Chapter 24 – Health Care
24-1
Chapter 24 – Health Care
McConnell Brue Flynn 21e
DISCUSSION QUESTIONS
1. Why would increased spending as a percentage of GDP on, say, household appliances or
education in a particular economy be regarded as economically desirable? Why, then, is there so
much concern about rising expenditures as a percentage of GDP on health care? LO1
2. What are the “twin problems” of the health care industry as viewed by society? How are they
related? LO1
3. Briefly describe the main features of Medicare and Medicaid, indicating how each is financed.
LO1
Chapter 24 – Health Care
24-2
4. What are the implications of rapidly rising health care prices and spending for (a) the growth of
real wage rates, (b) government budgets, and (c) offshoring of U.S. jobs? Explain. LO2
5. What are the main groups without health insurance? LO3
Chapter 24 – Health Care
24-3
6. List the special characteristics of the U.S. health care market and specify how each affects
health care problems. LO3
7. What are the estimated income and price elasticities of demand for health care? How does each
relate to rising health care costs? LO4
8. Briefly discuss the demand and supply factors that contribute to rising health costs. Specify
how (a) asymmetric information, (b) fee-for-service payments, (c) defensive medicine, and (d)
medical ethics might cause health care costs to rise. LO4
Chapter 24 – Health Care
24-4
9. How do advances in medical technology and health insurance interact to drive up the cost of
medical care? LO4
10. Using the concepts in Chapter 7’s discussion of consumer behavior, explain how health care
insurance results in an over allocation of resources to the health care industry. Use a demand and
supply diagram to specify the resulting efficiency loss. LO4
11. How is the moral hazard problem relevant to the health care market? LO4
12. What is the rationale for exempting a firm’s contribution to its workers’ health insurance from
taxation as worker income? What is the impact of this exemption on allocative efficiency in the
health care industry? LO5
Chapter 24 – Health Care
24-5
13. What are (a) preferred provider organizations and (b) health maintenance organizations? In
your answer, explain how each is designed to alleviate the overconsumption of health care. LO5
14. What are health savings accounts (HSAs)? How might they reduce the over-consumption of
health care resulting from traditional insurance? How might they introduce an element of price
competition into the health care system? LO5
Chapter 24 – Health Care
15. Why is the PPACA’s attempt to extend insurance coverage to all Americans so costly? How
does the PPACA attempt to obtain the funds needed to extend insurance coverage to all
Americans? LO6
24-7
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
16. How does the PPACA attempt to ensure affordable insurance for the poor? LO6
17. What were the objections made by opponents of the PPACA? LO6
Chapter 24 – Health Care
24-8
18. LAST WORD What are the three major cost-reducing features of the Singapore health care
system? Which one do you think has the largest effect on holding down the price of medical care
in Singapore? What element of the Singapore system is shared by the Whole Foods and State of
Indiana systems? What elements are missing? How difficult do you think it would be to
implement those missing elements in the United States? Explain.
Answer: The three major cost-reducing features of the Singapore health care system are:
REVIEW QUESTIONS
1. Which of the following best describes the United States’ level of health care spending as
compared to that of other nations? LO1
a. The lowest of all nations.
b. A bit lower than average.
c. Average.
d. A bit higher than average.
e. The highest of all nations.
Chapter 24 – Health Care
24-9
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Answer: e. The highest of all nations.
International data on health care spending as a percentage of GDP reveals that the United
States’ level of health care spending is the highest of all nations.
2. Which of the following make a person less likely to have health insurance? LO3
Select one or more answers from the choices shown.
a. Working for a larger firm.
b. Being a low-wage worker.
c. Being employed.
d. Having excellent health.
e. Being chronically ill.
3. A patient named Jen visits Dr. Jan. Dr. Jan is nearly certain that Jen only has a cold. But
because Dr. Jan is afraid of malpractice lawsuits, she orders an extensive battery of tests just to
make sure that Jen can never claim—if she turns out to have something more severe—that Dr.
Jan shirked her duties as a medical professional. Dr. Jan’s behavior is an example of: LO4
a. Asymmetric information.
b. Fee-for-service.
c. Defensive medicine.
d. Positive externalities.
Chapter 24 – Health Care
24-10
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Answer: c. Defensive medicine.
Dr. Jan’s behavior is an example of defensive medicine because she is recommending
more tests than is warranted medically or economically in order to protect herself against
malpractice lawsuits.
While Dr. Jan may indeed charge her patients on a fee-for-service basis, her motivation in
this case is protecting herself from lawsuits rather than generating more income from
fees. So fee-for-service is not a correct answer.
Neither is asymmetric information, because while Dr. Jan does know more than her
patients about medical illnesses, her extra medical knowledge is not what is causing her
to order these tests for Jen.
Finally, there are no positive externalities here. So positive externalities is not a correct
answer, either.
4. All MegaCorp employees who stay on the job for more than three years are rewarded with a 10
percent pay increase and coverage under a private health insurance plan that MegaCorp pays for.
Tina just passed three years as a MegaCorp employee and reacts to having health insurance by
taking up several dangerous sports because now she knows that the insurance plan will pay for
any injuries that she may sustain. This change in Tina’s behavior is known as: LO4
a. Defensive medicine.
b. Asymmetric information.
c. The moral hazard problem.
d. The personal mandate.
5. By increasing demand, health insurance creates: LO4
a. A deadweight loss related to overconsumption.
b. A deadweight loss related to underconsumption.
c. Neither of the above.
Chapter 24 – Health Care
24-11
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Answer: a. A deadweight loss related to overconsumption.
By increasing demand, health insurance creates a deadweight loss related to
overconsumption. This happens because health insurance increases the demand for
medical care by lowering the out–of-pocket marginal costs actually paid by consumers for
any given medical procedure.
For instance, if the price you had to pay to visit a doctor were $100 per visit, you would
probably only go to the doctor when you were really sick. But if you have a health
insurance policy that covers 90% of the cost, then you will only have to pay $10 (= 10
percent of $100) for a visit. That low out–of-pocket price will incentivize you to go to the
doctor more often.
In fact, you will go to the doctor on any occasion where the MB of going exceeds the
trip’s $10 out–of-pocket cost. But this will lead to overconsumption and a deadweight
loss to society because while the out–of–pocket price to you of a doctor’s visit is only $10,
the actual underlying cost of providing you with the doctor’s time, access to his facilities,
the services of his assistants, and so on is actually the $100 price that the doctor charges.
Thus, the low out-of-pocket prices paid by people with medical insurance cause them to
demand and receive many medical procedures for which the total MC exceeds their
individual MB. The end result is a deadweight loss related to overconsumption.
6. Ralph will consume any health care service just as long as its MB exceeds the money he must
pay out of pocket. His insurance policy has a zero deductible and a10 percent copay, so Ralph
only has to pay 10 percent of the price charged for any medical procedure. Which of the
following procedures will Ralph choose to consume? LO5
a. An $800 eye exam that has an MB of $100 to Ralph.
b. A $90 hearing test that has an MB of $5 to Ralph.
c. A $35,000 knee surgery that has an MB of $3,000 for Ralph.
d. A $10,000 baldness treatment that has an MB of $16,000 for Ralph.
Chapter 24 – Health Care
24-12
7. True or False. Under the PPACA, Americans are free to decide for themselves whether or not
they should have health insurance coverage. LO6
PROBLEMS
1. Suppose that the price elasticity for hip replacement surgeries is 0.2. Further suppose that hip
replacement surgeries are originally not covered by health insurance and that at a price of $50,000
each, 10,000 such surgeries are demanded each year. LO2
a. Suppose that health insurance begins to cover hip replacement surgeries and that everyone
interested in getting a hip replacement has health insurance. If insurance covers 50 percent of the
cost of the surgery, by what percent would you expect the quantity demanded of hip replacements
to increase? What if insurance covered 90 percent of the price? (Hint: Do not bother to calculate
the percentage changes using the midpoint formula given in Chapter 4. If insurance covers 50
percent of the bill, just assume that the price paid by consumers falls 50 percent.)
b. Suppose that with insurance companies covering 90 percent of the price, the increase in
demand leads to a jump in the price per hip surgery from $50,000 to $100,000. How much will
each insured patient now pay for a hip replacement surgery? Compared to the original situation
where hip replacements cost $50,000 each but people had no insurance to help subsidize the cost,
will the quantity demanded increase or decrease? By how much?
Chapter 24 – Health Care
24-13
Feedback:
Part a: We can apply the elasticity relationship discussed above to health care and
insurance. However, for the price elasticity we need to take into account the inverse
relationship between quantity demanded and price movement.
Part b:
To answer this part of the question we must first calculate the change in cost (price) to
2. The Federal tax code allows businesses but not individuals to deduct the cost of health
insurance premiums from their taxable income. Consider a company named HeadBook that could
either spend $5000 on an insurance policy for an employee named Vanessa or could increase her
annual salary by $5000 instead. LO4
a. As far as the tax code is concerned, HeadBook will increase its expenses by $5000 in either
case. If it pays for the policy, it incurs a $5000 health care expense. If it raises Vanessa’s salary
by $5000, it incurs a $5000 of salary expense. If HeadBook is profitable and pays corporate profit
taxes at a marginal 35 percent rate, by how much will HeadBook’s tax liability be reduced in
either case?
b. Suppose that Vanessa pays personal income tax at a marginal 20 percent rate. If Head Book
increases her salary by $5000, how much of that increase will she have after paying taxes on that
raise? If Vanessa can only devote what remains after paying taxes on the $5000 to purchasing
health insurance, how much will she be able to spend on health insurance for herself?
c. If HeadBook spends the $5000 on a health insurance policy for Vanessa instead of giving it to
her as a raise, how many more dollars will HeadBook be able to spend on Vanessa’s health
insurance than if she had to purchase it herself after being given a $5000 raise and paying taxes
on that raise?
Chapter 24 – Health Care
24-14
d. Would Vanessa prefer to have the raise or to have HeadBook purchase insurance for her?
Would HeadBook have any profit motive for denying Vanessa her preference?
e. Suppose the government changes the tax law so that individuals can now deduct the cost of
health insurance from their personal incomes. If Vanessa gets the $5000 raise and then spends all
of it on health insurance, how much will her tax liability change? How much will she be able to
spend on health insurance? Will she now have a preference for HeadBook to buy insurance on her
behalf?
Feedback:
Part a: Corporate profit tax is paid on accounting profit, which is the difference between
revenue and expenses. Since either option will increase the firm’s expenses by $5000, it
24-15
3. Preventive care is not always cost effective. Suppose that it costs $100 per person to administer
a screening exam for a particular disease. Also suppose that if the screening exam finds the
disease, the early detection given by the exam will avert $1000 of costly future treatment. LO4
a. Imagine giving the screening test to 100 people. How much will it cost to give those 100 tests?
Imagine a case in which 15 percent of those receiving the screening exam test positive. How
much in future costly treatments will be averted? How much is saved by setting up a screening
system?
b. Imagine that everything is the same as in part a except that now only 5 percent of those
receiving the screening exam test positive. In this case, how much in future costly treatments will
be averted? How much is lost by setting up a screening system?
Feedback:
Part a: It will cost $10,000 to administer the screening exam (= $100 (cost per person) x
Part b: Imagine that everything is the same as in part a except that now only 5 percent of
those receiving the screening exam test positive. In this case, how much in future costly
treatments will be averted? How much is lost by setting up a screening system?