Care Costs Climb
Subject Comparative Statics
Topic Equilibrium
Key Words Inflation, Medicare spending, trust fund, costs, GDP, technology, payments, inefficiencies
News Story

A federal advisory panel has determined that the inflation assumptions underlying projections for Medicare spending need to be revised. The implication is that the hospital insurance trust fund, which pays the hospital bills of Medicare beneficiaries, will be depleted by 2021 rather than 2025. Further, it had been assumed that health care costs per beneficiary after 2025 would grow at the same rate as GDP, but the panel suggests that health care costs will grow 1 percent faster each year.

The reason for the revision is that advances in medical technology have increased the cost of health care. New technology includes medical devices, diagnostic products, drugs, and surgical procedures (such as angioplasty, hip replacement, and radioactive seeds to treat prostate cancer). Although some procedures are less intrusive, safer, and cheaper, such as the removal of a gall bladder through a few small incisions, the number of people having the surgery has increased, driving up costs. Future generations are likely to demand more technology.

Cutbacks in payments to health care providers and the crackdown on fraud have helped to restrain the rise in health care costs. Managed care also reduces inefficiencies. However, it is unlikely to stem the introduction of new technology.

(Updated January 1, 2001)

1. Draw a supply and demand diagram of the market for Medicare-funded health care. Mark the initial equilibrium price and quantity.
a) Show what happens to the equilibrium as new technology which increases the cost of treatment is introduced. Why have you shifted the curve you did?
b) Doctors are expected to treat more patients as new technology becomes available. How will this affect the equilibrium price and quantity of health care?
c) In overall terms, what happens to the equilibrium price and the equilibrium quantity of health care? Explain.
2. The government is concerned at the growing cost of Medicare. On your diagram, shade in the area representing the initial total cost of Medicare payments, and contrast it with the area representing the total cost after the introduction of advanced technology.
3. There have been attempts to combat fraud, payments to providers have been cut, and managed care has been introduced. How have these measures affected the equilibrium price and quantity of Medicare-funded health care? Illustrate on a new supply and demand diagram and explain what you have drawn.
Source Robert Pear, "Health Costs Underestimated, Experts Say," The New York Times, November 30, 2000.

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