covered work loss and disability.
• Group life insurance.
• Widows social security bonus.
• Covered nursing home costs.
• Pensions.
• Taxes on earnings.
• Fires.

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per pack
SMPCMSC
MSC0
DMPB
MSB0
MSB
Q0
Q1
Cigarette Packs

• At Q0 MSC0 gt MSB0
• Cigarettes are being over-consumed.

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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.

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per pack
MPC0 T
MPC0MSC
P1
P0
P2
DMPB
MSB
Cigarette packs
Q1
Q0
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With tax

• Market price of cigarettes P1
• Cigarette manufacturers receive P2 per pack.
• Tax burden
• Consumer pays P1 - P0
• Seller pays P0 - P2

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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.

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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??

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Regulations

• 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.

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Regulations

• 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.

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Price
S
PC
D
QD
QS
Physician visits
38

• With full insurance, consumers want QD visits.
• But the government has fixed the price of visits
  at PC.
• Only QS visits will be provided.
• Shortage of physician visits QD - QS.

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Consequences

• 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.

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Lesson There is no free lunch under cost
containment. Price ceilings can lead to

• 1) Shortages.
• 2) Longer waiting lines.
• 3) Nonprice rationing.
• 4) Poorer health outcomes.

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The FDA and Drug Advertising

• Fine Print in Drug Ads Sparks a Debate
• WSJ 4/1/97
• What does the new advertising of drugs on TV say
  about special interest vs. public interest
  theory?
• Who are the special interest groups?
• What is in the publics best interest?
• Do drug companies all agree?

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THE NEW YORK TIMES

• Editorial The Need
• for Regulation
• For All of the
• Nations Imports
• 9/16/2007