Response to Price

The law of demand applies to health care as in other markets: as the price of health care increases, you demand less of it. But we must be careful. What matters is the price of health care to you. If you have health insurance, this price may be much lower than the actual cost of providing you with care. Under most health-insurance contracts, the marginal private cost of care to a household is less than the marginal social cost of providing that care. The household has an incentive to purchase a lot of health-care services because its purchases are, in effect, being subsidized by insurance companies. We take up the topic of health insurance later in this chapter.

Another key characteristic of health care is that demand is relatively inelastic. If you are sick and require care, you will purchase health-care services at almost any price. Of course, your ability to purchase health care is ultimately limited by your income, but you are likely to trade off spending on many other products to purchase the medical care you need. This is why we often read stories about people without insurance being bankrupted by medical expenses.

Health as Investment

Everyone prefers being healthy to being sick. The demand for health care is in part an expression of this preference. One thing that makes health care different from most other goods and services, though, is that it is simultaneously an investment. Money you spend on being healthy today will also benefit you in the future. There are several different ways in which spending on health care represents an investment.

Mortality. One clear impact of our health-care choices can be seen in terms of mortality rates. Mortality rates measure how likely we are to die at different ages. In 2004, the mortality rate in the United States for people ages 15–24 was about 80 out of 100,000, or 0.08 percent. In contrast, the mortality rate for those over the age of 85 was 13,823 out of 100,000, or 13.8 percent.Mortality rates can be found at the National Center for Health Statistics, National Vital Statistics System, “Mortality Tables,” accessed March 14, 2011, http://www.cdc.gov/nchs/nvss/mortality_tables.htm. In other words, the typical young person has about a 1 in 10,000 chance of dying in a given year, whereas the typical old person has more than a 1 in 10 chance of dying.

It is not surprising that the mortality rate increases with age—that is, that young people have a lower probability of dying than older people. (Infants are an exception: a 6-month-old child is more likely to die than an 18-month-old child because very young children are particularly susceptible to certain diseases.) But these average mortality rates disguise a lot of variation, much of which is under our control. There are many behaviors that have predictable effects on our likelihood of dying. Smokers have a higher probability of dying than nonsmokers. Those who are obese have a higher probability of dying than those who are not. Diet, exercise, and risky behaviors (which includes everything from unprotected sex to skydiving) affect mortality rates as well.

Cigarette smoking is linked to lung cancer and thus to mortality. If you compare two similar individuals of the same age, one who is a smoker and the other a nonsmoker, then the mortality rate is significantly higher for the smoker. This does not mean that the smoker will necessarily die before the nonsmoker. It means that all else being the same, smoking increases the probabilityThe percentage chance that an outcome will occur. of death. Refraining from smoking is a type of investment in your future.

Our diet also affects our probability of becoming ill and of dying. As with cigarettes, there are often trade-offs between eating and drinking things we enjoy and the effects of such consumption on our long-term health. Making these types of choices is an economic decision. Each of us makes different choices because we value the taste of particular foods differently, and we value our overall health differently as well. If a thirty-year-old discovers he has elevated cholesterol levels that pose a long-term risk of heart disease, he may decide to adjust his diet, perhaps consuming less red meat. If an eighty-year-old learns the same news, he may not think the long-term benefit is worth giving up his steaks for.

Productivity. Being healthy also means that you can work and earn wages. One of the costs of poor health is lost days at work. This is a cost not only to the individual but also to society as a whole: the economy’s population is producing less output. If you are in poor health, then you risk losing wages for the days when you cannot come to work. Many employers provide insurance for these lost wages through the provision of sick days: if you are sick, you are not expected to work but you will still be compensated up to a contracted number of days per year. In addition, there is disability insurance as part of the social security system in the United States.The government program is summarized at http://www.ssa.gov/disability. Private employers sometimes also offer disability insurance as part of their compensation packages, and you can also purchase insurance directly from an insurance company.

Information Problems

Health care is an example of a good for which the typical individual is unable to determine the quality of what is being purchased. You can think of other examples, such as legal services and used cars. In such situations, how can we make good decisions? Generally we do so by relying on the advice of experts. In the case of health, these are the doctors, dentists, and other health professionals who are trained to analyze our health situation and make suggestions to us. We listen, try to understand, and, using their advice, make an informed choice.

Suppose you get a phone call from someone telling you they know of a stock, trading on Wall Street, that will double in price the following day. You might be very skeptical, suspecting that they have other reasons for wanting you to buy. Compare this to a conversation with a medical expert. Generally you are going to believe that the expert is acting in your best interests. Although you might get a second (or third) opinion, you do so because health problems are complex and the first expert may have missed something, not because you are afraid the doctor is misleading you in order to profit from your visit. But why do we trust medical experts so much more than the provider of stock tips? We generally do so because we trust that their incentives are aligned with our goals; that is, we hope that they are motivated to act in our best interests.

Doctors

If you look at the wall in your doctor’s office, you will typically see a large number of framed degrees and other qualifications. To become a doctor, you must first succeed as an undergraduate and then go through multiple years in medical school. After this comes an internship and then you finally graduate and can practice on your own. In most countries, you must have a license to practice medicine. This makes sense: you would not want anyone to advertise as a doctor regardless of their skill level. Most of us would be unable to tell whether a particular individual was a qualified professional or a quack. When buyers cannot easily evaluate the quality of the good or the service they are purchasing, it is useful to have external validations of quality.

Licensing provides more than a guarantee of quality, however. It also limits entry into the profession. Suppose you learned that a small group of lobbyists in your hometown wanted gas station owners to be licensed in the same way as physicians. You would quite rightly suspect that their goal was not to guarantee high-quality gasoline. More likely, they would be trying to limit the number of gas stations to increase their market power. Your suspicions would not be allayed if these lobbyists argued that gas was potentially a very harmful commodity, so by licensing the sellers of gas, they were protecting the community. In the case of doctors, the underlying reason for licensing is not so nefarious. But it still creates a barrier to entryA cost for new firms (or individuals) to enter into and compete in a market. that limits competition and increases market power, just as it would with gas stations.

Doctors differ from gas station owners in many other ways. Typically, we suppose that gas stations and other firms in an economy have profit maximization as a goal. It is this presumption that allows us to develop our theory of supply. Doctors not only think about profits but also take an oath of office, called the Hippocratic Oath, which is as follows:

This oath is administered to nearly everyone obtaining a medical degree.

Other Health-Care Workers

In addition to doctors and specialists, there are many other kinds of workers in the health care industry, including nurses, dental hygienists, administrative staff, technicians, staff in care facilities such as hospices and nursing homes, and many others. The health-care industry employs almost 10 percent of all civilian workers in the United States.

Table 16.1 "Employment in Health Services (in Millions)" shows the breakdown of employment by health-service site for three years: 2000, 2003, and 2006. We list some (not all) of the types of health sites. From the table, we see that the number of workers in this industry has increased from 12.2 million in 2000 to about 14.4 million in 2006. This increase is typical of many service industries and contrasts with manufacturing, where the number of workers employed is declining.

Hospitals are the most important type of employment site for health-care workers. In 2006, 40 percent of health-care workers were employed in hospitals. About three-fourths of the workers in the health-care sector are women. Women are particularly prevalent in nursing care facilities: of the 1.6 million workers in nursing care facilities in 2000, about 1.4 million were women.

There is a wide variety of occupations within health care: managers, professionals (doctors, dentists, pharmacists, etc.), service occupations (assistants, cooks, cleaners, etc.), and office workers. Professional groups account for about 44 percent of all workers, while about 32 percent of the jobs are in service occupations. There will typically be considerable variation of wages within a sector because of the different occupations of workers in that sector. For example, individuals working in diagnostic laboratories earn, on average, close to twice the wage of workers in nursing homes.

Health-Care Capital

When we look at an industry such as health care, one way of describing it is by counting the number of doctors’ offices, clinics, and so on. There are many different kinds of establishments that provide health services. Hospitals are only one example; others include doctors’ offices, clinics, nursing homes, and so on. According to the Bureau of Labor Statistics (http://www.bls.gov/oco/cg/cgs035.htm), in 2008, there were 595,800 establishments in the health-care sector in the United States. Of these, doctors’ offices are 36 percent. Hospitals are only 1 percent.US Department of Labor, Bureau of Labor Statistics, “Career Guide to Industries, 2010–11 Edition: Healthcare,” accessed March 14, 2011, http://www.bls.gov/oco/cg/cgs035.htm. Another way to describe the industry is by detailing the number of workers employed in different activities, as in Table 16.1 "Employment in Health Services (in Millions)".

Taken together, these statistics paint an interesting picture. Hospitals are a small fraction of the total health-care establishments but employ 35 percent of the workers. This tells us that there are relatively few hospitals (compared to doctors’ offices), but they are big. About 70 percent of hospitals employ more than 1,000 workers. Such a pattern is not peculiar to the health-care sector. In US manufacturing, the majority of establishments are small, and a few large establishments employ the majority of workers.This is described in Steven J. Davis, John C. Haltiwanger, and Scott Schuh, Job Creation and Destruction (Boston, MA: MIT Press, 1998). We discuss this phenomenon in more detail in Chapter 9 "Growing Jobs".

The ownership of hospitals is also complicated. Some are private, while others are public, meaning that federal, state, or even county governments run them. In addition, not all private hospitals are in business for profit; some are classified as not-for-profit institutions. Table 16.2 "Hospital Activity, 2005" provides a breakdown of hospitals by type. From this table, you can see that most admissions are in not-for-profit hospitals that are not federally run. Their goal is largely to provide a public service. These hospitals have a length of patient stay averaging about 5.5 days.

There are other capital goods that enter the production function for the health sector. For example, pharmaceutical production facilities are part of this capital stock. So too is the capital stock of companies that produce the machines, such as MRIs, used in doctors’ offices and hospitals.

Technological Progress

Technological advances in health care are truly staggering. Technological progress in this sector, as in other sectors, comprises both product and process innovations. By product innovations, we mean increases in the types of goods and services available to households and doctors. A leading example is the vast array of drugs now available on the market, which is the outgrowth both of research and development at pharmaceutical companies and of publically funded research. Another example is the advanced machinery used in modern health-care facilities. A modern dentist’s office is filled with high-speed drills, x-ray machines, and other pieces of technology that would have been unthinkable in your grandparents’ day. MRI machines are another example: these are a significant advance over previous imaging techniques such as X-rays, but they are expensive—a new MRI machine will typically cost a hospital more than $1 million.An article describes this technique at NOVA, “The Picture Becomes Clear for Magnetic Resonance Imaging,” accessed March 15, 2011, http://www.science.org.au/nova/062/062key.htm.

Process innovations refer to how techniques are implemented. For example, surgeons today can perform operations that surgeons of previous generations could not even imagine. The knowledge for these procedures was created by a few people and then taught to others in medical school and other training programs.

Process and product innovations come together when you compare how certain procedures are performed now relative to years ago. Consider surgery to repair a hernia. The first hernia (hiatal) surgery took place around 1919, and the procedure was risky and painful. Even relatively recently, a procedure like this involved hospital stays, many days lost from work, and a significant risk of medical complications.For the history of hiatal hernia surgery, see Nicholas Stylopoulos and David W. Rattner, “The History of Hiatal Hernia Surgery: From Bowditch to Laparoscopy,” Annals of Surgery 241, no. 1 (2005): 185–193, accessed March 14, 2011, http://www.pubmedcentral.nih.gov/articlerender.fcgi?artid=1356862. Today, the leading method for surgery uses a piece of capital called a laparoscope—a tube with light that allows a surgeon to see inside a patient’s abdominal cavity. Then, using another instrument, again inserted through a small incision, the surgeon can repair the hernia. Remarkably, this is an outpatient procedure. The patient emerges from the hospital with a few small wounds and can return to work and normal life within a few days.