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