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Demand for Health Care
Comprehension Questions
Indicate whether the statement is true or false, and justify your answer. Be sure to cite evidence from the chapter and state any additional assumptions you may need.
- Unlike with most types of goods, deriving a demand curve for health care is quite simple because people rarely skimp on health care.
FALSE. Just as with any good, deriving a demand curve for health care is dif- ficult because it requires information about how the same population would react to different prices. This requires either parallel universes or, more real- istically, a randomized experiment.
- The RAND study was especially useful for measuring price elasticities be- cause it randomly assigned insurance plans to participants (as opposed to letting them choose).
TRUE. Randomization ensured that the groups facing different prices were statistically equivalent. That meant that any difference in demand between groups was attributable to price, not some other characteristic.
- The Oregon Medicaid Experiment is not truly “randomized” because lottery winners did not all end up with insurance, and some lottery losers did end up with insurance.
FALSE. Although the Oregon Medicaid Experiment was not exactly a con-
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trolled experiment, it did use randomization to assign participants to differ- ent groups, and one group (the “lottery winners”) were much more likely to obtain health insurance.
- The RAND HIE found that people assigned to the free health plan had the same rate of hospitalization as people assigned to the cost-sharing plans.
FALSE. The people assigned to the free plan visited the hospital more fre- quently and were more likely to visit the ER.
- In the RAND HIE, the arc elasticity of demand for inpatient care was larger (in absolute value) than the arc elasticity of demand for outpatient care.
FALSE. That result would imply that people are more price sensitive when it comes to more urgent health care. Instead, the arc elasticity of demand for impatient care was smaller in absolute value.
- Unlike the usual measure of elasticity, an arc elasticity can be calculated from just one price-quantity data point.
FALSE. Any measure of elasticity requires data from at least two price levels in order to measure responsiveness to price.
- Both the RAND and Oregon studies find that demand for health care is ap- proximately unit elastic, that is, ✏ ⇡ 1.
FALSE. The RAND HIE finds that demand for health care is very inelastic, with arc elasticities around 0.2.
- In the RAND HIE, being assigned more generous insurance did not gener- ally improve participants’ health outcomes, except among certain subgroups.
TRUE. The RAND HIE finds that generous insurance only provided small health improvements to healthy people. However, high-risk participants (like those who were smokers or had high blood pressure) did receive sub- stantial health benefits from more generous insurance.
- To date, no major health insurance experiment has studied the impact of uninsurance, just different levels of insurance.
FALSE. The Oregon Medicaid Experiment studied the impact of uninsur- ance.
- Results from the Oregon Medicaid Experiment suggest that having health in- surance has a positive impact on health status.
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Demand for Health: The Grossman
Model
Comprehension Questions
Indicate whether the statement is true or false, and justify your answer. Be sure to cite evidence from the chapter and state any additional assumptions you may need. Review the basic assumptions of the Grossman model before answering these questions.
- In real life, investments in health can generate long-lasting benefits, but the Grossman Model neglects this aspect of health.
FALSE. One of the central features of the model is that health is (in part) an investment good. If someone invests in his health today, it will be higher both today and in the future.
- In the framework of the Grossman model, one’s level of health is completely controlled by her actions. Thus, in any given period, an individual is uncon- strained in her choice of health status.
FALSE. Individuals do have a lot of control over their health level, but there may be high levels of health that they cannot achieve given time and income constraints. If someone invests all her time and money in improving health, she may still not be as healthy as she would like.
- In the Grossman model, the marginal efficiency of investment in health care declines as health improves.
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TRUE. Someone who is very unhealthy receives major dividends from even a small improvement in health, but someone who is already very healthy receives little benefit.
- Aging shifts the marginal efficiency of investment in health curve inward.
FALSE. As aging occurs, the depreciation rate of health increases. This re- sults in a movement along the marginal efficiency of investment curve up- ward, which implies worse optimal health.
- An hour spent exercising always pays for itself by decreasing the time spent sick by more than an hour.
FALSE. This is only true in the “free lunch zone.” Once a certain level of health is attained, an hour spent exercising generates less than an hour of additional productive time.
- Assume the PPF is as pictured in Figure 3.3. People might choose point E as their optimum even if they value the home good Z.
FALSE. The only way someone might choose point E is if his indifference curves are vertical. But a vertical indifference curve means he does not value the home good, Z at all.
- In the Grossman model, optimal health status declines with age.
TRUE. See Figure 3.13 for an explanation.
- The fact that older people spend more on health care is evidence against the Grossman model, which predicts that spending will decline as increases.
FALSE. The Grossman model predicts that health optimally declines with age; it does not predict that health expenditures decline with age. The effect of aging on health expenditures is ambiguous in the Grossman model. As you age, you need to spend more money and time on health to maintain a fixed level because of the increasing depreciation rate of health capital.
- People who drop out of high school are able to produce more health than college graduates because they have more free time to invest in health pro- duction.
FALSE. In the Grossman model, more education shifts out the marginal effi- ciency of investment curve. This means that better educated people have a
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Socioeconomic Disparities in Health
Comprehension Questions
Indicate whether the statement is true or false, and justify your answer. Be sure to cite evidence from the chapter and state any additional assumptions you may need.
- In the United States, well-educated males can expect to live longer than poorly-educated males.
TRUE. This is a classic example of a socioeconomic health disparity.
- Unlike in the U.S., there are no socioeconomic status gradients in health in countries that provide universal health care coverage to all citizens. That is, in such countries, poorer and richer citizens have (on average) the same health.
FALSE. Canada and the United Kingdom both provide universal health care, but dispari- ties are still found there. This chapter covered evidence of disparities between rich and poor children in Canada, and between high and low-grade civil servants in the United Kingdom.
- Health status earlier in life is a good predictor of wealth later in life.
TRUE. Smith (1999) found evidence of this from surveys in the United States that tracked people over a long time period.
- According to Smith (1999), nearly all of the differences in health outcomes between rich and poor in America can be attributed to differences in access to medical care.
FALSE. Smith cites evidence that health shocks can actually affect income. In those case, the rich are rich due to their better health.
- The thrifty phenotype hypothesis states that early life events after birth have a strong influ- ence on health status even in adulthood.
TRUE. This hypothesis, sometimes also called the Barker Hypothesis, is supported by evi-
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dence from the Dutch Famine study and other studies of early childhood deprivation. It also emphasizes the importance of events that happen before birth.
- People who have a newly-diagnosed chronic disease, such as diabetes, often suffer large de- clines in their wealth over time. This decline in wealth is entirely explained by decreased hours of work.
FALSE. These people do suffer large wealth declines, but only a fraction of these losses are attributable to decreased income.
- In the Whitehall study, access to health care was a key variable determining the relative health outcomes of high and low grade British civil servants.
FALSE. Because all British citizens have access to health care through the National Health Service, variation in access to care can not explain the disparity in health outcomes between high- and low-grade civil servants.
- One leading theory about why the poor are in worse health than the rich is that the rich enjoy a greater allostatic load.
FALSE. Allostatic load is the psychological toll or stress of dealing with life’s experiences. The allostatic load theory argues that less wealthy people are in worse health because of the greater stresses they face in life. The Whitehall studies present evidence for this hypothesis.
- In a study of babies born during the Dutch famine toward the end of World War II, those ex- posed to the famine in utero were more likely than those not as exposed to be obese as adults.
TRUE. This is considered evidence for the thrifty phenotype hypothesis, which states that individuals facing starvation conditions in utero and shortly after birth adapt by program- ming their bodies to store more fat.
- In Canada, unlike in the U.S., the gap between rich children and poor children in health sta- tus does not widen as children age.
FALSE. Currie (2003) showed that the gap does widen in Canada after age 10.
- There is a consensus among health economists that socioeconomic status has a major impact on health, but health does not have a significant effect on SES.
FALSE. There is a consensus that the relationship is bidirectional: wealth affects health and health affects wealth.
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- Compared with doctors who are paid on a fee-for-service basis by health insurers, doctors who are paid on a capitated (per patient) basis have incentives to provide too much care.
FALSE. The opposite is true: doctors who are paid a fee for each service have incentive to convince their patients to demand a lot of services.
- In part, physicians’ salaries are higher than secretaries’ salaries because it takes more years to train to become a physician than it does to become a secretary.
TRUE. The training process to become a doctor is much more expensive (in terms of both time and money), so salaries for doctors must be higher to compensate physicians for the time and money they spend on training.
- The fact that practicing surgeons who have finished residency earn more than practicing pe- diatricians implies that the rate of return to choosing surgery exceeds the rate of return to choosing pediatrics for a medical school graduate.
FALSE. Surgeons have to spend more years in residency and typically work longer hours. These factors may be enough to justify their higher salaries. In fact, the rate of return to choosing pediatrics may be higher if becoming a pediatrician is significantly easier.
- Once length of residency and hours of work are taken into account, the internal rate of re- turn of choosing a specialized branch of medicine over a more generalized branch is roughly equal to the real rate of interest in the economy.
FALSE. The rate of return to choosing certain specialties has been measured at over 20% (Nicholson 2002).
- If physicians are earning monopoly rents, then there must be more barriers to entry in the labor market for physicians than is socially optimal.
FALSE. Monopoly rents do imply that there are barriers to entry in this labor market, but they may be justified if the barriers ensure higher physician quality and patients value that assurance highly.
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The Hospital Industry
Comprehension Questions
Indicate whether the statement is true or false, and justify your answer. Be sure to cite evidence from the chapter and state any additional assumptions you may need.
- American hospital admission rates have dropped in the past two decades.
TRUE. Per capita hospitalization rates in the U.S. have dropped sharply be- tween 1990 and 2010. In 1990, there were about 13,800 hospitalizations per 100,000 people in the U.S., while in 2010 there were about 12,549. This decline happened despite an increase in the average age of the American population.
- There were more hospitals in the U.S. in the late 1990s than there were in 1940; the largest source of growth has been among for-profit hospitals.
TRUE. Part of this growth was spurred by the Hill-Burton Act of 1946.
- The average length of hospital stays in the U.S. has remained flat after a sharp decline in the 1980s.
FALSE. The average length of hospital stays in the U.S. has been falling as a result of the shift toward outpatient care due to both technological advances and financial incentives.
- Higher values of the Herfindahl-Hirschman index indicate higher levels of competition in those markets.
Chapter 6 | The Hospital Industry | 3
- Doctors are typically direct employees of hospitals in the U.S., whereas in the U.K., they do most of their work in private practice settings.
FALSE. In the U.K., doctors are typically direct employees of the National Health Service. U.S. doctors typically run private practices while maintain- ing a working relationship with hospitals, although in recent years, there have been increasing number of hospitalists who work as direct employees of hospitals.
- In a DRG payment system, hospitals receive payment according to the num- ber of services rendered.
FALSE. DRG payment systems compensate hospitals based on the patient di- agnoses. For example, a Medicare patient entering the hospital with kidney failure earns the hospital the same amount regardless of the actual services rendered (under some regulation by Medicare). A payment system based on number of services rendered is known as a fee-for-service model.
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Demand for Insurance
Comprehension Questions
Indicate whether the statement is true or false, and justify your answer. Be sure to state any additional assumptions you may need.
- In the model of insurance and uncertainty discussed in the chapter, an indi- vidual exhibits declining marginal utility of income if and only if she is risk averse.
TRUE. Under this simple model, the shape of the income-utility curve de- termines one’s taste for risk. If the individual exhibits declining marginal utility of income, her income-utility curve will be concave and she will be risk averse.
- A consumer with declining marginal utility of income will never prefer actu- arially fair partial insurance to actuarially unfair full insurance.
FALSE. Even someone risk averse might forgo full insurance if it is too ex- pensive.
- Risk-averse consumers always prefer insurance that is actuarially fair but not full to full insurance that is actuarially unfair - but the opposite is true for risk-loving consumers.
FALSE. Consider uninsurance, which is technically actuarially fair but defi- nitely not full. Sometimes, risk-averse consumers will prefer full insurance to uninsurance, even if it is actuarially unfair.
Adverse Selection: Akerlof’s Market
for Lemons
Review the basic assumptions of the Akerlof model before answering these ques- tions. Many exercises will refer to these basic assumptions.
Comprehension Questions
Indicate whether the statement is true or false, and justify your answer. Be sure to state any additional assumptions you may need.
- In the Akerlof model, suppose that the price of used cars is P and the quality of used cars (X) held by sellers varies between 0 and 100. Suppose further that sellers’ utility is given by
U (^) S = M + a
n  i
Xi
where M is the number of units of video games, which sell at $1 per game, and a is a utility function parameter that is strictly less than one (a < 1). Then sellers will offer cars with quality Xi = P on the market.
TRUE. If a < 1, then sellers get more utility from P dollars than from a car with quality P. Therefore, they will offer cars of quality P for sale.
- In the model, buyers know the utility function of sellers, but do not know anything about the general quality of cars for sale.
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FALSE. Buyers do not know anything about the quality of a particular car, but they know how the quality distribution of all cars.
- If buyers care sufficiently more about cars than do sellers, then there are prices at which transactions can occur. In that scenario, there is no longer any adverse selection (although there still may be some information asym- metry).
FALSE. There are prices at which transactions can occur under these con- ditions, but there is still adverse selection because worse cars are offered for sale and better cars are not.
- The Akerlof model indicates that government intervention is the only way to solve the adverse selection problem.
FALSE. Adverse selection will occur as long as an information asymmetry persists. If a government or other organization – like a consumer watchdog group or even a private company – dismantles the information asymmetry, adverse selection will cease.
- If the quality of cars is normally distributed rather than uniformly distributed, the market will not unravel.
FALSE. The market may still unravel under these conditions.
- Ultimately, the market unravels because buyers are risk averse. If buyers were risk neutral, there would always be prices at which cars would sell.
FALSE. We are already assuming that buyers are risk neutral. It is true that the market would be more likely to unravel with risk-averse buyers, because uncertainty about car quality is more likely to dissuade them from buying cars.
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a lower per-unit price for it.
FALSE. There is actually a bulk markup for large amounts of insurance. In- tuitively, this reflects the fact that insurers are suspicious of people who want a lot of insurance. The companies assume they are frail, and charge them a higher per-unit premium.
- In a Rothschild-Stiglitz model separating equilibrium, low-risk consumers of insurance are quantity constrained. They cannot buy as much insurance as they want because the insurance company is worried it will lose money on them.
TRUE. Robust individuals would like to have full, fair insurance but the sep- arating equilibrium offers them two less attractive choices: full insurance that is actuarially unfair or fair insurance that is partial.
- Under certain circumstances in the R-S model, a separating equilibrium can- not exist.
TRUE. If there are enough robust people in the population, a pooled con- tract can be offered that will break the separating equilibrium.
- In the Rothschild-Stiglitz model, an individual who is offered a choice be- tween full insurance and no insurance will always choose full insurance if they are risk averse.
FALSE. An individual will choose to be uninsured if the full insurance con- tract lies below their indifference curve going through their endowment point.
- A pooling equilibrium can exist if the contract being offered lies on the same indifference curve as the endowment point of the robust population.
FALSE. There exists a contract that can be offered that will attract the ro- bust population away from the ”pooled” equilibrium. In essence, a pooling equilibrium will never exist unless mandated.
- Under the typical assumptions of the RS model, there is nothing that an insurance company can to do to distinguish between robust and frail cus- tomers.
FALSE. If firms offer generous insurance that lies below a robust individual’s indifference curve through their endowment point, firms can indirectly dis- tinguish between robust and frail customers because robust customers will not choose the generous insurance.
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Chapter 9 | Adverse Selection: The Rothschild-Stiglitz Model | 3
- Private markets are powerless to combat adverse selection, so the only solu- tion is a government-mandated insurance contract.
FALSE. If health differences emerge only later in life, there are ways to design private insurance contracts that would eliminate adverse selection.
- The main advantage of a Cochrane insurance contract over a guaranteed re- newable contract is that it does not rely on a legally unenforceable binding lifetime commitment.
FALSE. The main advantage of a Cochrane contract is that it is renegotiated each year, which allows competition between multiple insurance companies. Neither type of contract requires a binding lifetime commitment.
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