Tuesday, June 1, 2010

Substitution Effect And Monopoly Pricing In Health Care

The comment I posted on "Where Are the Health Care Entrepreneurs?" by Andrew Samwick on capitalgainsandgames blog.
As you are aware, when goods are expensive, consumers switch to lower cost providers and also to substitute goods. From a researcher point of view, health care is only medical care (doctors, nurses, hospitals, etc) and pharmaceuticals.

From a consumer perspective, health care includes alternative medicine, such as vitamins, supplements, acupuncture, massages, etc. Plus, it includes lifestyle changes, such as eating less red meat, smoking less, exercising, drinking a glass of red wine, etc.

Additionally, health is affected by environmental and safety factors. The water and air are much cleaner and cause fewer ill health effects than decades ago. Likewise, the automobile, which is the primary cause of accidental deaths, is also much safer and auto deaths have declined.

Go to any major store that sells plastic bottles and you will see them advertise BPA free bottles, because of consumer concern about the health affects of BPA.

Tremendous innovation, entrepreneurship and efficiencies occur in health care, when the boundary of health care is broadened to match the views of the consumer.

Additionally, paying more is not necessarily better. Does a $15,000 Rolex watch tell time better than a $50 Seiko?

Doctors are a monopoly created by government licensing restrictions, and foreign-trained doctor restrictions and AMA restrictions on number of medical schools and number of graduating doctors. The number of graduating doctors has remained unchanged for decades despite population growth, while the number of applicants to medical schools has increased.

In monopolies, of course there are inefficiencies, high prices, lack of innovation and poor quality (poor health outcomes). Aren't insurance companies just capturing some of the economic rent that goes to doctors' monopoly pricing power? Aren't medical care consumers behaving similarly to other monopoly product consumers?

As the number of primary care doctors has declined as a percentage of the population, has it become somewhat like a luxury goods. Is there a status signaling effect as medical care costs increase? Is going to the doctor for a minor ailment a status signal, similar to owning a Lexus instead of a Camry?

Monopoly, luxury good effect, and failure to look at a broader consumer "health care" behavior can probably explain most of what we see happening in doctor provided medical care costs.

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