Introducon to the of Health and Medical Care Session 1A—January 5, 2015 Health Economics PHARM 568 Winter 2015

Co-Coursemasters: Lou Garrison, PhD Norma Coe, PhD

1 Agenda

• Course Objecves, Overview, and Resources • Economic Way of Thinking • Is Health Care Different? • Reminder • Stylized Facts and Stascal Overview

2 Course Objecves

• Master key economic concepts and analycal tools needed to analyze human economic behavior in general.

• Understand and apply microeconomic principles to analyze the major issues of the health care sector.

• Understand the key instuonal and market factors that affect the incenves of the stakeholders in the key health care markets.

• Understand both the perspecve and limits of economic analysis applied to health care.

• Gain some historical economic perspecve on the evoluon of major health policy issues 3

Assignments and Grading

Biweekly Homework Assignments A. All students are expected to complete the four weekly homework assignments. Each will require a 500-1000 word short essay of topic of interest. B. All parcipants will complete a take-home exam midway in the course. C. Final exam will be scheduled for in-class during the scheduled me block

GRADING:

Classroom Parcipaon 5% Homework assignments 20% Midterm 30% Final Exam 45%

Grading will be based on student performance using the grading system for graduate students published in the 2002 - 2004 University of Washington General Catalog for Graduate and Professional Students, pp. 13.

4 Lectures

5 Key Economic Terms and Concepts

• Adverse selecon • Experience rang • Opportunity cost • Cerficaon • Externality • Parallel import • Coinsurance • Hyperbolic discounng • Pareto opmality • Community rang • Human capital • Posive economics • Consumer surplus • Indemnity • Post-experience good • Consumpon • • Price discriminaon • Cost efficiency • Informaon asymmetry • Price elascity of demand • Cost-benefit analysis • (Internal) rate of return • Private • Cost-effecveness analysis • Internaonal reference pricing • Public goods • Cost-ulity analysis • Investment good • Reference pricing • Decision fague • Licensure • Residual claimant • Deadweight loss • Loss aversion • Shirking • Deducble • Luxury good • Status quo bias • Defaults • Market concentraon • Sunk cost • Demand • Market failure • Supplier-induced demand • Differenal pricing • Monopolisc compeon • Tax subsidy • Discount rate • Monopoly • Technical efficiency • Dissipaon of rents • Monosony • Therapeuc reference pricing • Economic efficiency • Moral hazard • Uncertainty • Economic rents • RBRVS • Welfare economics • Economies of scale • Necessity good • Welfare loss • Economies of scope • • Equilibrium • Normave economics • Experience good • Nudge

6 Readings

Handbooks of Health Economics (Vols IA and IB). Culyer A and Newhouse JP. (eds.) 2000. Handbooks of Health Economics, Vol. 2, Pauly MV, McGuire TG, and Barros PP (eds.), Elsevier/NH, 2011.

Here is the UW link to the Handbook of Health Economics: hp://uwashington.worldcat.org.offcampus.lib.washington.edu/wcpa/oclc/690107506?page=frame&url=hp %3A%2F%2Fwww.sciencedirect.com%2Fscience%2Fhandbooks%2F15740064%26checksum %3Dd9a3c797d966ba524cd5a34433ea16fd&tle=&linktype=digitalObject&detail=:noframes

Elgar Companion for Health Economics, Second Edion (Andrew Jones.), 2012. Available as e-book in UW library: eb.ebscohost.com.offcampus.lib.washington.edu/ehost/ebookviewer/ebook/ bmxlYmXzQzMzgxOF9fQU41?sid=e61a1cb4-3012-4e47- a91d-8e3409d482e3@sessionmgr4004&vid=1&format=EB&rid=1

Oxford Handbook of Health Economics (eds. Glied S and Smith PC) 2011. Available as Kindle e-book for $31.49.

Other readings are available as electronic journal arcles through Healthlinks. All arcles not available through Healthlinks and some of the book chapters will be provided electronically as needed.

7 Resource: Khan Academy

8 Resource: Commonwealth Fund

9 Resource: Kaiser Family Foundaon

10

Stascal Abstract of the U.S.

12 Economic Report of the President

13 Agenda

• Course Objecves, Overview, and Resources • Economic Way of Thinking • Is Health Care Different? • Microeconomics Reminder • Stylized Facts and Stascal Overview

14 What is the economic way of thinking?

15 What is the Economic Way of Thinking? • Fuchs (“Who Shall Live?”, 1974): Economic point of view is rooted in three observaons: 1. “resources are scarce in relaon to human wants” 2. “resources have alternave uses” 3. “people . . . have different wants”

àBasic economic problem: “how to allocate scarce resources so as to best sasfy human wants” Two contrasng points to view: -”Romanc”—fails to recognize scarcity -”Monotechnic”—only one way to do things

16 Economics vs. Health Economics

• Economics is the study of how societies allocate their inherently scarce resources to satisfy the demands of their citizens.

• Health economics focuses on how these scarce resources are allocated to produce health and provide the medical services needed

• Economics posits that private markets are generally an “efficient” mechanism for allocating resources, maximizing the benefits received from the limited resources

• However, in the case of health care markets, a number of special circumstances occur that require special interventions and adaptations to improve efficiency

17 Rise of Health Economics

18 Aims of Economic Analysis— Two General Approaches

• Posive (or Behavioral Economics)—What “is” and why is it?

• Normave—What “should” be?

19 Economic Analysis Strategies— Two General Approaches

• Market failure approach—welfare economics

• Polical economy approach—theory of interest groups

--Both can be used posively or normavely.

20 Economic Perspecve: Premise and Implicaons • Key Behavioral Premise: – Individuals act to maximize their happiness (i.e., well-being or “welfare”) by choosing among economic goods (or allocang resources so as to best sasfy wants); economists refer to this as maximizing “ulity.”

• Simplest mathemacal formulaon (two goods, one period):

– Max U(X,Y) subject to income constraint px X+ pyY = I • Where X and Y are quanes of goods X and Y, p’s are prices, and I is income

• What can you predict from this? àDemand curves slope downward!

• Foundaon of ulitarianism (Jeremy Bentham, 1748-1832)

21 Adam Smith’s “Invisible Hand”

“...every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promong it. By preferring the support of domesc to that of foreign industry, he intends only his own security; and by direcng that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intenon. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the .” Adam Smith on Self-Interest

• Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me what I want, and you shall have this which you want, is the meaning of every such offer; and it is the manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self- love. Efficiency Benchmark—Compeve Economy (General Equilibrium Model) • Individuals maximize Ulity [U(x1,..xn)] subject to an income constraint • Firms maximize Profits π=px-c(y1..yn) subject a producon relaonship x=f(y1..yn) • Everyone a price-taker • Result: Pareto-efficient or Pareto-opmal • How would you choose between two Pareto-efficient distribuons? Idealized Compeve Model (1)

• “Collecve acon enables society to produce, distribute, and consume a great. . . “ • Premise: individuals generally act in their own best interest. – “Voluntary agreement”—mostly – Policy analysts concerned with “legimate coercive powers of government” Idealized Compeve Model (2)

• Model: Perfectly compeve economy – Many ulity-maximizing consumers – Many profit-maximizing producers • Under certain assumpons, leads to “efficient” global outcome—called “Pareto opmal” – “It would not be possible to change the paerns [of producon and consumpon] in such a way as to make some person beer off without making some other person worse off.” • “Market failures”—violaons of assumpons that would lead to inefficiency – Raonale for government/policy intervenon. Implicaons of General Equilibrium Theory: 1. Pareto opmality: “If a compeve equilibrium exists at all, and if all commodies are in fact priced in the market, then the equilibrium is necessarily opmal in the following precise sense (due to V. Pareto): There is no other allocaon of resources to services which will make all parcipants beer off.” 2. Income redistribuon: “Operaonally, . . . . if the allocaon mechanism in the real world sasfies the condions for a compeve model, then social policy can confine itself to steps taken to alter the distribuon of purchasing power.”

27 Important Efficiency Disncons ***Warning: Efficiency terminology is not used consistently in economics***

• Technical Efficiency (or producve efficiency) – Maximum physical output for a given set of inputs – A producon funcon concept: Output =f(capital, labor, other inputs)

• Cost Efficiency – Achieving a given output target and minimum cost – Implies that the opmal input mix has been chosen

• Economic Efficiency – Have chosen to produce and consume the “right” amount of output – AND assumes that both technical and cost efficiency have been met

• Other, related efficiency concepts: Pareto efficiency, allocave efficiency, distribuve efficiency 28

Pareto Efficiency

Source: Katz and Rosen, Microeconomics Pareto Improvement

Source: Katz and Rosen, Microeconomics What does “ceteris paribus” (“other things equal”) have to do with it?

31 Agenda

• Course Objecves, Overview, and Resources • Economic Way of Thinking • Is Health Care Different? • Microeconomics Reminder • Stylized Facts and Stascal Overview

32 What is unique about the economics of health care?

33 Arrow—Uncertainty and the Welfare Economics of Medical Care • How the medical care industry differ from the “norm” of the compeve model. “Uncertainty and the Welfare Economics of Medical Care”—K. Arrow, AER, 1963

• “Special economic problems of medical care can be explained as adaptaons to the existence of uncertainty in the incidence of disease and the efficacy of treatment”

35 Health Care Markets: Special Features

• Pervasiveness of uncertainty* – In terms of what works and doesn’t work – The demand for services difficult to predict – Insurance used to deal with financial risk – Limited learning from experience – “Informational asymmetry” between providers and patients and between insurers and subscribers

* K. Arrow, American Economic Review, 1963

36 Special characteriscs of the medical care market (Arrow, AER, 1963)

• Nature of demand—irregular; unpredictable; risky and costly. • Physician behavior—element of trust needed; ethical restricons—no adversing or price compeon; advice divorced from self interest; departure from profit move. • Product uncertainty—recovery is unpredictable; lile learning from experience; info asymmetry.

37 Special characteriscs of the medical care market (Arrow, AER, 1963)

• Supply condions—licensing; subsidized educaon; raoned entry; • Pricing pracces—price discriminaon; fee for service; no price compeon.

38 Health Care Markets: Special Adaptaons

• Intervenons and instuons have arisen in response to this uncertainty: – Insurance and its regulaon – Provider licensure – Drug and device regulaon – Subsidized educaon – Health technology assessment

39 What are the unique features? (Fuchs, 2010)

• “Does anybody behave as a ‘raonal actor’ in the health care market?”

• What are the unique features of the health care sector?

1. Government involvement 2. Dominant presence of uncertainty 3. Differences in knowledge 4. Externalies

“Uncertainty looms everywhere.”

40 Criquing US Health Care (Fuchs)

41 Criquing US Health Care (Fuchs)

• “The coefficient of rank correlaon (Spearman ρ) is −0.15, which is not stascally significantly different from zero.” • “For the 25 higher-income US states, the coefficient is−0.24 also not stascally significantly different from zero. However, there is a stascally significant correlaon (−0.40) for the 25 lower-income US states, but in the direcon opposite to the usual assumpon (P < .05) (ie, higher expenditures are correlated with lower life expectancy).” • “A balanced crique of US health care and health policy should also include consideraons of other goals in addion to extending life expectancy or reducing health care expenditures. Although difficult to do, it is important to account for quality of life, an appropriate balance between personal and social responsibility, and possible trade-offs among efficiency, freedom of choice, and generaonal, ethnic, and social equity.”

42 Welfarism vs. Extra-Welfarism Views Welfarism: The situation is efficient, both the donor and the recipient know the costs and benefits. Both consider themselves to be better off after the transaction. The end result may be inequitable or ethically unpalatable – but that is a separate issue.

Decision Making (Extra-Welfarism): Society is a better judge of the costs and benefits than individuals. This decision reflects the short-sightedness of individuals and inequitable income and health distribution. The transaction results in an inefficient allocation of health and also may be inequitable and unethical.

“…non-welfarist perspectives take an exogenous defined societal objective and budget constraint.” (Briggs et al., 2006.

43 Welfarism Extra-Welfarism

Professor Mark Pauly Professor Karl Claxton University of Pennsylvania York University

44 45 46 Agenda

• Course Objecves, Overview, and Resources • Economic Way of Thinking • Is Health Care Different? • Microeconomics Reminder • Stylized Facts and Stascal Overview

47 The Demand Funcon

Q = Q (p) Quanty demanded as a funcon of price.

48 Demand Curve: Movement Along vs. Shi

In the simplest model, only a change in income can shift demand.

49 50 Defining Economic Value: Standard Definion

What is “economic value”?

• “Value”= what fully informed paents would be willing to pay (WTP) for a new medicine based on:

1) any cost savings,

2) life years gained (LYs),

3) improvements in quality of life or morbidity

(2+3)àQuality-adjusted life years--QALYs

51 51

Defining Economic Value: Broadening the Measure • What is “economic value”?

• “Value”= what fully informed paents would be willing to pay (WTP)—usually via insurance—for a new medicine based on: 1) any cost savings, 2) life years gained (LYs), 3) improvements in quality of life or morbidity ( 2+3àQALYs) 4) producvity gains 5) reducon in uncertainty due to beer data or the value of knowing (e.g, ,via personalized medicine) 6) improvements in populaon-level adherence and uptake (via personalized medicine) 7) innovaon—scienfic spillovers 8) opon value--survival creates an opon to benefit from future advances; “value of hope”

52 52

What elements of value?

Less frequently / Usually recognised consistently recognised

• Health effects • Health effects that are that are well less well captured captured • Wider societal impacts • Cost offsets • Severity /unmet need • Uncertainty • Process issues • Informaon • Innovaon

53 Elements of ‘Value’ internationally

E&W Australia Canada France Italy Japan Sweden Clinical effecveness ü ü ü ü ü ü ü Cost effecveness ü ü ü ü Alternaves available / ü ü unmet need Disease severity EoL ü ü ü New mode of acon ü Paediatric ü Cost savings beyond ü health care Producvity ü

54 How measured, evidenced, and valued/rated?

• Measured: • e.g. health effect: Use of QALYs, clinical outcomes, PROs, disease specific • Evidenced: • e.g. health effect: Use of RCTs, observational studies, patient testimony, clinical opinion • Valued/rated • e.g. use of population or patient values • e.g. use of categories or discrete scales

55 Consumer Surplus

Source: Weimer and Vining Figure 4.8 Consumer Surplus

© 2010 Pearson Addison-Wesley. All rights 4-57 reserved. Source: Phelps, 2010. Ulity and Health

• Ulity = U(X,H)

– X: all other goods – H: Health capital

58 Figure 2.1

© 2010 Pearson Addison-Wesley. All rights 59 reserved. Figure 2.2

© 2010 Pearson Addison-Wesley. All rights 60 reserved. Health vs. Medical Care

• Both can be thought of as economic goods.

• How are they related? How do they differ?

61 Agenda

• Course Objecves, Overview, and Resources • Economic Way of Thinking • Is Health Care Different? • Microeconomics Reminder • Stylized Facts and Stascal Overview

62 Why is health care spending so much higher in the US: “It’s the prices, stupid…” Anderson et al. Health Affairs, 2003.

• % GDP to health spending: US—15% in 2003 vs. 8.5% OECD • Per capita spending: US--$5,267 vs. $2,193 OECD median • Hospital beds per 1000: US—2.9 vs. 3.7 OECD median • Physicians per 1000: US—2.4 vs. 3.1 OECD median • Nurses per 1000: US—7.9 vs. 8.9 OECD median • MRI units per 1000: US—8.2 vs. 5.5 OECD median • CT scanner per mill: US—12.8 vs. 13.3 OECD median

63 64 NHE, 2013 (Hartmann et al., 2015)

65

67 Distribution of National Health Expenditures, by Type of Service, 2009

Note: Other Personal Health Care includes, for example, dental and other professional health services, durable medical equipment, etc. Other Health Spending includes, for example, administration and net cost of private health insurance, public health activity, research, and structures and equipment, etc. Source: Kaiser Family Foundation calculations using NHE data from Centers for Medicare and Medicaid Services, Office of the Actuary, National Health Statistics Group, at http://www.cms.hhs.gov/NationalHealthExpendData/ (see Historical; National Health Expenditures by type of service and source of funds, CY 1960-2009; file nhe2009.zip). CMS, Office of Actuary, 2013 69 70 Source: CBO, Nov. 2007 Source: CBO, Nov. 2007 71 72 Per Capita Health Spending And 15-Year Survival For 45-Year-Old Women, United States And 12 Comparison Countries, 1975 And 2005

Source: Muennig and Glied, Health Affairs, 2010 73 Discussions of health spending often focus on averages, but spending varies considerably across the population Contribuon to total health expenditures by individuals, 2012

100% 97%

90% 82% 80% 76%

70% 66%

60% 50% 50%

40% 23% of total 30% health spending 20%

10% 3% 0% Top 1% of Top 5% Top 10% Top 15% Top 20% Top 50% Lower 50% health spenders

Source: Kaiser Family Foundation analysis of Medical Expenditure Panel Survey, Agency for Healthcare Research and Quality, U.S. Department of Health and Human Services Peterson-Kaiser Health System Tracker People age 55 and over account for about half of total health spending Share of total health spending by age group, 2012 100% 11% of spending (by 25% of populaon) 90% Under 19 13% (by 22%) 80% 9% (by 13%) 70% 19 to 34 60% 16% (by 14%)

50% 35 to 44 40% 21% (by 12%) 45 to 54 30%

20% 55 to 64 31% (by 14%) 10% 65 and over 0% Share of Populaon Share of Spending

Source: Kaiser Family Foundation analysis of Medical Expenditure Panel Survey, Agency for Healthcare Research and Quality, U.S. Department of Health and Human Services Peterson-Kaiser Health System Tracker US Mortality Gains in 20th Century

Cutler, “Your Money or Your Life.”, 2004 76 77 78 79 Source: CBO, Nov. 2007 GDP and Health Care Spending (Fuchs, 2013)

80 GDP and Health Care Spending (Fuchs, 2013)

81 82 83 Projected NHE Growth (Sisko et al., 2014)

84 85 86 87 Thanks!

88