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Optimal Price Rules, Administered Prices and Suboptimal Prevention: Evidence from a Medicare Program

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  • Avi Dor

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Abstract

Pricing methodologies in Medicare vary from one component of the system to another, often leading to conflicting incentives. Failure to recognize linkages may result in inefficient allocation of resources and higher overall costs. To motivate the analysis, I derive pricing rules for a welfare-maximizing regulator. I show that while optimal inpatient payments are standard Ramsey prices, optimal outpatient payments must incorporate net loss due to unnecessary hospitalizations, as well as supply elasticities. Ignoring this leads the myopic regulator to underprovide preventive services. The dialysis program is a useful case for empirical investigation, since payments for maintenance care are more rigidly determined than payments for related hospital care. Given constant prices, empirical analysis focuses on the effect of dialysis intensity on hospital use. Results indicate that greater dialysis intensity reduces hospital use, even at levels considered more than “adequate”. A simple cost-benefit calculation suggests that for every dollar of additional spending on outpatient intensity, about $2 in hospital expenditures can be saved. This suggests that the current pricing structure within aspects of the Medicare program is inefficient, underscoring the problem of regulatory myopia. Copyright Kluwer Academic Publishers 2004

Suggested Citation

  • Avi Dor, 2004. "Optimal Price Rules, Administered Prices and Suboptimal Prevention: Evidence from a Medicare Program," Journal of Regulatory Economics, Springer, vol. 25(1), pages 81-104, January.
  • Handle: RePEc:kap:regeco:v:25:y:2004:i:1:p:81-104
    DOI: 10.1023/B:REGE.0000008656.82249.3a
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    References listed on IDEAS

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    1. John Mullahy, 1998. "Much Ado About Two: Reconsidering Retransformation and the Two-Part Model in Health Economics," NBER Technical Working Papers 0228, National Bureau of Economic Research, Inc.
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    3. Hagen, Kare P. & Sheshinski, Eytan, 2005. "Positive second-best theory: A brief survey of the theory of ramsey pricing," Handbook of Mathematical Economics,in: K. J. Arrow & M.D. Intriligator (ed.), Handbook of Mathematical Economics, edition 2, volume 3, chapter 25, pages 1251-1280 Elsevier.
    4. Baumol, William J & Bradford, David F, 1970. "Optimal Departures from Marginal Cost Pricing," American Economic Review, American Economic Association, vol. 60(3), pages 265-283, June.
    5. Cutler, David M, 1995. "The Incidence of Adverse Medical Outcomes under Prospective Payment," Econometrica, Econometric Society, vol. 63(1), pages 29-50, January.
    6. Harris Schlesinger & Emilio Venezian, 1986. "Insurance Markets with Loss-Prevention Activity: Profits, Market Structure, and Consumer Welfare," RAND Journal of Economics, The RAND Corporation, vol. 17(2), pages 227-238, Summer.
    7. Mark V. Pauly, 1974. "Overinsurance and Public Provision of Insurance: The Roles of Moral Hazard and Adverse Selection," The Quarterly Journal of Economics, Oxford University Press, vol. 88(1), pages 44-62.
    8. Ellis, Randall P., 1998. "Creaming, skimping and dumping: provider competition on the intensive and extensive margins1," Journal of Health Economics, Elsevier, vol. 17(5), pages 537-555, October.
    9. Richard W. Blundell & Richard J. Smith, 1989. "Estimation in a Class of Simultaneous Equation Limited Dependent Variable Models," Review of Economic Studies, Oxford University Press, vol. 56(1), pages 37-57.
    10. Gerald Nordquist & S. Y. Wu, 1976. "The Joint Demand for Health Insurance and Preventive Medicine," NBER Chapters,in: The Role of Health Insurance in the Health Services Sector, pages 35-72 National Bureau of Economic Research, Inc.
    11. Selden, Thomas M., 1990. "A model of capitation," Journal of Health Economics, Elsevier, vol. 9(4), pages 397-409, December.
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    Cited by:

    1. Karen Eggleston & Randall P. Ellis & Mingshan Lu, 2007. "Prevention and Dynamic Risk Adjustment," Boston University - Department of Economics - Working Papers Series WP2007-023, Boston University - Department of Economics.
    2. William Encinosa & Didem Bernard & Avi Dor, 2010. "Does Prescription Drug Adherence Reduce Hospitalizations and Costs?," NBER Working Papers 15691, National Bureau of Economic Research, Inc.
    3. William Encinosa, 2009. "Value-based insurance design in medicare," Applied Health Economics and Health Policy, Springer, vol. 7(3), pages 149-154, September.
    4. repec:clg:wpaper:2007-06 is not listed on IDEAS

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    Keywords

    price regulation; pricing; prevention; medicare;

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