A Bitter Pill
Subject Inflation
Topic Employment, Unemployment, and Inflation
Key Words Inflation, Economic Growth
News Story

Health care costs are on the rise again. From 1996 to 1999, health care costs increased by 3.5 percent or less each year. These increases are substantially lower than the late 1980s and early 1990s when health care cost increases reached as high as 9 percent. Last year, health care costs rose 4.1 percent, and indications are that this year's increase will be even higher. A consequence of rising health care costs is that workers signing up for health plans now will face the largest rate increases in 10 years.

In response to rapidly escalating health care costs in the late 1970s and early 1980s, managed care companies became a fixture in the health care industry. Their objective was to control health care costs for employers by negotiating with doctors and hospitals to significantly lower their charges, and they were generally successful. However, in recent years it has become increasingly difficult to generate the same magnitude of cost savings. Employees have sought increased freedom to select doctors and hospitals, and insurance companies have acceded to these requests. Hospital mergers have given hospitals increased power in negotiating with insurers and hospitals have been raising their prices. Another factor contributing to increasing health care costs is the upward creep in the average age of the American population, which translates into more medical bills.

Insurance premiums are now increasing faster than insurance companies' costs. Insurers are apparently trying to compensate for the 1996 to 1999 period when premiums did not cover costs. Employees of many companies are facing premium increases of roughly 15 percent, according to a survey taken last month by Hewitt Associates. Most large employers are absorbing as much of an increase as their employees, so the employee share of health insurance costs is relatively constant.

The September 11 terrorist attacks will probably increase claims for additional medical treatment that will show up in next year's premiums. There will be higher mental health costs as people seek treatment for depression. One estimate predicts that health care costs will increase by 1 to 1.5 percent in the Northeast.

(Updated November 1, 2001)

1. Explain briefly how the consumer price index (all urban consumers) is calculated?
2. How important are medical care costs in the consumer price index? (Hint: see http://stats.bls.gov/news.release/cpi.t01.htm) How much on average do families pay for health insurance? (See: http://stats.bls.gov/data/home.htm and select Consumer Expenditure Survey)
3. What happens to aggregate supply if health care costs rise to the employer? What is the consequence of this change on the aggregate price level and level of real gross domestic product (GDP)?
Source Milt Freudenheim, "High Cost of Being Well: Benefits at a Premium," The New York Times, October 16, 2001.

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