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Special Topic 8
The Economics of Health Care
OUTLINE
I. Structure of the Health Care Industry
A. Spending on health care has soared in recent decades.
1. Measured as a share of the economy, total health care spending has risen from 5.2
percent in 1960 to 9.2 percent in 1980, and 17.9 percent in 2011.
2. Expenditures on both Medicare and Medicaid have soared during the last three
decades.
B. Discrimination Against the Direct Purchase of Health Insurance
1. The tax system encourages employees to demand and employers to provide low–
deductible, small co-payment health insurance policies.
a. As a result of this distortion, more health care bills are paid for by third-party
II. Third-Party Payments and Health Care Inflation
A. Since the mid-1960s, the direct expenditures of health care consumers gradually
declined and those of third-party payees expanded.
1. The out-of-pocket spending of consumers accounted for only 14 percent of health
care spending in 2011, down from 55 percent in 1960.
B. The growth of subsidies to health care consumers and greater reliance on third-party
payments of recent decades
1. increased the demand for medical services and
III. The Growth of the Elderly Population and Health Care
A. In the next two decades, the elderly population will grow more rapidly than in recent
decades.
1. Under the current Medicare program, this will increase the demand for health care
services and the share of medical payments financed by a third party.
2. It can also be expected to result in higher health care prices and increased taxes for
the finance of Medicare.
IV. American Health Care at a Crossroads
A. Perverse Incentives and the Provision of Health Care
1. The structure of government programs relies on third-party payments that erode the
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families to purchase a health insurance policy that fits their preferences.
3. State regulations that force insurers operating in the state to cover numerous items
such as in vitro fertilization, drug rehabilitation, marriage counseling, acupuncture,
B. Controlling Health Care Spending
1. The Patient Protection and Affordable Care Act sought to control the future growth
of health care spending.
a. The act will set more than 7,000 reimbursement rates for medical procedures.
b. All doctors will be required to keep patient records in electronic form.
c. The breadth of mandated coverage and number of people insured will increase.
V. How to Improve the Performance of the Health Care Industry
A. Several reforms would help avert the crisis that will occur when baby boomers retire.
1. Equalize the tax treatment of out-of-pocket medical expenses and the direct
purchase of health insurance with that of health insurance purchased through an
employer.
2. Allow the residents of each state to purchase health care from out of state
providers.
3. Encourage health savings accounts and the direct payment of medical bills from
the accounts.
OBJECTIVES
This special topic analyzes why spending on health care has soared in recent decades. We focus on
the impact of subsidies to health care consumers and the greater reliance on third-party payments.
We then discuss why health care spending and inflation will likely rise over the next two decades
as baby boomers begin to retire. The special topic concludes with five reforms that would make
health care more efficient and cost effective.
IMPORTANT POINTS AND TEACHING SUGGESTIONS
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1. Review with students the data of Exhibits 1 and 2. Exhibit 1 documents that health care
spending has soared over the past four decades. Measured as a share of the economy, total
2. Exhibit 3 shows that direct expenditures of health care consumers has fallen dramatically and
those of third-party payees expanded. The out-of-pocket spending of consumers accounted for
only 14 percent of health care spending in 2011, down from 55 percent in 1960.
3. Be sure to explain that the growth of subsidies to health care consumers and greater reliance
4. Discuss the impact of the retirement of baby boomers will have on the health care system. Under
the current Medicare program, this will increase the demand for health care services and the
5. An interesting topic for class discussion is how to reform the heath care system. The text
suggests six reforms:
a. Equalize the tax treatment of out-of-pocket medical expenses and the direct purchase of
health insurance with that of health insurance purchased through an employer.
6. Class discussion of Critical Analysis questions 1, 3, and 5 will help students integrate the major
concepts of this chapter.
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS