Health Care in the United States: Why Is Supply So Price Insensitive?

By Das, Monica; Das, Sandwip K. | Contemporary Economic Policy, October 2009 | Go to article overview

Health Care in the United States: Why Is Supply So Price Insensitive?


Das, Monica, Das, Sandwip K., Contemporary Economic Policy


I. INTRODUCTION

A. Health-Care Industry in the United States: A Puzzle

Health-care expenditure in the United States is the highest among 30 high-income countries, both as a percentage of gross domestic product (GDP) and in per capita terms. (1) Also, the relative price of health care is sharply rising. Then, why is the supply of health care in the United States so unresponsive to the price incentive? There is evidence to suggest that high healthcare costs have an adverse impact on labor productivity, which inadvertently affects production in all industries. Is this not a case of negative externality in production in all sectors of the economy, which causes market failure? Finally, can the rising cost of health-care services affect the U.S. pattern of trade via its impact on labor productivity?

The main objective of this paper is to provide an analytical framework to explain the observed price insensitivity of the health-care supply. We begin our analysis by describing a puzzling feature of the health-care sector of the United States. Several sources in the literature indicate that the price of health-care services is rising. We present data in Figure 1 to illustrate this point. A great deal of research explains this tremendous rise in health costs. Baumol (1967) links rising health costs with rising labor intensity in the health industry. Hall and Jones (2007) attribute the rise to the discovery of new drugs capable of improving life expectancy. As income grows, saturation in nonhealth consumption drives consumers into spending a greater proportion of their incomes on health care, to purchase additional years of life. Murdock (1995) estimates that the demand for health-care professionals will increase by more than 50% from 1990 to 2050. (2) While demand expansion can be expected to push up the price of health care, one would also expect to witness a greater supply of health care caused by the price incentive. Herein lies the puzzle that the growth of health-care supply has been rather sluggish in United States during the last two decades, as mentioned by many authors such as Glied (1997), Kovner and Jonas (2002), and Murdock (1995). To illustrate this point, we also present some data in Figure 2 and Table 1. Therefore, the purpose of our paper was to formulate a theoretical model to explain this puzzle and suggest that rising health-care costs have resulted in loss of labor productivity, which is a negative externality for all industries. The related issue of market failure can be addressed in two alternative ways: (a) government intervention to control the rising cost of medical care or (b) a system that allows the firms to internalize the external diseconomy, namely, the loss of labor productivity due to higher health-care costs. (3)

[FIGURE 1 OMITTED]

[FIGURE 2 OMITTED]

TABLE 1
Reduced Access to Medical Care

Year    Did not get care    Delayed care    Did not get prescription
          due to cost        due to cost       drugs due to cost

1997          4.5                7.3                   4.7
2003          5.2                7.1                   6.2
2004          5.5                7.7                   7.1

Notes. Values are given as percentage of population, age adjusted.
Source: U.S. Department of Health and Human Services (2006), Table 78.

The existing literature does explain why the price of health care in the United States is rising and why more and more people are being placed out of the insurance network. However, the literature does not provide an adequate explanation of why the supply of health care is not responding to price incentives. A right-ward shift of the demand curve of health care, as suggested by Hall and Jones (2007), does explain the rising price of health care but it does not explain why supply growth is so sluggish, unless the health-care supply curve is extremely price inelastic. (4) Glied (1997) provides an explanation in terms of a market distortion caused by physicians who restrict the supply of new entrants through state-established licensing boards.

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