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									                          A Lecture Presentation
                              in PowerPoint
                                   to accompany
                           Exploring Economics
                                  Second Edition
                           by Robert L. Sexton
                                             Copyright © 2002 Thomson Learning, Inc.
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                                                     Printed in the United States of America
                                                                ISBN 0030342333

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                     Chapter 15
             Income Distribution, Poverty,
                  and Health Care




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                      15.1 Income Distribution
          n    The ultimate purpose of producing
               goods and services is to satisfy the
               material wants of people.
          n    But for whom does society produce
               consumer goods and services?
          n    Why are some people able to consume
               much more than others?



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      Income Distribution in The United States


                           Family Income                            Distribution
                         Under $15,000                                10.5%
                         $15,000–$24,999                              12.0
                         $25,000–$34,999                              11.9
                         $35,000–$49,999                              16.5
                         $50,000–$74,999                              21.2
                         $75,000–$99,999                              12.7
                         $100,000 and over                            15.2

                         SOURCE: U.S. Bureau of the Census, 2000.




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                      15.1 Income Distribution
          n    While there have been changes in the
               distribution of measured income, there
               remains substantial income inequality.
          n    Inequality might be overstated due to
               failure to consider differences in
                 n   age,
                 n   certain demographic factors,
                 n   institutional factors,
                 n   and government redistributive activities.


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                            Before-Tax Income Shares


            Lowest Second                      Third   Fourth Highest Highest
        Year Fifth  Fifth                      Fifth    Fifth  Fifth    5%
       1935             4.1%            9.2%   14.1%   20.9%   51.7%   26.5%
       1950             4.5            12.0    17.4    23.4    42.7    17.3
       1960             4.8            12.2    17.8    24.0    41.3    15.9
       1970             5.4            12.2    17.6    23.8    40.9    15.6
       1980             5.3            11.6    17.6    24.4    41.1    14.6
       1990             4.6            10.8    16.6    23.8    44.3    17.4
       1999             4.3             9.9    15.6    23.0    47.2    20.3
        SOURCE: U.S. Bureau of Census.




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                      15.1 Income Distribution
          n    At any moment in time, middle-age
               persons tend to have higher incomes
               than younger and older persons
               because
                 n   they are at an age when their productivity
                     is at a peak and
                 n   they are participating in the labor force to a
                     greater extent.



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                      15.1 Income Distribution
          n    Even if every individual earned exactly
               the same income over his or her
               lifetime, there would still be inequality at
               any given moment in time, so that
               inequality resulting from this overstates
               the true inequality in the lifetime
               earnings of people.
          n    The increased proportion of Americans
               that are either very young or very old
               has tended to increase the observed
               inequality in the distribution of income.
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                      15.1 Income Distribution
          n    Other demographic trends have also
               caused the measured distribution of
               income (measured in terms of
               household or family income) to appear
               more unequal.
                 n   increased number of divorced couples
                 n   rise of two-income families
                 n   DINKS (Double Income, No Kids)



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                      15.1 Income Distribution
          n    A family that decides to have two bread
               winners instead of one would move into
               a higher income quintile and create
               greater apparent income inequality.
          n    At the same time, divorces create two
               households instead of one, lowering
               income per household for divorced
               couples; thus, they move into lower
               income quintiles, also creating greater
               apparent income inequality.
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                      15.1 Income Distribution
          n    The impact of increased government
               activity should be considered in
               evaluating the measured income
               distribution.
          n    Government-imposed taxes burden
               different income groups differently.
          n    Also, many government programs
               benefit some groups of income
               recipients more than others.

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                      15.1 Income Distribution
          n    When taxes and in-kind income are
               included, many economists conclude
               that they have served to reduce levels
               of inequality significantly from the levels
               suggested by aggregate income
               statistics.




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                      15.1 Income Distribution
          n    The evidence suggests
                 n   inequality of money income in the United
                     States declined from 1935 to 1950,
                 n   then remained rather stable until 1980;
                 n   since then, the distribution of income has
                     become less equal.




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                      15.1 Income Distribution
          n    However, if we consider age
               distribution, institutional factors, and in-
               kind transfer programs, it is safe to say
               that the income distribution is
               considerably more equal than it
               appears.




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                      15.1 Income Distribution
          n    While the distribution of current income
               is an important piece of information, it is
               also critical to know how much
               movement goes on between different
               income levels.
                 n   The people that make up a given income
                     group are not always the same people
                     because there is substantial movement
                     between income groups.


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                      15.1 Income Distribution
          n    Reasons people make more income
                 n   age
                       n Wages generally increase up to the age of 50
                         and fall dramatically at retirement age.
                       n Younger people tend to make little income
                         when they begin their working careers.
                 n   skill
                 n   education
                 n   training
                 n   preferences toward risk and leisure.

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                      15.1 Income Distribution
          n    As productivity increases, workers can
               command higher wages.
          n    Some workers are just more productive
               than others, as a result of both innate
               skills and training and education.
          n    Some workers’ skills are just more in
               demand than others.
          n    Those that work longer hours or more
               intensely earn more.

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                      15.1 Income Distribution
          n    Those who prefer more amenities at
               work or more time for leisure earn less.
          n    Those who work in riskier or more
               unpleasant jobs earn more as
               compensation.
          n    Despite difficulties in measurement,
               international comparisons of income
               distribution have been made.


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                      15.1 Income Distribution
          n    Income inequality is greater in the
               United States and United Kingdom than
               in Sweden and Japan.
          n    However, many developed countries
               have more equal distributions of income
               than developing countries.




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     Global Income Inequalities as a Percent of
               Total Nation Income
                                      Lowest           Second                Third             Fourth         Highest
     Countries                         Fifth            Fifth                Fifth              Fifth          Fifth
  Japan                               10.6%             14.2%               17.6%               22.0%              35.7%
  Sweden                               9.6              14.5                18.1                23.2               34.5
  Germany                              8.2              13.2                17.5                22.7               38.5
  India                                8.1              11.6                15.0                19.3               46.1
  Canada                               7.5              12.9                17.2                23.0               39.3
  France                               7.2              12.6                17.2                22.8               40.2
  United Kingdom                       6.6              11.5                16.3                22.7               43.0
  China                                5.9              10.2                15.1                22.2               46.6
  United States                        5.2              10.5                15.6                22.4               46.4
  Russian Federation                   4.4               8.6                13.3                20.1               53.7
  Mexico                               3.6               7.2                11.8                19.2               58.2
  Chile                                3.5               6.6                10.9                18.1               61.0
  Brazil                               2.5               5.5                10.0                18.3               63.8
  SOURCE: World Bank, World Development Report 2000/2001.
  NOTE: The income inequality differences are approximations, because the data vary according to survey year and
  different methods are used for computing the distribution of income in different countries




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                      15.1 Income Distribution
          n    While income inequality within nations
               is often substantial, it is far less than
               income inequality among nations.
          n    A majority of income inequality reflects
               differences in living standards among
               countries rather than disparities within
               nations.



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    15.2 The Pros and Cons of Income
                Equality
          n    Because of the difficulty of measuring
               welfare, it is impossible to "prove" that a
               given income distribution is better than
               another.
          n    Political and social changes in the past
               century or two have generally worked to
               reduce income inequality.



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    15.2 The Pros and Cons of Income
                Equality
          n    The economic theory that supports
               income redistribution is derived from the
               principle of diminishing marginal utility:
                 n   where increases in income generate less
                     additional happiness (utility) at higher
                     levels of income.
          n    Taking from the rich and giving to the
               poor could increase society's total utility
               if the rich family loses less utility than
               the poor family gains from the
               redistribution.
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         Diminishing Marginal Utility of Income


                            Marginal Utility


                                                       Utility gain from
                                                       receiving $30,000



                                                                 Utility loss from
                                                                 losing $30,000


                                                                                     MU

                                               0   10 40          270 300
                                                       Income per Year
                                                    (thousands of dollars)
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    15.2 The Pros and Cons of Income
                Equality
          n    The theoretical argument favoring
               income redistribution is based on the
               assumption that people are alike in how
               they experience diminishing marginal
               utility from increasing income, a
               proposition impossible to prove.
          n    If you believe society should try to
               equalize happiness among its
               members, some income redistribution
               could arguably make sense.
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    15.2 The Pros and Cons of Income
                Equality
          n    The principal disagreement over income
               redistribution is not over whether we
               should have some redistribution, but
               rather over at what point we should stop
               in our redistributive efforts.
          n    Some believe we should go further than
               we have, while others think we have
               already gone too far in attempts to alter
               the distribution of income in favor of the
               poor and less affluent.
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    15.2 The Pros and Cons of Income
                Equality
          n    Arguments against a radical
               redistribution of income to eliminate
               virtually all inequality include the equity
               argument:
                 n   It is not “fair” to take most of the income of
                     hard-working, talented persons who earn
                     high incomes, particularly when some of it
                     is given to persons who perhaps are
                     shiftless and lazy.


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    15.2 The Pros and Cons of Income
                Equality
          n    Other arguments against redistribution:
                 n   Some income inequality would seem
                     desirable because consumption needs may
                     well vary with family size, age of family
                     members, and other factors.
                 n   Radical redistribution would reduce
                     economic growth and future real income.




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          Differences Marginal Utility of Income


                            Marginal Utility of Income




                                                                               Utility gain from
                                                                               gaining $30,000


                                                                                Utility loss from
                                                                                losing $30,000


                                                                             MUPOOR                 MURICH

                                                         0   Y´POOR Y´POOR      Y´POOR Y´POOR

                                                                      Income (Y´) per Year

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    15.2 The Pros and Cons of Income
                Equality
          n    At some level of taxation, substantial
               disincentive effects develop.
          n    At some higher tax rate, people will tend
               to produce, save, and invest less.
          n    To the extent that this is the case,
               nations may face a trade-off between
               more equality now and less growth over
               time.


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    15.2 The Pros and Cons of Income
                Equality
          n    It is possible that the poorest of the poor
               in a high-growth, high-inequality
               economy might be far better off in a few
               generations than the middle class would
               be in a low-growth, but low-inequality
               country.




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    15.2 The Pros and Cons of Income
                Equality
          n    Where income is very unequally
               distributed, a move to increase income
               equality through redistribution of income
               might be made without sacrificing very
               much economic growth.
          n    Economic growth might actually
               increase as the redistribution to lower
               income groups raises their productivity
               via improved health and education.

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    15.2 The Pros and Cons of Income
                Equality
          n    At some point however, increased
               redistribution of income might create
               increasing disincentive effects, and
               reduce the rate of savings, retarding
               capital formation.
          n    Ultimately, the cost of more current
               income equality is less income growth.



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Income Redistribution and Economic Growth
        —A Possible Relationship

                      Rate of Economic Growth




                                                    B

                                                A       C



                    Low Equality             High Equality
                           Degree of Income Equality
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                         15.3 The Economics of
                             Discrimination
          n    Job-entry discrimination
                 n   A worker is denied employment on the
                     basis of some factor without regard to the
                     productivity of the worker.
          n    Wage discrimination
                 n   Workers are given employment at wages
                     lower than that of other workers on some
                     basis other than productivity differences.



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                         15.3 The Economics of
                             Discrimination
          n    In a world where sex and race have
               absolutely no bearing whatsoever on
               the employment circumstances of
               persons (e.g. talent, education,
               willingness to work, move, ...),
          n    every occupation would, apart from
               random variations, have a workforce
               with the same sex and race proportions
               as the population at large.
          n    However, that is not the case.
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                         15.3 The Economics of
                             Discrimination
          n    A strong statistical correlation exists
               between lifetime earnings and years of
               schooling.
                 n   High-school graduates earn roughly two-
                     thirds of the salary of college graduates.




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                         15.3 The Economics of
                             Discrimination
          n    While a major reason women and
               nonwhites earn less than white males is
               that they occupy jobs that are lower
               paying, it is possible also that they earn
               less because of wage discrimination—
               being paid less for a job strictly because
               of their race or sex.




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                         15.3 The Economics of
                             Discrimination
          n    Merely demonstrating that wages are
               lower for blacks and females does not
               in itself prove wage discrimination,
               although it is consistent with the notion
               that discrimination occurs.
          n    If occupational and wage differentials
               are not caused by discrimination, what
               are the causes?


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                         15.3 The Economics of
                             Discrimination
          n    Several scholars have developed
               statistical models that argue that a great
               deal of the earnings differentials across
               the sexes and races can be explained
               by differences in productivity.
          n    Employers hire and pay workers
               roughly an amount equal to their
               perceived contributions (marginal
               revenue product).

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                         15.3 The Economics of
                             Discrimination
          n    One explanation for higher productivity
               among Caucasian males than others is
               that various environmental factors have
               prevented blacks and women from
               gaining the training, skills and
               experience necessary to achieve high
               productivity.




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                         15.3 The Economics of
                             Discrimination
          n    This environmental explanation of
               productivity differences does not rule
               out discrimination, but rather argues
               that past discrimination's perverse
               influences on the environment of
               women and nonwhites has caused
               them to have an inferior endowment of
               human capital now, even if present-day
               employers were color- and sex-blind in
               terms of paying workers.
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                         15.3 The Economics of
                             Discrimination
          n    It might appear that discrimination is
               totally inconsistent with rational utility-
               maximization.
          n    To maximize profits, a firm should
               minimize costs by hiring the best
               persons available per dollar of wage
               expenditure, regardless of the age, sex,
               race, or other attribute of the worker.


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                         15.3 The Economics of
                             Discrimination
          n    To some extent, discrimination may
               reflect information costs.
          n    Based on past experience, race or sex
               may be used as a screening device, to
               narrow the list of job candidates,
               because it costs money and time to
               evaluate the prospects of every
               applicant.


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                         15.3 The Economics of
                             Discrimination
          n    The information cost reduction from
               hiring on the basis of color or sex may
               exceed the perceived benefits from the
               identification of good workers of a
               particular color or sex.




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                         15.3 The Economics of
                             Discrimination
          n    It is a fact that some people prefer to
               associate with persons with certain
               racial and/or sexual attributes.
          n    In such cases, the utility gained from
               having the desired racial or sexual mix
               might exceed the loss in income from
               not having the best employees.



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                         15.3 The Economics of
                             Discrimination
          n    In competitive industries, firms that
               discriminate may lose out.
                 n   The nondiscriminating firm hires the
                     unfavored but equally competent workers
                     and has a cost advantage, allowing it to
                     undercut discriminating competitors’ prices
                     and either force them out of business or
                     make them change their hiring practices.
          n    In the long run, competition has the
               potential to reduce discrimination.
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                         15.3 The Economics of
                             Discrimination
          n    The primary means used to address
               economic discrimination in our country
               is affirmative action programs, in which
               employers are strongly encouraged to
               hire more minority group workers in
               occupations where those groups are
               now relatively under-represented and to
               correct wage and salary inequities.


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                         15.3 The Economics of
                             Discrimination
          n    Some environmental causes of
               productivity differences have also been
               attacked.
          n    There is some evidence that these
               various efforts have met with some
               success.
          n    Still, the economic differences between
               different races and sexes are rather
               large.

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                         15.3 The Economics of
                             Discrimination
          n    Affirmative action job hiring programs
               are controversial.
          n    The establishment of what are, in effect,
               quotas on the hiring of minorities
               increases the probability that some
               persons will be hired on some basis
               other than productivity.



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                         15.3 The Economics of
                             Discrimination
          n    While this may be desirable from the
               standpoint of equalizing opportunities
               between demographic groups, it also
               can serve to lower the output of society
               as a whole and profits to firms.
          n    Also, the "reverse discrimination" equity
               argument is raised.



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                         15.3 The Economics of
                             Discrimination
          n    An alternative approach to one using
               implicit quotas would be to subsidize
               employers for hiring minority workers,
               which would provide employers with
               greater incentive to increase minority
               job opportunities.




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                                             15.4 Poverty
          n    Our concern over income distribution
               largely arises because of a feeling that
               people with low incomes (“the poor”)
               suffer in a material sense relative to
               other persons.




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                                             15.4 Poverty
          n    Economic growth can have important
               effects on poverty and welfare.
                 n   Strong economic growth since 1993 has
                     helped
                       n raise median household income,
                       n lower the poverty rate, and

                       n lower the number of welfare recipients.




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Improvements in Household Income, Poverty
               and Welfare
          Household Income Poverty Rate



                                          15.1 percent           Number of Welfare
                                                                    Recipients          $40,816
             and Welfare Recipients




                                          14.1million

                                                                                     Poverty Rate


                                                                                       11.8 percent

                                                            Real Median
                                          $35,539        Household Income
                                                           (1999 dollars)            5.8 million

                                           1993     1994 1995 1996 1997 1998 1999 2000
                                                                       Year



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                                             15.4 Poverty
          n    The federal government measures
               poverty by using a set of money income
               thresholds that vary by family size and
               are adjusted for inflation.
                 n   If the family’s total income is less than the
                     established threshold—the poverty line—it
                     is considered poor.
          n    The poverty rate is the proportion of
               persons who fall below that absolute
               standard.
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                                             15.4 Poverty
          n    The poverty rate for the United States is
               currently set at three times the cost of
               providing a nutritionally adequate diet—
               slightly less than $20,000 for a family of
               four.
          n    The poverty rate may overstate the
               level of poverty because it does not
               include noncash benefits, such as
               public housing, Medicaid, and food
               stamps.
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    Number of Poor and Poverty: 1939 to 1999


                                                                           Recession
     45
     40
                                                       Number in poverty
     35
                                                                                       32.3 million
     30
     25
     20
     15
     10                                                     Poverty rate               11.8 percent
      5
      0
       1959         1964         1969        1974   1979   1984   1989     1994   1999
                                                    Year



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                                             15.4 Poverty
          n    With a definition of poverty that is
               determined at some fixed, real income
               level, poverty over time should decline
               and, indeed, largely disappear, unless
               lower income groups do not share at all
               in rising incomes because real incomes
               generally rise over time with economic
               growth.


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                                             15.4 Poverty
          n    Thus, one cure for poverty, as defined
               by some absolute income or standard of
               living criterion, is economic growth.
          n    The greater the rate of economic
               growth, the more rapidly poverty will be
               eradicated.




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                                             15.4 Poverty
          n    Many “poor” individuals in the United
               States, using the official definition,
               would be considered well off, even
               “rich” in many less-developed countries.
          n    Rather than being classified by an
               ability to buy some specific basket of
               goods and services, poverty is often
               thought of as a relative income concept.


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                                             15.4 Poverty
          n    A person is “poor” if his or her income is
               low relative to the incomes of most
               other persons in the same geographical
               area.




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                                             15.4 Poverty
          n    Using definitions of poverty based on
               relative income measures, as economic
               growth proceeds, the income necessary
               to avoid being considered poor by this
               measure increases.
          n    Using this definition, then, poverty
               cannot be eradicated by economic
               growth, but only by income
               redistribution.

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                                      15.5 Healthcare
          n    Like the production of any other good or
               service, however, healthcare involves
               the utilization of scarce resources.
          n    Not only must the healthcare sector
               compete with other sectors for
               resources, but those resources must be
               allocated across patients facing vastly
               different circumstances.


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                                      15.5 Healthcare
          n    The United States spends more money
               on healthcare per person and as a
               percentage of national income than any
               other industrialized nation.
          n    Medical expenditures comprise
               approximately 13.5 percent of GDP.




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U.S. Healthcare Expenditures as a Percentage
             of GDP Since 1960

                           16
                           14
          Percent of GDP




                           12
                           10
                            8
                            6
                            4
                            2

                            1960   1965      1970   1975   1980   1985   1990   1995   1999
                                                           Year




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                                      15.5 Healthcare
          n    The utilization of medical care involves
               trade-offs.
                 n   Scarce resources allocated toward the
                     production of health services cannot be
                     used in the production of other goods and
                     services.




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                                      15.5 Healthcare
          n    Investment in healthcare bears
               similarities to investment in human or
               physical capital.
          n    By promoting health and removing
               disabilities, medical care may
                 n   improve the productivity of workers on the
                     job and reduce missed workdays;
                 n   extend the average number of years of
                     participation by people in the labor force.


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                                      15.5 Healthcare
          n    Increases in the quality and quantity of
               labor available due to better healthcare
               will shift an economy’s production
               possibilities curve outward.




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                              PPC Between Healthcare and All
                                      Other Goods
Quantity of All Other Goods




                                                                   Quantity of All Other Goods
                                           A
                               Quantity
                               of other
                               Goods                    B
                              Sacrificed                                                                        PPC2
                                           Additional
                                            Medical
                                            Services
                                                            PPC1                                        PPC1
                                  Quantity of Healthcare                                         Quantity of Healthcare


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                                      15.5 Healthcare
          n    Both the demand for and supply of
               healthcare have increased over the last
               several decades.
          n    Demand for medical coverage has been
               significant due to changes in:
                 n   income
                 n   insurance coverage
                 n   population demographics


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                              The U.S. Health Dollar: 1999

                                                                                                 Program
                                         Other                                              Administration and
                                        Private2                                              Net Cost 32.3¢
                  Other Public1          15.7¢                                 Prescription Drugs
                     15.7¢                                                           32.3¢
                                                                       Nursing Home
                                                                        Care 32.3¢
                                                   Private                                                Other Spending
            Medicaid
                                                  Insurance                                                    32.3¢
             15.7¢
                                                    32.3¢                           Physician Services
                Medicare                                                                 Care 32.3¢      Hospital Care
                 17.6¢                                                                                       32.3¢




                                       Out-of-pocket
                                           15.4¢
1
    “Other Public” Includes programs such as workers’ compensation, public health activity, Department of Defense, Department of Veteran Affairs, Indian health
    services, and State and local hospital and school health.
2
    “Other Private” Includes industrial inplant, privately funded construction, and non-patient revenues including philanthropy.
3
    Other Spending includes dentist services, other professional services, home health, durable medical products, over-the-counter medicines and sundries, public
    health, research, and construction.
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                                      15.5 Healthcare
          n    Consequently, the price of medical care
               has risen at the same time the
               utilization of services has increased.




Copyright © 2002 by Thomson Learning, Inc.
                                    The Market for Healthcare

                Physician Service                        S2


                                    $350                      S1
                  Dollars per




                                     250



                                                                   D

                                       0     300,000 500,000
                                                  Quantity of
                                               Physician Services
Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Rising U.S. real income has contributed
               to the increase in demand for medical
               services.
          n    Most healthcare services are normal
               goods.




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Estimates of the price elasticity of
               demand for healthcare generally range
               between 0.2 and 1.0, indicating
               significant inelasticity of demand for
               medical services.
          n    The quantity of medical care demanded
               appears to be quite insensitive to
               changes in price.


Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Healthcare is considered a necessity
               with few good substitutes, particularly
               when it comes to serious illness.




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    The health services market differs from
               many others in that, due to insurance,
               the consumer often pays only a fraction
               of the direct cost of care.
                 n   Third-party payers, such as insurance
                     companies or health maintenance
                     organizations, play significant roles in this
                     industry, which have important incentive
                     effects and alter the behavior of both
                     patients and providers.

Copyright © 2002 by Thomson Learning, Inc.
        Type of Health Insurance and Coverage
          Status in the U.S., All People 1999


               Individual                    Uninsured
                 8.2%                         15.5%
           Military/
           Veterans                                      Employment-based
                                    Medicaid              insurance 62.8%
            3.1%                     10.2%
                                         Medicare
                                          62.8%




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    In addition to increasing the quantity of
               healthcare demanded by reducing
               price, insurance alters the incentive of
               patients in other ways.
                 n   Insurance reduces the cost to the insured
                     of undertaking risky activities.
                 n   In an accident or illness, the healthcare
                     costs are borne by the insurer.
                 n   This creates what economists call a “moral
                     hazard” problem.

Copyright © 2002 by Thomson Learning, Inc.
                     Demand for Physician Services

                      Dollars per
                       Physician
                      Office Visit                                        S = MC
                                     $150                             Overallocation
                                                                            of
                    Paid by                                            Resources
                  Insurance 100                                           to the
                   Provider                                            Healthcare
                                                                         Sector

    Paid by                                  20
                                                                       D = MB
   Consumer
                                              0       1,000,000 1,600,000
                                                  Quantity of Office Visits
Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Moral hazard in healthcare exists
               whenever insurance makes a person
               more likely to engage in risky behavior
               (which could lead to an accident or
               illness) and less likely to undertake
               preventative measures against illness.




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Insurance companies or third-party
               payers attempt to reduce moral hazard
               problems by requiring patients to pay
               higher deductibles and/or co-payments,
               thereby compelling the insured to share
               a greater proportion of incurred costs.




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Insurance may pose additional
               problems for the healthcare industry.
                 n   A situation of asymmetric information exists
                     whenever patients know more about their
                     own health status than prospective
                     insurers.
                       n   This is known as "adverse selection" because
                           the chronically ill are more likely to demand
                           health insurance than are those in good health.




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    An insurance company inviting
               voluntary participation in a plan may
               find that it has insured an adverse
               selection of largely ill patients and
               would be forced to increase insurance
               premiums to stave off losses.




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    As insurance premiums increase,
               however, healthy enrollees are more
               likely to drop out of the plan (opting
               instead for cheaper, less generous
               health insurance plans or for self-
               insurance).
          n    This further exacerbates the adverse
               selection problem.


Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Insurers can reduce adverse selection
               risk by
                 n   limiting the period of open enrollment in
                     health insurance plans,
                 n   requiring physical exams (so that an
                     individual cannot purchase insurance after
                     serious illness strikes), and
                 n   insuring entire groups (such as all
                     members of a large employer or union) in
                     order to ensure a diversity of health
                     statuses.
Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    The aging of the U.S. population is an
               additional factor that explains the
               increase in demand for healthcare.
                 n   The elderly consume a disproportionate
                     share of healthcare services (three to four
                     times as much as the rest of the
                     population).




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    The supply of healthcare has increased
               slowly since 1960.
          n    The number of providers has increased
               but has not kept up with the demand for
               medical services.
          n    There has been an increase in the cost
               of medical education and training as
               well as a greater use of high-cost
               technological equipment in the
               healthcare industry.
Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Escalating healthcare costs over the
               last decade, however, have led to a
               greater emphasis on cost containment.
                 n   “Managed care,” including health
                     maintenance organizations (HMOs) and
                     preferred provider organizations (PPOs)




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Medical research and technological
               progress has vastly improved the
               quality of medical care.
                 n   Innovative therapies help reduce disability,
                     improve health, and prolong life.
                 n   Some innovations undoubtedly reduce the
                     overall cost of healthcare.
                 n   Other innovations, however, significantly
                     add to the cost of healthcare.


Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Technological advances have led not
               only to an increase in the supply of
               healthcare, but through its interaction
               with insurance, also a significant
               increase in the demand for medical
               care.
                 n   Insured patients who bear a small fraction
                     of healthcare costs naturally desire the
                     best possible care, contributing to a rise in
                     healthcare costs that far exceeds the
                     average level of inflation.

Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Healthcare markets are imperfectly
               competitive for several reasons,
               including
                 n    the presence of legal or administrative
                     barriers to entry,
                 n   economies of scale,
                 n   collusion, and
                 n   restrictions on advertising.



Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Compulsory licensing
                 n   Restricts entry into the healthcare market.
                 n   Licensing requirements and limitations on
                     hospital privileges are justified as
                     protecting patients from inferior-quality
                     medical care by certifying that physicians
                     possess a certain level of competency.
                 n   Restricting the supply of physicians,
                     licensing and hospital privilege
                     requirements limit the quantity of services
                     provided and lead to higher medical prices.
Copyright © 2002 by Thomson Learning, Inc.
                           Leftward Supply Curve Shift


                                                         S2
       Physician Service



                                                                  S1
         Dollars per




                             $350

                                250

                                                              D


                                     0       300,000 500,000
                                         Quantity of Physician Services

Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Healthcare economies of scale
                 n   Specialty services may be utilized
                     infrequently requiring large populations be
                     served by only a few providers.
                 n   Cities and towns are often unable to
                     support a large number of hospitals.
                 n   Only in densely populated metropolitan
                     areas may it be economical for numerous
                     hospitals to compete.
                 n   Conditions may be such that "natural
                     monopolies" exist in many areas.
Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    Healthcare providers possess
               significant market power, making price
               discrimination and collusive behavior
               (such as price-fixing) more likely to
               occur.




Copyright © 2002 by Thomson Learning, Inc.
                                      15.5 Healthcare
          n    In Canada, where a national healthcare
               program controls prices and strictly
               rations care, conditions of excess
               demand for surgery prevail.
          n    Likewise, shortages prevail in the
               market for organ transplants.




Copyright © 2002 by Thomson Learning, Inc.
                            Excess Demand for Organs


                                                             S
       Heart Transplant
         Dollars per




                          $200,000


                           100,000
                                                  Shortage
                                                     of          D
                                                   Hearts

                                     0       3,000 3,500 5,000
                                         Quantity of Heart Transplants

Copyright © 2002 by Thomson Learning, Inc.

								
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