Assume now that like most Americans the patient has insurance coverage. Begin with a policy that covers a constant proportion (e.g., 80 percent) of spending on either D or M. Out-of-pocket patient costs are $10 for each prescription (20 percent of $50) and $20 for a medical visit (20 percent of $100). Because the slope of the patient’s budget line does not change, the optimal choice remains at point E, and the patient continues to buy four units of drugs and six visits. Total drug costs will continue to be minimized with the patient paying 20 percent ($160) and the insurer paying 80 percent ($640) of the $800 total bill. However, D and M often are not treated uniformly under traditional health insurance. Consider a policy that pays 80 percent of medical costs but requires a deductible of only $5 (copayment) for each prescription. The patient’s drug price is the $5 deductible regardless of the actual price of the medication. If the patient’s out-of-pocket drug costs diminish, the numerical slope of the cost-minimizing budget line diminishes (in our example, it is now -5/20 = 0.25). The patient will have an incentive to substitute D for M at E–. Continuing with the example, let D2 increase from 4 to 5, and M2 fall from 6 to 5.75. The patient’s cost burden diminishes from $160 to $140 or: However, the total cost of care (patient plus insurer) increases from $800 to $825. We know this is true because we already determined that E is the least costly combination to provide HS1. Similarly, if prescription prices (to the insurer) increase, say to $100, the patient still pays $5 and will remain at E– with the insurer picking up the increased drug costs. Patients have no incentive to economize by making substitutions and moving toward E. The higher the prescription price, the greater is the distortion. A similar distortion toward excessive levels of M and greater total costs occurs when the patient’s coverage excludes or limits drug benefits. Here, the savings from reducing M will more than offset the additional drug spending from improved drug coverage.
Technological Change
At the turn of this twenty-first century, a new category of experimental drugs, blood vessel inhibitors,
generated extraordinary excitement in the medical community by fighting both cancer and
heart disease. Technology often is associated with major breakthroughs. More often, however, new
drugs are similar to existing drugs, but they may produce somewhat better outcomes (if only for
some patients) or reduced side effects.
With technological improvements, fewer inputs are needed to produce a given health outcome,
or outcomes that were previously unattainable are now attainable. For example, begin with
HS1 in Figure 17-3 and let HS1
* represent all combinations of inputs with a new drug that leads to the same health status as HS1. If the cost-minimizing ratio of inputs at a given price ratio remains
unchanged, so that it lies along the ray 0E (denoted (M/D)0), the innovation represents a neutral
technological change. As drawn, the new drug saves a relatively high amount of the medical input at
any given price ratio. That is, drug utilization increases relative to medical care as the patient moves
to E* and substitutes D for M. As noted in the figure, the lower ratio of M to D is reflected in the less
steeply sloped ray, (M/D)1.
New technology can increase costs for two reasons. First, it can routinely provide health levels
that were unattainable previously (e.g., HS2
* at point E**). It may require much more drug use and
possibly increased use of M, as well. When health improvements are dramatic or when drugs treat
serious conditions that were not treatable previously, cost concerns are likely to be far less troublesome
than those leading to only marginal improvements in health.
The second cost pressure comes from insurance. As we have seen, a patient with a constant
copayment will not face any price increases of the new drug. Assume that the slope of the budget
line in Figure 17-3 reflects the patient’s copayment of $5 and the patient moves from E to E*
. If the
price of the new drug is high enough, the total cost of care at E* could be substantially higher than
total costs at the original equilibrium at E.
For conventional goods, where the consumer pays the entire price out of pocket, such technological
changes will not be introduced because they will not be demanded. With insurance, the
determination and elimination of cost-inefficient technology are far more difficult. A drug-maker
may market a socially cost-inefficient drug successfully simply beca
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