• Rules of thumb for health care consumers

    For a few weeks now, I’ve been enjoying the content at the Altarum Institute’s HealthPolicyForum.org, some of it from long ago, as it turns out. Last week on that forum, Wendy Lynch posted some rules of thumb for health care consumers. They’re worth repeating. The following are Lynch’s words, though she writes more about each point (click through for that).

    1. Newer medical treatments and medicines are not always more effective or safer, but will likely be more expensive than those that are already available.
    2. Prices for medical services do not reflect effectiveness or likelihood to improve health.
    3. Which type of doctor you see will influence what treatment recommendation you get.
    4. Life expectancy has improved mostly to low-tech discoveries, not because we have access to amazing, new medical technologies.
    5. Don’t underestimate the risks in health care.
    6. Last but not least: health care is a business.

    I think those are all, basically, sound. I have something to add, though. First, about point 2, Lynch writes, among other things,

    [H]ealth care prices are based on the technical sophistication of the procedure, the training of the professional, and the malpractice risk involved—not whether or not the procedure works.

    About point 3, she writes, “The more specialized their training, the more expensive [doctors’] advice will be.”

    Both of these reflect a type of cost-based thinking that is very common. Try this test: go find a non-economist. He or she could be your spouse or coworker, or a friend you email. Ask him or her what explains the price of some product or service, like a restaurant meal. I bet you he will first talk about how much it costs to produce that product or deliver that service. “Well, first they have to buy all the ingredients. Then they have to pay the chef. Those tables cost money, as does the space itself, including heat, water, and so on.”

    All true! Though that begins to explain the cost to the restaurant of producing a meal, it does not explain the price you pay, not fully anyway. Something important is left out: supply and demand, including the effects of market power. A lot of people miss this idea. If they mentally add up how much it should cost to produce the entree they ate, they can’t come anywhere near the $35 they paid for it. Maybe they figure it cost the restaurant $25 to make and deliver it to the table. What accounts for the other $10? Friends have asked me this very question. “What am I missing?” they say. “The restaurant can’t be that inefficient, can it?” they wonder.

    It’s a bit odd that people don’t understand this. Try this test: imagine you made a product. Let’s think of it as a piece of art. You just drew a picture, say. Maybe it’s that doodle you made during your last meeting. Now go sell it! (Not really, just think about it.) How would you price it? Sure, you could try to account for the cost of producing it. But do you want to sell it for that cost, which could be pennies? No! You want to sell it for as much as you can get for it, hopefully way more than cost. Maybe it is the only doodle of its type in the universe, and all of a sudden people in your town are going nuts for this new doodle style. A doodle craze has broken out. Your neighbor will pay you $1,000 for one. Your colleague offers $2,500. This is awesome. Take the money, draw more doodles!!!

    Guess what. You just (mentally) exercised market power. Supply was limited (only you could produce the doodle). Demand was through the roof. The price had almost nothing to do with cost.

    Though market power is rarely as strong as just illustrated, these concepts apply in all markets and for all goods and services, including health care. Wendy Lynch knows this. About point 6 she writes, “[T]his $2.4 trillion [health care] industry is no less interested in making a profit than any other.” Without market power, there can be no economic profit.

    What explains health care spending? Health care costs certainly play a role. But we don’t pay costs. We pay prices. They’re different. Prices in health care can be very high, even when costs are (or could be) low.

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    • I’m 45 years removed from my Marketing 101 course but the “doodle” scenario you describe as market power pricing, I would think of as “price to value.” There is another textbook form of pricing (in addition to price to cost, price to profit, etc. — or is that the course where I didn’t buy the textbook?) that better describes the supply/demand situation: price to market.

      There is a debate in Massachusetts right now that might inform your thinking: Are the prices charged by the world-renowned medical insitution, Massachusetts General, due to market power or the value of its staff and facilities? I think the chairman of the MGH board was quoted as saying something like (I’m paraphrasing): “How come every politician in the state who says our high prices are the problem with RomneyCare not woking calls me for a favor when their sister gets sick?”

    • This is a good point, but I think that it makes it seem like cost has no impact on price. That’s obviously not true either. If there were low-cost alternatives, you could have a distruptive agent in the market that would force prices down because costs were lower. Hard to imagine a cheaper way to make doodles, so it’s hard to extend your analogy, but say a school comes along that produces the doodles as part of a class project and so has much lower costs per doodle than you do and can under-cut your pricing.

      Costs matter too – I’m sure you know that, but reading this it sort of seems like suppyl and demand are all that matter.

    • I’d include ~98% of policy wonks in the pool of people who do not understand the difference between costs and prices. What is the RBRVS if not the embodiment of cost-based thinking.

      I’m happy to see that Austin understands the distinction, and would welcome the application of this understanding to the public versus private cost-growth studies that he has frequently cited. Have public payers driven down costs – or simply providers to accept lower prices for the same care?

      • Underlying costs are rarely (but not never) observable to researchers.

        • Does it follow from the fact that we usually don’t know costs that we usually don’t know profit margins?

          I understand that we can cut costs by reducing the use of ineffective procedures. In general, doesn’t not knowing costs or profit margins make it more difficult to know where we can cut costs without undermining quality?

          Can we rely on public or private quality of care measures to detect any loss of quality caused by cost cutting procedures? I have no idea of sensitive existing measures are.

    • Thomas, even costs are influenced by demand and marketthe power. A company or industry with a lot of market power OR (and I think this is equivalent) a very inelastic demand curve will have less pressure to be efficient, and there will be less pressure on wages, and there is likely to be less hard bargaining with subcontractors. All of that results in a higher cost structure, which of course is easy to find in American health care.