DHA 721 Week 1 Economics Applied to Health Care Example

Why a Hospital Is Not a Furniture Plant: Applying Economic Thinking to Health Care in a Rural North Carolina Region

[Student Name]

University of Phoenix

DHA/721: Health Care Economics

Week 1 Assignment

[Instructor Name]

[Date]

The rural hospitals, the trustee, the furniture company, service decisions and dollar figures are composites written for a model paper; research findings come from the sources cited.

At the end of a long board meeting in which the region's smallest hospital voted to keep its obstetrics unit open despite losing about $1.3 million a year, a trustee who owns a furniture plant asked the regional vice president a question. In his business, he said, a product line that loses money is closed, prices are posted and customers shop. Why can't the hospital work the same way? This paper uses economic concepts to answer him.

Scarcity

Economics begins with scarcity: resources are limited and wants are not. The four rural hospitals have a fixed capital budget of about $14 million this year, a shortage of nurses and physicians and limited space. Every choice to spend on one service means not spending on another.

Opportunity Cost

What a choice really costs is whatever else the same resources could have done at their next best use. Keeping obstetrics open costs not only its $1.3 million loss but also what that money and those nurses could otherwise do, such as expanding behavioral health or hiring two primary care physicians. Economists call this opportunity cost, and it is the most useful idea the trustee could bring to the board.

Supply and Demand

In ordinary markets, demand describes how much buyers want at each price and supply how much sellers offer. Prices adjust until the two meet. A furniture plant that raises prices sells fewer chairs; one that cuts costs can lower prices and win customers. The question is how far this logic carries into health care.

Why Health Care Is Different: Uncertainty

The classic answer came from Kenneth Arrow, who argued that medical care differs from other goods in ways that explain its unusual institutions. People cannot know when they will fall ill or how badly, so their need for care comes in sudden, uneven bursts, and the product itself carries uncertainty, since neither patient nor physician can be sure of the outcome of treatment (Arrow, 2001).

Why Health Care Is Different: Information

Arrow also stressed the gap in knowledge between physicians and patients. The patient cannot judge the quality of the advice received as easily as a buyer judges a chair, so medical care relies on trust, professional ethics and licensing to protect patients (Arrow, 2001). A woman in labor cannot shop for the best-priced delivery, and she should not have to.

Why Health Care Is Different: Insurance

Because illness is unpredictable and expensive, people buy insurance. Insurance separates the person who uses care from the one who pays for it, which dulls the price signals that shape ordinary markets. Most patients in the region pay a small share of the price at the point of service, so posted prices change their choices only modestly.

Why Health Care Is Different: Barriers to Entry

Licensing, certificate-of-need rules and the high cost of hospitals limit who can supply care. In a rural county, there may be only one hospital within forty miles. Without competitors, the usual pressure that drives prices down and quality up is weak.

The Role of Government

Government is also a major buyer. Medicare and Medicaid pay for most of the region's inpatient care, at prices set by rules rather than negotiation. The region's hospitals cannot raise these prices, and commercial insurers cover a smaller share of patients than in urban areas.

What the Differences Mean for Obstetrics

These features explain the obstetrics vote. Births arrive regardless of price, many are paid by Medicaid at rates below cost, and closing the unit would force women to travel an hour or more for delivery. A furniture plant can drop a product line; a rural hospital that drops obstetrics changes where babies are born and how safe those births are.

The Spending Puzzle

The trustee also asked why health care costs so much. International comparisons help. Papanicolas and colleagues set the United States beside ten wealthy peers and found that in 2016 the US devoted 17.8% of gross domestic product to health care, while the peers ranged from Australia's 9.6% to Switzerland's 12.4%; yet American use of most services, including hospital discharges for common conditions, was broadly similar (Papanicolas et al., 2018).

Prices, Not Quantities

Since the volume of care looks ordinary, the gap must come from what each service costs. That was the argument of Anderson and colleagues, who examined data from thirty wealthy nations in 2000 and found the United States below the median on most measures of how much care people received, yet far above every other country in spending; the difference, they concluded, came mostly from what Americans paid for each drug, test, visit and hospital day (Anderson et al., 2003). Papanicolas and colleagues likewise pointed to prices for labor, drugs and administration (Papanicolas et al., 2018).

What This Means for the Region

For the rural hospitals, the price argument is complicated. Their prices from public payers are fixed, and their commercial prices are lower than the academic center's. Their challenge is less about high prices than about high average costs spread over small volumes. A rural emergency department must staff a physician and nurses around the clock whether it sees eight patients overnight or twenty, so the cost of each visit rises as volume falls. The academic center spreads similar fixed costs over far more patients. This is why the same Medicare payment can cover costs in a city and fall short in a small town.

Efficiency

Economists distinguish technical efficiency, producing a service at the lowest cost, from allocative efficiency, producing the mix of services that creates the most value. The region can improve technical efficiency by sharing purchasing and staff. Allocative efficiency asks the harder question the trustee raised: which services should four small hospitals provide at all?

Equity

Markets allocate goods by willingness and ability to pay. Most societies reject that rule for essential health care, choosing instead to provide care based on need. In the region, many families earn modest incomes, a large share of residents rely on public coverage and some have none, so care rationed by price would fall hardest on the people with the greatest need. The board's vote on obstetrics reflected a judgment about equity as well as efficiency.

Questions for the Course

The course will pursue several questions raised here: how supply and demand work in rural health care, how insurance changes behavior, how to decide at the margin, how to judge value for money and what role government should play.

Answering the Trustee

The hospital cannot work exactly like a furniture plant because patients cannot predict their needs, insurance and government set most prices, clinicians know more than patients and few competitors exist. But his instincts are useful. Opportunity cost, efficiency and attention to prices apply fully, and the board should use them.

Conclusion

Economics offers the region a disciplined way to think about scarce resources. Scarcity and opportunity cost apply to every service decision. Arrow's analysis explains why uncertainty, information gaps and insurance make health care different. International evidence shows high US spending driven mainly by prices, and the rural region's own challenge lies in small volumes and fixed public prices.

References

Anderson, G. F., Reinhardt, U. E., Hussey, P. S., & Petrosyan, V. (2003). It's the prices, stupid: Why the United States is so different from other countries. Health Affairs, 22(3), 89-105. https://doi.org/10.1377/hlthaff.22.3.89

Arrow, K. J. (2001). Uncertainty and the welfare economics of medical care. Journal of Health Politics, Policy and Law, 26(5), 851-883. https://doi.org/10.1215/03616878-26-5-851

Papanicolas, I., Woskie, L. R., & Jha, A. K. (2018). Health care spending in the United States and other high-income countries. JAMA, 319(10), 1024-1039. https://doi.org/10.1001/jama.2018.1150