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By Dr. Michael Walden, N.C. State Economist
Editor’s note: is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy.
RALEIGH, N.C. – One of my sisters-in-law is a health care professional. Whenever I bring up economics in a discussion about the issues involved in today’s health care debate, she waves me off my saying, "Economics has nothing to contribute to these issues, because health is more important than dollars and cents."
Needless to say, this has led to some arguments between us (mostly civil), because I believe just the opposite – that economics has some very important contributions to make as the country gets ready to perhaps change how we receive and pay for health care.
But, of course, you might expect me to say this because I’ve been a professional economist so long that economics is in my blood, and I see applications for my discipline everywhere. So let me present some ways in which I think economics can be helpful in thinking about health care and, of course, let you decide if I’m right – or my sister-in-law is.
Price and Cost Are Different:
Price is what is paid for one unit of a product or service, whereas cost is the price multiplied by the number of units bought. So if hamburgers have a price of $1 each and you buy three, your cost is $3.
Therefore, a higher cost doesn’t necessarily mean a higher price if a greater quantity is being used. But while the quantity of hamburgers is easy to see, the quantity of other things is more difficult to measure. Certainly no one would consider the "quantity" of services from today’s cell phones to be the same as from the first mobile phone 20 years ago, but it’s hard to put a number on the difference.
Most experts would consider the quantity of medical care received from today’s procedures, operations and treatment to be much greater compared to years ago. Modern medicine can do so much more and do it much better. What this means is that the price of medical care may not have risen – indeed, some economists say it has gone down. Instead, we’re paying a higher cost for health care because we’re using more quantity.
The Demand Curve Lives:
One of the oldest of economic concepts is the demand curve, which simply says we purchase more quantity of something when its price (per unit) falls. So if health care reform makes health care cheaper (lower price) to consumers, expect the amount (quantity) of health care used to increase. Depending on the size of this response, this could make the total amount we spend on health care actually rise when the price drops.
At the heart of economics is the notion that people respond to incentives. If people are rewarded more, they’ll do more; if they’re rewarded less or even penalized, they’ll do less. It’s the common idea of the carrot and the stick.
So if we want people to have annual check-ups, eat better and exercise and lead healthier lifestyles, this economic idea says we should give them an incentive to do so, through lower insurance premiums, for example. Therefore, it’s important for people to have a financial stake in their health, so called "skin in the game." If consumers are shielded from the financial consequences of their health-related behavior, they won’t be as concerned about monetary implications.
Insurance Costs More for Sure Things:
Insurance was created to pay for big expenses related to unexpected losses, but at a relatively low cost to the buyer. Let’s say 100 people face an equal likelihood this year of suffering a loss of $10,000. The loss will hit one unlucky person, but no one knows who it will be. If each person paid $101 for insurance coverage, then the $10,000 loss could be paid, and the insurance company would keep $100 for its effort.
The key word term here is unexpected loss. Let’s say the insurance company is required to pay $50 each year for a mandatory medical check-up for each person. Now the $50 payment isn’t unexpected – instead, it is expected and known. It’s a sure thing. The result – the annual insurance premium paid by each person immediately rises from $101 to $151.
Choices Must Be Made:
This is maybe the crowning principle of economics. Indeed, economics as a field of study only exists because choices must be made. Collectively, at any one time, there aren’t enough resources to give everyone everything they want.
The only question is, what is the mechanism by which these choices are made? That is, who makes the choices? In the context of health care, who decides what operations and treatments are given and when? The possible answers are the patient, physician, insurance company, the government or some combination of these. As with most resource decisions, it’s often the entity that controls the purse strings that makes the ultimate decision.
While these economic concepts won’t resolve the health care debate, hopefully they help illuminate some of the issues and make you more informed about the possible options.
So who wins, my sister-in-law or me? You decide!