Problem Set 2- Solutions

Economics 548 - The Economics of Health Care Korinna K. Hansen Answers to Problem Set # 2 l)a) DISAGREE. Going to medical school and becoming a surgeon looks very profitable when we consider surgeons' wages. Yet the fact that surgeons earn high salaries is only half the story. When making the decision whether to become a surgeon is a good financial investment or not we also need to account for the high opportunity cost of the training (tuition expenses, foregone income and alternative career). The internal rate ofreturn measures the desirability ofan investment. The IRR is essentially the interest rate that the bank would have to give to make someone indifferent between investing tuition + foregone wages in the bank versus investing in medical school. Investing in medical education implies some sacrifices today but promises high returns for later years. The relative desirability ofconsumption today versus consumption can also affect this financial investment decision. 1)b) DISAGREE. Provider prices can differ despite the similarity in quality of service. We know that doctors price discriminate, charge different amounts to differently insured individuals for the same service. The economic model of monopolistic competition describes the market for physician services the best. Demand is downward slopping and tangent to average cost curve in long run equilibrium (where neither entry or exit takes place). Even if different physician firms face the same demand curve, equilibriunl prices will differ across firms in this market structure because cost curves generally will differ. , ? "' ,. 11 I I 2). a). The variations literature refers to the differences in treatment of equally sick patients by different physicians and health care providers across geographic regions. Demand inducement is something very different. It's the debatable consideration that providers care about their financial reward and because ofthat they "create" demand for health care. They do not behave as honest agents oftheir patients; they encourage higher health care use to increase their own personal profits. Providers create the extra demand with different rates across different geographic regions. That implies variation in care. The existence of demand inducement in health care is a debatable issue and an empirical question. In the demand inducement literature the main idea is that providers adjust treatment recommendations to achieve higher financial reward. Ifwe can see clear geographic vaJ.;ations in the delivery of care, where there are no differing financial incentives for physicians, then we have evidence ofvariation that CANNOT be explained by denland inducement. 3). Since St. Slow's hospital is going to concentrate in the production oflower quality of care (where fewer amenities and less medical technology is important) the following is true for St. Quick's hospital: Demand for low quality care at St. Quick's goes down (St. Slow's provides most oflow quality care now), and demand for high quality at St. Quick's goes up (because St. Slow hospital doesn't provide much high quality of care anymore). Average cost curves do not shift. The not-for profit hospital is in equilibrium when AR = AC (when it breaks even). The EE curve rotates to E'E'. We can look at the backwards bending part ofthe E'E' curve to collect information about Quality (S), Quantity (N) levels that St. Quick's can produce in equilibrium if all resources are employed (PPF curve). Everything in the graphs below is for St.Quick's hospital. The demand curves have shifted because ofthe behavior of St. Slow's hospital, but otherwise, St. Slow's doesn't appear anywhere on the graph. The solid line gives the old PPF. The new PPF has to show (according to E'E' curve) lower quantities for low qualities and higher quantities for high qualities. So, the new PPF is found by rotating the old. Depending on what the indifference map for trusties looks like, thick (if trusties value quality a lot) or thin (if trusties value quantity more), trusties will end up happier (on a higher indifference curve) or less happy (on a lower indifference curve) in the new situation. Q~~~ AC 7-CkJ!""Q"~''} t5 £' / I' , Gl\A\~