Question

Consider a not-for-profit hospital that faces a tradeoff in producing quantity and quality. The hospital has a three-member board of trustees with each member having different personal preferences regarding the combination of quality and quantity that should be produced.Person Z prefers high quality and low quantity, Person Y prefers medium quality and medium quantity, and Person X prefers low quality and high quantity.

a. What combination of quantity and quality is this hospital likely to provide? Please explain.

b. Suppose the board of trustees is “self-replicating”, meaning that if Person Z, Person Y, or Person X exits the board, then these three members decide on who the replacement will be. If Person Z exits the board, what is the probable impact on the combination of quantity and quality provided by the hospital? What if Person Y exits instead? Please explain.

Answer 1

Suppose we want to explain why health care is more expensive in the United States than in Europe. Then supply and demand seems like a natural starting point. If we imagine a market for health care drawn in the usual way, with the quantity demanded on the horizontal axis and the price on the vertical axis, then the question becomes, “Why is the price of health care higher in the United States than in Europe?”

"Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe"). The prices can be high because demand is high. For example, if the demand curve is further to the right in the United States compared to Europe (part [a] of Figure "Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe"), this implies—all else being equal—higher prices in the United States. The other reason for high prices is because supply is limited. If the supply curve in the United States lies further to the left than the supply curve in Europe (part [b] of figure"Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe"), then this also would imply—all else being equal—higher prices for health care in the United States. Neither argument seems that compelling, which naturally leads us to wonder if the supply-and-demand framework is really the best framework for analyzing health care. In fact, there are good reasons to think that the supply-and-demand framework is not the best approach to this market.

Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe

Supply and demand offers two possible explanations of high health-care costs in the United States: demand in the United States is high (a), or supply in the United States is limited (b). Neither is a very compelling explanation.

Let us think about the demand side first. Our standard approach to demand is based on the idea that each individual will consume a good or a service up to the point where the marginal valuation from one more unit equals the price of that additional unit. "Everyday Decisions" explains this idea in more detail.Unfortunately, the health-care consumer often has very little idea of the value—let alone the marginal valuation—of the particular treatment being received. The consumer is very often not paying the full price for that treatment because the cost is frequently covered, at least in part, by insurance. Together, these mean that our traditional approach to demand does not work very well for health-care services.

The supply side is also problematic. First of all, some health-care suppliers have significant market power. This does not mean that we can get no insights from supply-and-demand reasoning. But it is trickier to compare the price of health care across countries because we have to consider differences in market power as well. A bigger problem is that some health-care suppliers, such as hospitals, are either government-controlled or not-for-profit institutions. The standard economic approach presumes that firms seek to make as much profit as possible, but government or not-for-profit hospitals may not have profit maximization as their goal.

"Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe"). The prices can be high because demand is high. For example, if the demand curve is further to the right in the United States compared to Europe (part [a] of Figure "Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe"), this implies—all else being equal—higher prices in the United States. The other reason for high prices is because supply is limited. If the supply curve in the United States lies further to the left than the supply curve in Europe (part [b] of Figure "Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe"), then this also would imply—all else being equal—higher prices for health care in the United States. Neither argument seems that compelling, which naturally leads us to wonder if the supply-and-demand framework is really the best framework for analyzing health care. In fact, there are good reasons to think that the supply-and-demand framework is not the best approach to this market.

Two Explanations for Why Health Care in the United States Is More Expensive Than in Europe

Supply and demand offers two possible explanations of high health-care costs in the United States: demand in the United States is high (a), or supply in the United States is limited (b). Neither is a very compelling explanation.

Let us think about the demand side first. Our standard approach to demand is based on the idea that each individual will consume a good or a service up to the point where the marginal valuation from one more unit equals the price of that additional unit."Everyday Decisions" explains this idea in more detail.Unfortunately, the health-care consumer often has very little idea of the value—let alone the marginal valuation—of the particular treatment being received. The consumer is very often not paying the full price for that treatment because the cost is frequently covered, at least in part, by insurance. Together, these mean that our traditional approach to demand does not work very well for health-care services.

The supply side is also problematic. First of all, some health-care suppliers have significant market power. This does not mean that we can get no insights from supply-and-demand reasoning. But it is trickier to compare the price of health care across countries because we have to consider differences in market power as well. A bigger problem is that some health-care suppliers, such as hospitals, are either government-controlled or not-for-profit institutions. The standard economic approach presumes that firms seek to make as much profit as possible, but government or not-for-profit hospitals may not have profit maximization as their goal.