ECON 100/FALL 2005 REINHARDTTHE CONCEPTS OF “EFFICIENCY” AND “ECONOMIC WELFARE”IN THE CONTEXT OF HEALTH CAREWith these preliminaries, let us now turn to the set of questions that comprise this homework assignment. Please detach the QUESTION part of this write up starting on the next page, enter your and your preceptors name at the top of the page and answer all questions in the space provided in the body of the text. Please write neatly. You may want to clip in additional pages or graphs. For convenience, we reproduce the graph below once again at the end, so that you may detach it and print it out several times for use in part of your answers.ECON 100/FALL 2005 REINHARDT HOMEWORK ASSIGNMENT NO. 4 THE CONCEPTS OF “EFFICIENCY” AND “ECONOMIC WELFARE” IN THE CONTEXT OF HEALTH CARE PREAMBLE In this homework assignment, you are invited to think whether the individual consumers’ demand curve for health care and the horizontal summation of such curves into the market demand for health care ought to be viewed as reliable guides to the social value of health care. You will do this with the help of a somewhat stylized model, designed to bring out the issues clearly, but based on current health policy in the real world. To describe that world to you, we begin with a somewhat lengthy description of the policy issues at hand. Thereafter we present the model and the questions based thereon. So, bear with us on the length of the assignment. THE POLICY CONTEXT Although, unlike all other industrialized nations, the United States does not have a universal health insurance system providing coverage to every resident and, in fact, leaves some 45 million mainly low-income Americans without health insurance at any one time, the country does have two large, government-run health insurance programs: (1) the federal Medicare program for Americans aged 65 or older and (2) the federal-state Medicaid program, mainly for children and their mothers in very low-income families, the blind, the disabled and pauperized elderly Americans who are also entitled to Medicare (which does not cover many services needed by the elderly). Jointly, these two government programs account for about 40% of the $1.8 trillion or so the nation now spends on health care. We note in passing that this large overall level of national health spending is, in fact, unrivaled in the world, as is clear from the following two graphs, based on comparable data assembled by the Organization for Economic Cooperation and Economic Development (OECD). 7.77.98.48.49.89.39.29.910.111.111.5150 2 4 6 8 10 12 14 16United KingdomJapan ItalyOECD medianNetherlandsAustralia SwedenCanadaFranceGermanySwitzerlandUnited States% OF GDP SPENT ON HEALTH CAREHEALTH SPENDING AS % OF GDP SELECTED OECD COUNTRIES, 2003(IN PURCHASING POWER PARITY INTERNATIONAL DOLLARS)SOURCE: OECD DATA 2004 16% IN 20052$1,835$2,139$2,231$2,258$2,280$2,594$2,699$2,976$2,903$3,003$3,781$5,635$0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000SpainJapanUnited KingdomItalyOECD MedianSwedenAustraliaNetherlandsFranceCanadaSwitzerlandUnited StatesHEALTH SPENDING PER CAPITA, SELECTED OECD COUNTRIES, 2003(IN PURCHASING POWER PARITY U.S. $)SOURCE: OECD DATA 2004= 67% of U.S. level= 53% of U.S. level In an editorial entitled "Gammon's Law Points to Health-Care Solution" that was published by the prestigious The Wall Street Journal (November 12, 1991), Nobel Laureate economist Milton Friedman, formerly of the University of Chicago and now at the Hoover Institute of Stanford University, sharply attacked the government-run Medicare program for the elderly and the Medicaid program for the disabled and the poor. He concluded thus: The inefficiency, high cost and inequitable character of our medical system can be fundamentally remedied in only one way: by moving in the other direction, toward re-privatizing medical care. ... The reform has two major steps: (1) End both Medicare and Medicaid and replace them with a requirement that every U.S. family unit have a major medical insurance policy with a high deductible, say $ 20,000 a year or 30% of the unit's income during the prior two years, whichever is lower. (2) End the tax exemption of employer provided medical care. ... Each individual or family would, of course, be free to buy supplementary insurance, if it so desired (Emphasis added). The "deductible" in a health insurance policy is the annual amount the family must finance with its own resources before any insurance coverage begins. To put Friedman's policy recommendation into perspective, note that in 1990, at about the time Friedman formulated his recommendation, median pretax income in the United States was $29,943 for all households and $35,353 for "families," that is, for households with two or more members. If we assume that Friedman meant to base the recommended deductible not on the sum of the family's income during the past two years but only the average annual family income over the prior two years, then that deductible in 1990 would have been $ 10,500 per year for a family with median pretax income of $ 35,353. The outlays on health care of a relatively health family probably would not have reached that deductible. A family stricken with serious illness almost surely would have had to pay that much out of pocket before insurance coverage would set in. In addition, of course, each family would have to pay the premium for the catastrophic insurance policy. Professor Friedman injected his editorial into the presidential election campaign of 1991-92, during which health policy had moved to center stage. He acknowledged the contribution to his editorial by fellow Nobel Laureate economist Gary S. Becker of the University of Chicago and by economist Thomas Moore, Ph.D., formerly of President Reagan's Council of Economics Advisors and now at the Hoover Institution of Stanford University. In short, we may regard the editorial as a significant statement made by prominent American economists who sought to influence with their normative analysis both the election and the path of public health policy.3 Although Professor Friedman’s policy prescription did not gain traction in the early 1990s, it has done so in the meantime in what is now known as “Consumer Directed Health Care” (CDHC. In essence, CHDC is a construct that coupled health insurance with very high cost sharing. For example, a family might be required to pay