South-Western College Publishing - Economics  
Higher Health-Care Costs: Who Pays?
Subject Determinants and graphical representation
Topic Elasticity
Key Words Rates, prices, demand, merger, competition, losses, premiums, costs, subsidy, co-payment, employees, workers, companies
News Story

Many managed-care plans are raising their rates after five years of stable prices. They argue that higher demand is the cause. In addition, plans are more expensive where they have merged and there is less competition, or where plans have been making losses.

Some companies are increasing the premiums or out-of-pocket costs that workers pay, in effect reducing the subsidy given. Some are increasing the co-payments on drugs, the prices of which are rising fast. One type of drug plan charges more for name-brand drugs than generic drugs. Others are adopting more restrictive health plans, limiting further which providers are covered, especially for rank-and-file employees. Yet others are encouraging employees to use health care less, such as through smoking cessation programs, or face higher premiums.

However, there is a great deal of variation. Where the employers are afraid that workers might quit as a result, such as among skilled workers or in the hi-tech sector, they are more reluctant to increase employee contributions. Large companies are also more likely to absorb health-care cost increases.

(Updated January 1, 2000)

1. a) What are the determinants of the elasticity of demand?
  b) When the co-payment for prescriptions is $10, how elastic would the demand for prescription drugs be in your opinion? Refer to the determinants of the elasticity of demand. What would be the implications for the use of prescription drugs?
  c) If the co-payment were to rise to $40 per prescription, how would the elasticity of demand change? Explain your answer. What would be the implications for the use of prescription drugs?
  d) Draw a diagram of the demand for prescription drugs. Show the quantity demanded at prices of $10 and $40. What do your answers to (b) and (c) imply about the elasticity of demand along the demand curve?
2. The news story states that skilled workers are less likely to experience increases in premiums.
  a) If skilled workers are highly sought after and have lots of alternative opportunities, what is the general slope of the labor supply curve? Explain your response.
  b) Does this imply that the labor supply curve is relatively elastic or inelastic?
  c) Draw a labor supply and demand diagram, with the real wage and employment on the axes. Show the labor supply curve with the general elasticity identified in (b).
  d) When the price of benefits, a complement to skilled labor, increases, what happens to the demand for skilled labor? Illustrate the consequences for equilibrium real wages and employment on your diagram. Are employers tending to pass the increased costs on to the workers or absorb them?
  e) How do these outcomes compare with the situation when workers have few alternative job opportunities? Illustrate in another diagram.
Source Carol Gentry, "Your Health Insurance for 2000: The Squeeze Is On," The Wall Street Journal, October 27, 1999.

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