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978-0077337735Chapter 21 Health Care
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
Answer: Increasing expenditures on goods such as household appliances or education is
regarded as desirable because production is expanding under relatively competitive
2. What are the “twin problems” of the health care industry as viewed by society? How are they
related? LO1
Answer: The “twin problems” are rising prices for all and limited access (lack of
3. Briefly describe the main features of Medicare and Medicaid, indicating how each is financed.
LO1
Answer: Medicare is a nationwide Federal health care program available to social
security beneficiaries and the disabled. It consists of a hospital insurance program and
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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
Answer: The real total compensation package, wages plus benefits, can only rise as fast
as productivity does. If health insurance benefits rise more rapidly than productivity,
5. What are the main groups without health insurance? LO3
Answer: One group of uninsured is the working poor, who make too much to qualify for
Medicaid but not enough to afford health insurance. Both they and their employers find
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6. List the special characteristics of the U.S. health care market and specify how each affects
health care problems. LO3
Answer: The health care market has many characteristics that differentiate it from a
perfectly competitive market. (1) There are ethical questions connected with health care
services that don’t arise when people are unable to afford other types of goods and
7. What are the estimated income and price elasticities of demand for health care? How does each
relate to rising health care costs? LO4
Answer: Income elasticity is 1.0 suggesting that health care spending will rise
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
Answer: (a) Asymmetric information refers to the fact that consumers of health care
often have very little understanding or access to the information about the health care
services that they need. Therefore, they must depend on health care professionals to
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9. How do advances in medical technology and health insurance interact to drive up the cost of
medical care? LO4
Answer: Significant advances in medical technology have occurred and have been
encouraged by the willingness of public and private insurance to pay for new treatments
10. Using the concepts in Chapter 6’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
Answer: Health care insurance removes or greatly lessens a person’s budget constraint at
the time health care is purchased, raising health care utility per dollar spent and causing
11. How is the moral hazard problem relevant to the health care market? LO4
Answer: The moral hazard problem is relevant to the health care market in two basic
ways. First, the insured individual may neglect preventive health care, knowing that the
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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? LO4
Answer: The underlying rationale is that spillover benefits exist from a healthy,
productive workforce. Therefore, it is appropriate to make health care more widely
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. LO4
Answer: (a) Preferred provider organizations (PPOs) are collective agreements among
hospitals, doctors, and insurance companies in which the providers (hospitals and
doctors) agree in advance to provide discounts on their services in exchange for receiving
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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? LO4
Answer: Health savings accounts are accessible to those with qualifying insurance plans
with annual deductibles of $1000 or more, and without other first-dollar coverage. It
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? LO5
Answer: The fact is that many of those without insurance are known to suffer from
extremely costly medical conditions. Indeed, these individuals were without insurance
precisely because private insurance companies (which have to either break‐even or go
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16. How does the PPACA attempt to ensure affordable insurance for the poor? LO5
Answer: The PPACA attempts to cover those with lower incomes in three ways. First,
the employer mandate will induce many larger employers to provide insurance for all of
17. What were the objections made by opponents of the PPACA? LO5
Answer: Some of those voicing objections worried that Federal control over the pricing
and content of insurance policies would lead to greater inefficiencies in health care by
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:
(1) Competition is encouraged by forcing hospitals to post prices for each of their
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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?
Feedback: Consider the following example. 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.
Recall that an elasticity relates how the percentage change in one variable translates to a
percentage change in another variable.
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Part a:
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
Part b:
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?
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
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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 HeadBook
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?
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: Consider the following example. 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.
Part a:
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?
Corporate profit tax is paid on accounting profit, which is the difference between revenue
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Part b:
b. Suppose that Vanessa pays personal income tax at a marginal 20 percent rate. If
HeadBook 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?
Part c:
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?
Part d:
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?
Vanessa would prefer to have HeadBook purchase insurance for her rather than receiving
Part e:
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?
Since individuals can now deduct the cost of health insurance, Vanessa’s taxable income
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?
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Feedback: Consider the following example. 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
Part a:
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?
It will cost $10,000 to administer the screening exam (= $100 (cost per person) x 100
(number of people)).
Part b:
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?
In this case, only 5% of the those receiving the test come back positive for a particular