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Chapters 11 and 22 Questions
11.8. Consider two workers, Ralph and Steve. Both of them work
for the same employer, and each earns $15 per hour. Steve is
taxed at the 15 percent marginal rate. However, Ralph is married, and due to his wife’s income, he is taxed at the 28 percent marginal rate. Using Figure 11-3, indicate which one
would be expected to seek more health insurance and why.
11.9. Suppose that Charlie’s Pizzeria in Kalamazoo, Michigan,
employs 10 employees at a wage level of $8 per person. All
other costs (ovens, rent, advertising, return to capital) total
$40 per hour, and the pizzeria sells 12 pizzas per hour at a
cost of $10 per pizza. Suppose the state of Michigan
mandates health coverage that can only be covered at a cost
of $1 per hour, if it is offered at all. Charlie finds that if he offers insurance, he could maintain production by letting one
worker go and running his pizza ovens a little hotter, leading
to costs of $45 per hour.
(a) What are Charlie’s original profits?
(b) What is Charlie’s elasticity of demand for labor? How
is this calculated?
(c) What will happen to Charlie’s profits in the short run if
he chooses to pay for mandated insurance?
(d) What will Charlie’s long-run decision be? Why?
22.6. Consider two households. They have the same incomes and
face the same prices. Household H tends to be healthy and
household U tends to be unhealthy. Suppose that two insurance plans are available:
A—$2,500 deductible and a 5 percent coinsurance rate after
meeting the deductible.
B—$250 deductible and a 20 percent coinsurance rate after
meeting the deductible.
(a) Using a budget constraint and indifference curves on
the diagram below, model the two insurance plans.
(b) Assume that a voluntary HSA is made available upon
the purchase of a high-deductible policy. Assume that if
the money is not used it is lost. Which of the households
is likely to participate? Use the diagram below to explain why.
(c) Consider part (b) above, but assume now that the
unused portion in the HSA can be distributed to the
individual at the end of a designated period or at retirement. Would your answer to part (b) change? If so,
how? If not, why not?
22.7. Use the demand-supply framework in Figure 22-5 to
explain how increased cost sharing could lead to lower
utilization and spending on health care.
Health Economics
Chapter 22
Health System Reform
Tianxu Chen

Goals of Reform
Ensuring Access to Care
Competitive Strategies
Health System Reform and International
• Quality of Care
• The Patient Protection and Affordable Care
Act (PPACA) of 2010
• Conclusions
• There is broad agreement that reform must
address four major issues:
– A health “safety net” for all residents,
irrespective of age, health status, or
employment status
– Mechanisms that promote cost containment
– Choice for patients and providers
– Ease in administration
Basic Issues in Reform
• One fundamental question is service coverage.
• A related issue is whether there will be cost-sharing
for covered services and, if so, the extent of it.
• A third major issue is the cost of reform and how it
will be funded.
• The most challenging issue is to determine whether
health reform will build largely on the existing
framework of government programs and private
employment-based insurance.
The Costs of Universal Coverage
• From society’s point of view, the
incremental cost of NHI in the United States
is the extra total expenditure on health care
that would be incurred if we switched to
national health insurance.
Incremental Costs
• The truly incremental costs stem from several
– First, the major reason for switching to a NHI plan is
to extend coverage to the 50 million uninsured.
– Second, the insured population will incur some
incremental cost to the extent that an NHI plan
provides greater typical coverage than people already
choose to buy or have provided to them by other
– Third, any tax-supported system of financing care
potentially entails a deadweight loss to society.
Employer Versus Individual Mandates
• Under the employer mandate, the employer
must procure health insurance for its employees
and their dependents.
• Under the individual mandate, all residents are
obligated to purchase health insurance for
themselves and their families, either from
private insurance (individually purchased) or
through a group.
Employer Versus Individual
• Economists would argue that in either case,
the individual will pay the majority of the
cost of a mandate. Employer mandates will
ultimately be shifted backwards to
individual workers. Individual mandates
are more clearly seen as falling to
individuals and their families.
Separation of Health Insurance
from Employment
• In redesigning a health system, a good
argument can be made for revising or
replacing the prevailing system of
employer-provided insurance.
• Health insurance would no longer be
dependent on employment status and
coverage would be portable.
Single Payer Versus Multiple
• In principle, costs can be reduced by consolidating
insurers if there are economies of scale in
administration or if gains can be made from
pooling those insured. However, the same
administrative technology is available to the
private sector, and if further economies were
possible, it is likely that surviving private firms
would be those who merged to take advantage of
the economies, provided the existing firms were
not earning monopoly profits.
Single Payer Versus Multiple
• However, the single-payer system reduces
costs by eliminating the multiple forms and
policy rules that face hospitals, clinics, and
nursing homes.
• The operation of the government enterprise
also raises issues of incentives. Government
may fail to reduce costs because it usually
lacks the profit incentive and the discipline
of market competition.
Single Payer Versus Multiple
• A potential benefit of the single-payer
system lies with the possibility of common
• In contrast, the availability of many policies
from many companies offers variety,
tailoring policies to the individual
preferences for cost-sharing features and
• The battle is over the superiority of:
– increased government involvement through
both expanded regulation and additional
government programs to provide or finance
health care, or
– an increased emphasis on market mechanisms
and market forces with corresponding decreases
in the use of regulatory instruments.
• Proponents of further regulation tend to
argue that information imperfections,
flawed agency relationships, and other
distortions cannot be readily corrected by
attempts to promote partial forms of
• A competitive health care policy is one that relies
primarily on financial incentives rather than controls
to achieve goals. Those supporting this approach
believe that market participants respond to changes
in prices in a predictable and substantial way.
Supporters of competitive approaches also argue that
even imperfections in their strategies are preferable
to the distortions caused by imperfect regulation.
Development of Alternative
Delivery Systems
• The dominant competitive strategy, which
evolved in the 1970s, has been the promotion of
delivery systems that can provide an alternative
to traditional fee-for-service.
• The cornerstone of this strategy has been the
promotion of health maintenance organizations
(HMOs), preferred provider organizations
(PPOs), and other forms of managed care.
Consumer-Driven Health Plans
and Health Savings Accounts
• In most cases, a CDHP features a highdeductible health plan combined with an
Health Reimbursement Arrangement (HRA)
or Health Saving Account (HSA).
• The motive for the CDHP is the desire to
create highly informed consumers and to
give them the incentives and the tools so
that they take charge of their health care
Evidence on CDHPs and HSAs
• Feldman and colleagues (2007) do not find
significant savings for those enrolled in
• Dixon et al. (2008) found that enrollees in
the high-deductible CDHP were more likely
to cut back on utilization.
Drawbacks to CDHPs and HSAs
• Healthier individuals are more likely to be
attracted to high deductible health plans,
leaving sicker higher cost populations to be
insured by other plans.
• Patients may have incentive to scrimp on
preventive care.
• HSAs are more difficult to administer.
Drawbacks to CDHPs and HSAs
• A small proportion of individuals with
serious chronic and acute conditions
account for a large share of annual health
care spending. These patients will have
exceeded their maximum out-of-pocket
requirements and may not have a strong
incentive to economize on their use of
health care.
Other Market Reforms
• Two other reforms are important to
proponents of market-based solutions:
– The first deals with the tax subsidy of
employer-provided insurance.
– A second important reform under the
competitive approach is the elimination of
many mandated benefits as a way of increasing
the availability of lower-priced insurance
Representation of the
Competitive Approach
• The two broad
strategies of the
competitive approach
are to reduce demand
from D1 to D2 and to
increase supply from
S1 to S2. Together
these can reduce usage
and expenditures.
Figure 22-2 The Intended
Effects of Competitive
Strategies on Demand and
• Many business leaders believe that the United
States is at a competitive disadvantage compared
to countries with social insurance programs.
• Economists point out two features of employerbased universal health insurance that contradict
such claims:
– Health insurance is part of the total labor
compensation package, and
– the incidence of the implied tax falls primarily
on the worker.
Major Quality Issues
• 1. Moral hazard and the overutilization
associated with insurance (a theme we have
stressed throughout the text).
• 2. Applications of cost-effectiveness
analyses to distinguish economically
efficient from inefficient procedures,
technology and levels of care.
• 3. The greater use of financial incentives.
Significant PPACA Provisions
• Require most U.S. citizens and legal residents to have
health insurance, the individual mandate.
• Penalize employers with 50 or more full-time
employees that do not offer coverage at a fee of $2,000
per full-time employee.
• Expand Medicaid to all non-Medicare eligible
individuals under age 65 (children, pregnant women,
parents, and adults without dependent children) with
incomes up to 133% of the federal poverty level FPL
with a benchmark benefit package.
Significant PPACA Provisions
• Require most U.S. citizens and legal residents to have
health insurance, the individual mandate.
• Penalize employers with 50 or more full-time employees
that do not offer coverage at a fee of $2,000 per full-time
• Expand Medicaid to all non-Medicare eligible individuals
under age 65 (children, pregnant women, parents, and
adults without dependent children) with incomes up to
133% of the federal poverty level FPL with a benchmark
benefit package.
Significant PPACA Provisions
• Establish state-based health insurance exchanges, where
individuals and small businesses can compare policies and
buy coverage, administered by a governmental agency, or
a non-profit entity.
• Establish a uniform set of benefits, called Essential Health
Benefits, with 10 major areas of coverage including
prescription drugs and preventive services.
• Eliminate cost-sharing for Medicare-covered preventive
services recommended by the U.S. Preventive Services
Task Force, and waive the Medicare deductible for
colorectal cancer screening tests.
How well does PPACA address
reform goals?

Creating a safety net
Cost containment
Choice for patients and providers
Ease in administration
The Cost of the PPACA
• It is difficult to predict changes in health care
spending under the PPACA.
• In an early forecast by analysts at CMS, Sisko et al.
(2010) estimated that national health care spending as
a share of GDP will be 0.3 percentage points higher
(about $88 billion) in 2019 than without PPACA.
• Analysts expect Medicare to be $86.4 smaller under
PPACA in 2019 than under previous assumptions;
they expect Medicaid/CHIP, in contrast, to be $89.9
billion larger.
• Cost-containment and reduction or
elimination of the number of uninsured are
the principal goals of health system reform
in the United States.
• Other goals include administrative
simplicity and choice for providers and
• Improving the quality of care is also emerging as
a national priority.
• The most serious obstacle to reform the divide
over whether to expand the government’s role
through mandates, additional regulations, and
tax subsidies or whether to rely increasingly on
markets through deregulation and tax changes
that neutralize the current bias toward subsidized,
employer-based insurance.
• The PPACA is a long-term “fix” in that
provisions will step in gradually until 2018,
which formulates an individual mandate for
consumers to purchase health insurance and
provides market-pooling mechanisms to
make the insurance available to many who
were previously not able to get it.
Health Economics
Chapter 11
The Organization of Health
Insurance Markets
Tianxu Chen

Loading Costs and the Behavior of Insurance Firms
Employer Provision of Health Insurance: Who Pays?
Employer-Based Health Insurance and Labor Supply
The Market for Insurance
The Uninsured: An Analytical Framework
Technological Change, Higher Costs, and Inflation
• Consumers can improve their well-being by
sacrificing a (relatively) small but certain
premium to insure against the probability of a
considerably larger loss. It is important now to
demonstrate how the policies will be offered to
specific groups and why, in fact, some groups
will find it difficult to get insurance at all.
Impacts of Loading Costs
• Insurance firms incur costs of doing
business that are added to the claims
• These loading costs are largely related to
the numbers and types of customers and
claims processed and must be passed on to
consumers in order for insurers to cover
their costs.
Benefits of Insurance
• Near A, high probability of the uncertain
event, or B, low probability of uncertain
event, the marginal gain from insurance is
zero and the consumer will not purchase.
• Between A and B, the marginal gain
increases, reaches a maximum and then
Insurance for Heart Attacks and
• Because the loss associated with a heart
attack is larger than the loss associated with
a hangnail, the marginal gains from insuring
against a heart attack dwarf the marginal
gains from insuring against a hangnail.
• Insurance for a heart attack will occur for
probabilities lying between C’ and D’,
while no insurance will be offered for
Loading Costs and the Uninsured
• This analysis provides one avenue for addressing
the problem of the uninsured.
• It is apparent that the per-person costs of processing
information and claims of those individuals who are
outside larger organizations (either companies or
unions) are higher. This results in an increase in the
insurance firms’ marginal costs relative to the
consumer’s marginal benefits and can reduce or
eliminate the range of services that may be offered.
• The largest segment of the American
population acquires health insurance through
the workplace, and this began almost by
accident over 60 years ago.
• Federal government imposed wage and price
controls as anti-inflationary devices.
• Predictably, employers had to devise new ways
to attract workers. One of these fringe benefits
was health insurance.
Labor Market
• We assume that a lower market money wage rate
leads an employer to hire more workers for two
– the employer can substitute labor for more expensive
equipment or resources
– the employer can sell more products at lower prices,
hence requiring more workers
• Employers will hire workers as long as the
incremental (marginal) revenue from the goods
those workers produce exceeds the per hour
Labor Market With Health
Insurance Benefits
• Suppose that workers negotiate a health insurance benefit
worth $1 per hour to them, and costing exactly $1 for the
employer to provide. The employer, who was previously
willing to pay a wage of $20, will now be willing to pay
$20 less the $1 cost.
• The workers are no worse off at a wage of $19 with the
health insurance than at $20 without the health insurance
because the insurance is worth the $1 that it cost in reduced
wages. The employer earns no less profit for providing the
health benefit.
Labor Market Model
• D is initial labor demand
• S is initial labor supply
• Market clears at wage W1
with L1 employees
• D’ is labor demand after
insurance benefit of $z
• S’ is labor supply after
insurance benefit of $z
• Market clears at wage W2
with L1 employees
Figure 11-2 Interactions of
Health Insurance and
employee Wage
Labor Market Model
• However, there are several reasons that the
marginal benefits of the insurance to the
employees may fall short of the employer’s
marginal costs. How?
• Some contracts negotiate subsidized coverage for
prescription drugs, at a cost to the employer.
However, some employees are healthy and do not
use prescription drugs. This benefit has no value
to them. Then?
Spousal Coverage: Who Pays?
• Suppose employees can work in Beta or Alpha sectors.
Alpha employers employ only married men; half of the
spouses do not work and half work in the Beta sector. Half
of the Beta employees are spouses of men in the Alpha
sector and half are single. The pure wage for each
employee in both sectors is $80,000 per year.
• Alpha firms offer employees family coverage worth
$8,000 per year. Beta firms offer to pay $4,000 per year
per person for employees, but participating employees
must pay extra $240 per year.
Spousal Coverage: Who Pays?
• Who Pays?
– Two-worker families covered through Alpha firms pay
$10,000 for $8,000 in coverage: Wages have fallen by $8,000
in the Alpha sector and by $2,000 where their spouses work.
– Single-worker families covered through Alpha firms pay
$8,000 for coverage because wages have fallen by that
– Single-worker families covered through Beta firms pay $2,240
(reduced wages and $240 extra payment) for $4,240 in
• Alpha and Beta firms pay the same net wage ($80,000) for labor
services. Single workers at Beta firms benefit because they
receive $2,000 more in coverage than they pay—there is a
transfer from two-worker households to single-worker
How the Tax System Influences
Health Insurance Demand
• The tax treatment of health insurance benefits to
employees amounts to a subsidy for employees
which results in the purchase of more health
insurance than in the absence of the subsidy.
Who Pays the Compensating
Differentials?-Empirical Tests
• Gruber and Krueger (1992) examine workers’
compensation insurance, and Gruber (1994) looks at
mandated maternity benefits coverage. Both studies
confirm the existence of “group specific” average wage
• Jensen and Morrisey (2001) use 1994 and 1998 data from
the Health and Retirement Survey (HRS) to examine the
wage–coverage tradeoff for workers born between 1931
an …
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