1. Government Regulation and Intervention Part 1
4/1/2017
Government Regulation and Intervention Part 1
Vivian Ho
Health Economics
This material draws heavily from Santerre & Neun: Health Economics, Theories Insights and Industry Studies, Southwestern Cengate 2010

2. 4/1/2017
Introduction
Causes and consequences of government intervention in health care.
Types of government intervention.
Case studies
Cigarette taxes.
Price ceilings on health care services.
Hospital antitrust litigation.

3. Criteria for perfect competition
4/1/2017
Criteria for perfect competition
All firms and consumers are price takers.
Consumers and firms have perfect information.
All firms produce an identical product.
Firms can freely enter an exit an industry.
Price taking - There are many independent firms and consumers in the market. Firms and consumers believe their decisions will not affect price.
Perfect Information - Consumers have perfect info on their preferences, income levels, prices, and quality of goods purchased.
Firms have perfect info on costs, prices, technology.
Product homogeneity - Insures single market price, Any firm that raises price will lose all sales. Consumers consider only price when choosing between firms.
Perfect mobility of resources - no barriers to entry

4. Imperfect consumer information Monopoly Externalities
4/1/2017
Market imperfections may lead to inefficient or inequitable distribution of resources.
Imperfect consumer information
Monopoly
Externalities
Government intervenes to restore efficiency and/or equity.
“Public interest theory.”

5. Vote-maximizing politicians “supply” legislation.
4/1/2017
An opposing theory: The amount and types of government intervention are determined by supply and demand.
Vote-maximizing politicians “supply” legislation.
Wealth maximizing special interest groups are the buyers.
Successful politicians stay in office by satisfying special interest groups.

6. “Special interest group theory” Examples:
4/1/2017
“Special interest group theory” Examples:
Extended patent protection for brand name drugs.
Rejection of national health insurance in favor of private insurance companies.

7. Consumers are diverse, fragmented, more costly for them to organize.
4/1/2017
Special interest group theory claims that special interest groups gain at the expense of the general public.
Consumers are diverse, fragmented, more costly for them to organize.
Inefficient, inequitable resource allocation by government.
Which theory do you believe?
C-B analysis is needed to identify winners and losers.

8. Types of Government Intervention
4/1/2017
Types of Government Intervention
Provide public goods.
Correct for externalities
Impose regulations.
Enforce antitrust laws.
Sponsor redistribution programs.
Operate public enterprises.
Fund medical research.
Tax cigarettes, pollution.
FDA
Bar hospital mergers.
Medicare and Medicaid.
VA hospitals

9. 4/1/2017
Public Goods
>1 individual simultaneously receives benefits from the good.
i.e., no rivalry in consumption.
Costly to exclude nonpayers from consumption of the good.
Private firms unwilling to produce and sell public goods.
Are most medical services public goods?

10. 4/1/2017
Externalities
Definition: An unpriced byproduct of production or consumption that adversely affects another party not directly involved in the market transaction.
Cigarette smoking
Pollution
Medical treatment for cyclists who don’t wear helmets
Drunk drivers

11. Demand-side externality:
4/1/2017
Demand-side externality:
Marginal Social Benefit  Marginal Private Benefit
Supply-side externality:
Marginal Social Cost  Marginal Private Cost
Supply-side externality
A firm inflicts uncompensated costs on another party during production
Examples: pollution
Hospital hazardous waste disposal, if not done properly (HIV-infected needles washed up on Long Island shore in the late 1980’s)

12. Smokers impose work-related costs on nonsmokers.
4/1/2017
Cigarette smoking is an example of a (negative) demand-side externality.
Smokers impose work-related costs on nonsmokers.
Health insurance, pensions, sick leave, disability, group life insurance financed collectively by smokers and nonsmokers.
But smokers, die earlier, pay less taxes, premiums.
Demand-side externality, because:
The price consumers pays for cigarettes doesn’t take into the account costs imposed on others.
Smokers (CONSUMERS) impose costs on nonsmokers.
Example of a positive demand-side externality:
Vaccination of your dog for rabies.

13. Smokers also impose health care costs on nonsmokers.
4/1/2017
Smokers also impose health care costs on nonsmokers.
Smokers usually incur higher health care costs.
But nonsmokers die prematurely from passive smoking, smoking-related fires.
The total external costs of cigarette smoking are estimated to be 15¢ per pack (Manning et al., 1991)
15 cents differs from 33 cents cited in US News article. New figure:
1. Assumes 5% discount rate
2. Smoking, drinking, lack of exercise are correlated. So can’t overattribute bad health effects all 3 to just one bad health habit.

14. 4/1/2017
Keep in mind:
The problem which calls for government intervention is external costs, not internal costs.
The full extent of external costs must be measured using a lifetime approach.
1. Smokers pay for cigarettes, part of their own medical expenses, dry cleaning bills, smoking-related damages. Gov’t intervention not necessary for this part.
2. Discounting is important for the lifetime approach. Nonsmokers get more pension money over time, because they live longer. If this is not discounted at 5%, then smoking actually leads to negative external costs!

15. Manning et al.’s methods
4/1/2017
Manning et al.’s methods
Numerator takes into account life expectancy for smokers and the costs (savings due to early death) incurred each year.
1. Smokers pay for cigarettes, part of their own medical expenses, dry cleaning bills, smoking-related damages. Gov’t intervention not necessary for this part.
2. Discounting is important for the lifetime approach. Nonsmokers get more pension money over time, because they live longer. If this is not discounted at 5%, then smoking actually leads to negative external costs!

16. External Cost Components
4/1/2017
External Cost Components
Covered medical costs.
Covered work loss and disability.
Group life insurance.
Widow’s social security bonus.
Covered nursing home costs.
Pensions.
Taxes on earnings.
Fires.
1. Smokers pay for cigarettes, part of their own medical expenses, dry cleaning bills, smoking-related damages. Gov’t intervention not necessary for this part.
2. Discounting is important for the lifetime approach. Nonsmokers get more pension money over time, because they live longer. If this is not discounted at 5%, then smoking actually leads to negative external costs!

17. At Q0 MSC0 > MSB0 Cigarettes are being over-consumed. $ per pack
4/1/2017
$ per
pack
S=MPC=MSC
MSC0
D=MPB
MSB0
MSB Q1 Q0
Cigarette Packs
At Q0 MSC0 > MSB0
Cigarettes are being over-consumed.

18. 4/1/2017
Government can use taxes and subsidies to alter economic incentives, correct for externalities.
Charge a tax on cigarettes that reduces consumption to the socially optimal level Q1.
Levy a per-unit tax T on cigarette makers equal to vertical distance between MPB and MSB at Q1.

19. $ per pack MPC0+ T MPC0=MSC P1 P0 P2 D=MPB MSB Q1 Cigarette packs Q0
4/1/2017
$ per pack
MPC0+ T
MPC0=MSC P1 P0 P2
D=MPB
MSB Q1
Cigarette packs Q0

20. With tax: Market price of cigarettes = P1
4/1/2017
With tax:
Market price of cigarettes = P1
Cigarette manufacturers receive P2 per pack.
Tax burden
Consumer pays P1 - P0
Seller pays P0 - P2

21. 4/1/2017
The relative tax burden on consumers vs. producers depends on price elasticities for supply and demand.
If demand for cigarettes is inelastic, consumers bear a larger?/smaller? Share of the tax burden.

22. 4/1/2017
Further issues
The current tax per pack exceeds external costs. Is this “OK”?
Should smokers or cigarette companies be responsible for the external costs of smoking?
“Thank you for smoking.” Is this moral??
1. A) Higher taxes discourage teens from getting addicted in the first place.
B) Higher taxes may take into account the other stuff which is more difficult to quantify: nonsmokers hate smoke. Loss of loved ones. Costs of low birthweight.
C) This just may be another form of “redistribution.” But it goes the wrong way. Poorer people are more likely to smoke!
2. Bigger picture - did cigarette companies “lie” about the effects of smoking, purposely get people addicted?
3. They’re making money for all of us. Should we support public funding for smoking cessation programs?

23. 4/1/2017
Regulations
Government can attempt to control price, quantity, or quality of health care products.
Example: Price Ceilings in The Canadian Health Care System.
Consumers are fully insured by the government.
The government fixes the price the physician receives for each visit.

24. 4/1/2017
Regulations
Because consumers are fully insured, they will demand the number of visits as if the price per visit = 0.
Assume that the government sets a reimbursement rate for physician visits equal to PC.

25. 4/1/2017
Price S PC D QS QD
Physician visits

26. With full insurance, consumers want QD visits.
4/1/2017
With full insurance, consumers want QD visits.
But the government has fixed the price of visits at PC.
Only QS visits will be provided.
Shortage of physician visits = QD - QS.

27. 4/1/2017
Consequences
1)Physicians may treat patients on 1st-come, 1st-served basis, regardless of severity/urgency.
2)Patients will have to queue for care/not receive care.
3)Unethical doctors may take bribes from patients trying to jump the queue.

28. 4) Poorer health outcomes.
4/1/2017
Lesson: There is no free lunch under cost containment. Price ceilings can lead to:
1) Shortages.
2) Longer waiting lines.
3) Nonprice rationing.
4) Poorer health outcomes.

29. Antitrust: Sherman Antitrust Act
4/1/2017
Antitrust: Sherman Antitrust Act
Section 1:
Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states or with foreign nations, is hereby declared illegal.

30. 4/1/2017
Section 2:
Every person who shall monopolize, or conspire with any other person or persons to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be guilty of a misdemeanor.

31. 4/1/2017
The Act prohibits anticompetitive business practices that promote inefficiency and inequity in the marketplace, such as:
Price fixing - when business rivals enter a collusive agreement to refrain from price competition; fix the price of a good or service.
Hospitals in a given city cannot jointly establish the price of various hospital services.
Note how price fixing is legal in other countries - fixing of price of angioplasty in South Korea

32. 4/1/2017
Boycott - agreement among competitors not to deal with a supplier or a customer.
Physicians in an area can’t collectively agree to deny services to a particular managed care organization.
Market allocation - when competitors agree to compete with one another in specific market area.
Hospitals in the same city can’t collectively set geographic service boundaries.

33. Price fixing, boycotting, and market allocations are illegal per se.
4/1/2017
Price fixing, boycotting, and market allocations are illegal per se.
The plaintiff must only prove these actions took place for the defendant to be in violation of the Act.
In contrast, rule of reason doctrine is used to evaluate horizontal mergers under the Act.
While horizontal mergers may force price above the competitive level, they may also create benefits which could be passed on to the customer.

34. 4/1/2017
Redistribution
The government often taxes one group and uses the revenues to subsidize another. Why?
Interdependent utility functions.
Donors get utility from increasing the welfare of recipients.
Why is the government involved?
“free rider” problem.
Added utility from donations can be monetary or intangible.
Can get “satisfaction” from having made someone better off.
Or, increasing the education for the poor can improve work force productivity for everyone.
Free rider problem - non donors get utility from others’ donations.

35. Two notions of equity in redistribution programs
4/1/2017
Two notions of equity in redistribution programs
Vertical equity
“Unequals should be treated unequally.”
People who earn more should pay higher taxes.
Horizontal equity
“Equals should be treated equally.”
Two persons with the same income level should pay the same in net taxes.

36. Vertical equity in practice
4/1/2017
Vertical equity in practice
How much more in taxes should higher income people pay?
Suppose high income households pay $4,000 in taxes on average, and low income households pay $2,000. Is this equitable?

37. If the high income household makes $100,000, they pay a 4% tax.
4/1/2017
If the high income household makes $100,000, they pay a 4% tax.
If the low income household makes $10,000, they pay a 20% tax.
The notion of equity in taxation depends not just on total tax revenues, but on income levels and tax rates as well.

38. 4/1/2017
In practice, vertical equity is achieved when the net tax system is sufficiently progressive.
Taxes as a fraction of income rise with income.
Federal income tax system.

39. Other forms of redistribution
4/1/2017
Other forms of redistribution
Proportional.
The fraction of income going to taxes is constant as income rises.
The Medicare tax is a fixed % of payroll income.
Regressive.
The fraction of income going to taxes falls as income rises.
Sales tax
Sales tax is regressive
- Consumption expenditures as a fraction of income fall as income rises.

40. Implementing redistribution
4/1/2017
Implementing redistribution
Supply-side subsidies
Government funding aimed at reducing the costs of producing a consumer good or service.
Subsidy to a public hospital.
Tuition for nurses or doctors.
Potentially violates notion of vertical equity
if all persons have equal access to the subsidized product.

41. Demand-side subsidies - government funding for consumers.
4/1/2017
Demand-side subsidies - government funding for consumers.
In-kind: vouchers or reimbursements for specific services.
Food stamps, Medicare, Medicaid
Cash: government-provided income that people can use at their own discretion.
AFDC, Supplemental Security Income
Keep in mind: It is difficult to guarantee horizontal equity with multiple programs in operation.

42. Consumer Groups Accuse U.S. of Negligence on Food Safety
4/1/2017
Consumer Groups Accuse U.S. of Negligence on Food Safety
The New York Times, October 15, 2002

43. 4/1/2017
Back to the Start
Does government intervention correct for market imperfections, or is it ruled by special interest groups?

44. 4/1/2017
A Final Caveat
Market failure is a necessary, but not sufficient condition for government intervention.
It may cost the government $10m to correct a problem in the marketplace, which imposes $8m in damages.
While markets may fail and impose societal costs, the costs of government intervention may be greater.