baumol's cost disease
Post on 02-Jul-2015
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Medical Treatment & Baumol’s Cost Disease
CONTENTS
• Baumol’s Cost Disease (BCD)
• Medical Treatment
• BCD in Medicine – Reason for Increasing Cost
• Economic Analysis
• Remedies
• References
Baumol’s Cost Disease (BCD)
• Published in 1966 by William Baumol and William Bowen
• Studies rise in salaries in jobs with no increase in labor
productivity
• Goes against the theory of classical economics
• Usually applies to sectors that cannot be automated
• Not anyone's fault
• Sectors affected are Healthcare, Education,
Entertainment, etc.
Medical Treatment
• Demand highly inelastic
• No change in productivity due to technological advances
• Healthcare costs rise higher than the rate of inflation
• Increase in labor productivity slower than other sectors of economy
BCD in medicine – Reasons for Increasing Costs
• Treatment expansion2
• Technological progress in other sectors
• Labor productivity increase in other sectors
• Growing wages
• Innovations do not result in cost decrease
• Malpractice suits and high costs of end-of-life health care3
Economic Analysis
We have
VMPL = MPL * W
– Where VMPL = Value marginal product of labor
– MPL = Marginal product of labor
– W = Unit cost of labor
We also know that
MPL = ΔQ/ΔL where ΔQ is the change in quantity and ΔL
is the change in labor
Economic Analysis
• Because of treatment expansion, the services offered by the healthcare industry and thus the volumes, are increasing.
• Also there is currently a shortfall of doctors in the industry.
• Hence every doctor coming in will result in an increase in the marginal product of labor
• The treatment expansion will further augment this effect
• Hence the marginal product of labor for healthcare industry is always positive and increasing
Economic Analysis
• Due to the Baumol’s cost disease, the wages of doctors and other staff are increasing
• This is to prevent them from leaving their job and joining other sectors.
• Also, the treatment expansion does not result in a decrease in the labor or the labor costs.
• Hence the product of marginal product of labor and wage, i.e. the VMPL keeps increasing
Economic Analysis
• To maximize the profit, the VMPL should be equal to the price.
• Due to inelastic nature of the demand for healthcare, the price can be increased to match the VMPL.
• Hence, due to the effect of Baumol’scost disease on the wages, the price of healthcare keeps on increasing
Remedies
• Decrease Quality by
– Reducing staff size
– Reducing time per patient4
References
1) http://en.wikipedia.org/wiki/Baumol's_cost_disease
2) Rising health spending, new medical technology
and the Baumol effect : Marc Pomp, Sunčica Vujić
3) http://www.dailyfinance.com/story/reform-health-care-now-
end-of-life-costs-are-too-high/19084515/
4) ‘What Ails Us’ by James Surowiecki
THANK YOU
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