Healthcare / Uncategorized

Using the Principles of Economics to “Fix” Health Care

The phrase “at the margin” refers to the next decision made. Thus, marginal cost is the cost of the next good or service. So the marginal cost of apples is the cost of the next apple purchased. One of the fundamental principles of economics is that rational people think on the margin. That means that rational individuals make decisions based on the costs and benefits of the next decision.

A central stumbling block of the current health care “trilemma” (a word I made up to explain the three (or more) player game of health care) is the fact that patients do not accurately feel the marginal costs of medical care. Patients don’t accurately feel the costs of medical care because insurers generally bear that burden. Patients pay monthly premiums to insurers and deductibles when they need care, with the insurer covering any expenses above the deductible. After the deductible is paid, the patient has incentive to use as much care as possible – because they don’t lose anything from receiving it and the physician has incentive to give as much care as possible – because they receive more money for giving more care.

Imagine if a similar situation existed in the car market. You would go to the car lot, and find the nicest car possible. You don’t care what it costs – all you will be paying is your deductible so you might as well milk your insurer for the nicest possible car. The car salesman knows this, so he directs you to the most expensive car so he can maximize his profits. Eventually, too many cars are sold and they are all too nice and too expensive. What happened? The purchasing power was taken out of the hands of the entity that bears the marginal cost. Just like what is happening in health care.

Policy makers need to find a way to let patients feel the true marginal costs of health care. One approach is the co-pay method which forces patients to pay a percentage of the costs of all care they receive, attempting to help them feel the marginal costs. But patients who pay co-pays still do not feel the entire marginal cost, and most co-pay systems are inconsistent. Another approach is moving toward flexible/health savings accounts, which allow patients to save money while they’re healthy to pay for care when they get sick.

A more creative system might be based around individual accountability to peers. Say an employer decides to offer insurance to his employees. He determines to allow the individuals to decide when they need care and how much care to get. He sets a minimum percentage of each paycheck that he will deposit into the company’s insurance fund. Then, he displays the amount in the company’s insurance fund each day to the entire company. Then when people need medical care, they withdraw from the fund. Each worker does not only feel the marginal cost of the care, but the shame from withdrawing adds to that cost. It is easy to imagine situations in which the plan fails to cover the instances where people most need it, but it is an approach based on marginal cost. The Author has mixed feelings about such a plan.

Whichever route is chosen, marginal cost is a key concept for reforming our health care system.

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