Quality of life Today: Health care; environmental regulation; workplace safety

Today Three mini-lectures about issues related to quality of life Health care Full coverage is wasteful Environmental regulation Finding the lowest cost way to cut pollution Workplace safety How much safety is enough?

Health care “By 2017, total health care spending will double to more than $4 trillion a year, accounting for one of every $5 the nation spends, the federal government projects.” (Source: AP article on CBS’ website, “Health Care Will Cost $4 Trillion by 2017,” posted Feb. 26, 2008; see readings on class website for link)

Health care More from the AP article, quoting Centers for Medicare and Medicaid Services economists "Health is projected to consume an expanding share of the economy, which means that policymakers, insurers and the public will face increasingly difficult decisions about the way health care is delivered and paid for"

Health care As we will see, there is often too much money spent on health care, relative to the optimal amount of spending We will look at a simple case with constant MC

Health care Health care services, like all goods and services, have a demand schedule Demand denoted by MB curve

Health care Suppose that Angela has been admitted to the hospital after being in a car accident She has a substantial MB for the first night in the hospital, due to the care that she needs

Health care As Angela’s condition improves, her MB declines After Q2 days in the hospital, she is completely better

Will Angela pay for the full cost of her hospital stay? Not likely Most Americans have at least some health insurance Insured person usually pays a deductible or co-payment for medical services Some people have complete medical coverage No direct payment made to those that provide medical services

Equilibrium length of hospital stay with co-payment Assume that Angela pays X dollars (co- payment) for her hospital stay Let X be small relative to total hospital bill Angela will then decide to stay in the hospital as long as MB for each night exceeds its MC Note that Angela’s private MC is zero under this form of insurance

Equilibrium length of hospital stay with co-payment PUBLIC MC is positive Angela’s PRIVATE MC is zero If hospital lets Angela stay in the hospital as long as she wants, equilibrium occurs at Q2 MB and private MC are both zero here

What is optimal? Angela’s optimal length of hospital stay occurs when the PUBLIC MC equals MB This occurs at point A

What about a percentage co- payment? What if Angela had to pay 20% of her costs while in the hospital Her PRIVATE MC is now two-tenths of MC curve (See dashed line) Equilibrium is at the yellow circle 0.2 MC

What are some possible solutions to this problem? Health Maintenance Organizations (HMOs) Patients less likely to receive services with low MB Higher deductibles Closer to optimal outcome, since out-of-pocket payments are higher Reimbursement policies for medical services Review boards Discharge criteria from hospitals

Moral hazard With insurance, people are likely to do riskier activities, knowing that insurance will cover them if they get hurt Skydiving Bungee jumping Mountain climbing These activities lead to more medical costs, leading to higher premiums for everyone

Health care costs Is there a single solution to lowering health care costs? No: Many approaches will be needed Another issue: Drug costs Research and Development: Often millions of dollars for a single drug Patent protection  Market power

Summary: Health care Insurance often leads to more health care being used than what is optimal Co-payments help improve efficiency some, but not completely Some methods to help lower health care costs include the use of HMOs, higher deductibles, and reimbursement policies

Environmental regulation Environmental quality is a good that people want Problems with providing environmental quality Goods without markets (air quality, global temperature, rivers) Goods that governments own (parks)

Environmental regulation and externalities Recall Externalities Chapter With negative externalities, too much of some goods is produced, relative to efficient outcomes possible Three ways of reducing pollution Taxes Pollution permits Arbitrary controls (also known as “command and control” methods)

Environmental regulation and efficiency Assume we are trying to find efficiency in an air-polluted city To reach the efficient level of pollution, we need to find firms with the lowest cost to abate pollution

Environmental regulation and efficiency Example with 3 firms Efficient level of pollution, as determined by the government: 5 tons of smoke per day One of the two approaches (taxes or permits) is needed to solve for the optimal amount of pollution We do not spend much time on “command and control” methods since it is often sub- optimal

Example Three firms produce light bulbs With no abatement technology, each firm produces 4 tons of smoke per day 12 tons of smoke with no regulation To reach efficient level of 5 tons, 7 tons need to be abated Some firms can more easily abate pollution than others If firms with low abatement costs abate the most, we can get an efficient result

Example Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Notice that marginal abatement costs increase as more is abated Firm A: $14 MC to abate 1 st unit; $16 for the 2 nd unit; $20 for the 3 rd unit; $25 for the 4 th unit

Example Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 We need to find the 7 tons with the lowest abatement MC Let’s start by adding arrows to abatement MC of $20 per ton or less Not enough: Only 4 tons abated

Example Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Let’s try $30 abatement MC or less 7 green arrows We now have reached the efficient level of 5 tons of emissions

Our two methods to reach an efficient result Pollution tax Find a tax such that exactly 7 tons of pollution will be abated Sell pollution permits Find a price such that exactly 5 tons of pollution permits are demanded

Pollution tax Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Let’s try a $30 tax Firm A will abate all 4 tons of smoke, since abatement cost is lower for each ton of smoke removed Firm B will abate 2 tons and pollute 2 tons Firm C will abate 1 ton and pollute 3 tons

Pollution tax Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 7 tons abated 5 tons polluted We have found a tax that leads to the efficient pollution level

Pollution permits Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 What if you need a permit to pollute? What if we sell permits for $30 each? Firm A will demand no permits (and abate 4 tons) Firm B will demand 2 permits (and abate 2 tons) Firm C will demand 3 permits (and abate 1 ton)

Pollution permits Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 7 tons abated 5 tons polluted We have found a price for permits that leads to the efficient pollution level

Alternative to taxes and permits: Command-and-control methods An alternate method to control pollution is for the government to dictate that each firm reduce its pollution by a given percentage Example: Each firm must reduce emissions by 25% Problem: Usually not efficient

Alternative to taxes and permits: Command-and-control methods Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Example: Each firm must abate 1 ton Total cost: $59 Total cost if firm A abates 2 tons and firm B abates 1 ton: $50 (see green ovals)

Summary: Environmental regulation Markets with externalities usually require government intervention to have optimal outcomes to occur Taxes: Efficient (with the right tax) Permits: Efficient (if permit price leads to an efficient amount of pollution) “Command and control” methods: Almost never efficient

Workplace safety In a perfectly competitive labor market… Firms will provide the optimal amount of safety Workers will be hired by a firm Threat to leave firm will prevent the firm from lowering safety standards

The real world Many countries have laws dictating a minimum level of safety to workers Why? Although most labor markets are competitive in the long run, there are frictions in the short run that prevent immediate job movement

What else is going on? Today’s work affects the company today, but the worker for a lifetime  Workers value safety Example: Lose an arm  Firm lays you off; lower worker productivity for a lifetime Firm does not care about future earnings of the worker In many countries: Government support needed if the worker is unable to find a job

Unions and workplace safety Recall that unions not only fight for high wages, but also working conditions Unions can be beneficial in determining the optimal amount of worker safety

Other methods to increase safety Offer financial incentives Higher safety  Bonuses (money, gift certificates, tickets for prize giveaways) Increased training Shorter work days Tired people are more likely to be clumsy and inattentive Workers’ compensation Insurance system for those injured while working

An application of safety Look at Example 15.5 and Exercise 15.4 (p ) Uses many tools Benefit/cost analysis Workplace safety Game theory Prisoner’s dilemma Relative income

Safety outside of the workplace Many safety laws exist that are not related to workplaces These laws often affect children, who are “unable to fend for themselves” Child seats in cars Crib safety Reduced speeds near schools

Summary: Workplace safety Workplace safety laws try to establish an efficient amount of worker safety Other attempts to increase workplace safety: Unions, financial incentives, increased training, shorter work days, and workers’ compensation programs