Intro to Healthcare Economics

Intro to Healthcare Economics

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Healthcare economics is the field at the intersection of healthcare and economics that deals with how to efficiently manage a healthcare system so as to provide the best service to consumers. In the last decade, the intermingling of healthcare, economics, and policy has come into the forefront of political discourse. Unfortunately, it tends to create complex policy issues.

For many individuals, knowing how to secure proper healthcare insurance is as far as they go in understanding the industry. Underneath the polished veneer hospitals that insurance providers and healthcare executives portray, there’s a complex web of constantly evolving industries that contribute to an incredible amount of complexity. There are a few major players in healthcare economics: the federal government, government-funded hospitals, privately-owned hospitals, insurance companies, and the pharmaceutical industry. Each one plays a different role, but they all work to the same goal — profit. 

The Federal Government

In theory, the government serves the people by developing healthcare policy to benefit the consumer. This altruistic goal becomes largely subverted when faced with partisan politics. As such, the healthcare industry becomes exposed to the regulations of government.


The federal government has national regulations on the level of quality and care a hospital must provide to customers, i.e. patients. They’re quite stringent, and in terms of the quality of care, the United States is one of the strongest primary care providers in the world. 

However, when it comes to pricing, the federal government is notoriously absent. Generally, the stance on both sides of the aisle is to let medical treatment remain subject to market forces, i.e. supply and demand. Unfortunately, market forces have led to high prices across the board, making medical debt an issue for more roughly 137 million Americans. 


The elephant in the room is government funded and regulated healthcare, i.e. Medicare/Medicaid. Medicare is a federally funded healthcare program for those over the age of 65 as well as those under 65 who are disabled. Medicaid is a state and federal program that provides healthcare plans to low income households. Interestingly, Medicare and Medicaid have long been a bipartisan effort to secure affordable healthcare for low-income Americans, as well as provide a low-cost alternative to private plans for middle class families. However today, a debate rages on whether it’s the federal government’s responsibility to provide healthcare for every American. While this debate goes on, prices continue increasing to a point where even Medicare or Medicaid aren’t enough to provide adequate healthcare for many Americans. 


Another major facet of the healthcare industry influenced by the federal government is control over patents. Patents are intellectual property that protects a person’s or a company’s product or idea from being made by a competitor.

The short summary on patents is that most drug manufacturers have 20 years of exclusive production/licensing rights. Licensing rights refer to the exclusive ability of an entity that holds a patent to give permission to manufacture its product to another entity in some agreed upon arrangement. In an industry heavily predicated on product scaling, licensing of new therapeutics is often an advantageous route for many small to mid size pharmaceutical companies.

However, loopholes like the Hatch-Waxman Act, as well as Orphan Drug Laws, enable drug manufacturers to retain exclusive rights to patents for far longer than the public often realizes. On one hand, longer exclusivity rights allow drug companies to fund R&D using the revenues generated from the exclusive sale of their drug, which should allow them to create better products. On the other hand, it can allow drug companies to loot the American public since they have ultimate price control over their product. 

Government Funded Hospitals

Government Funded Hospitals (GFHs) are more common than you think. Almost any hospital that accepts Medicare/Medicaid or conducts institutional research is somewhat government funded. Private hospitals can also accept Medicare/Medicaid plans without government funds. GFHs recently came into focus with the CARES Act. Hospitals across the nation were unable to delineate exactly how CARES funds were used during the coronavirus pandemic.

Generally, GFHs act as non-profits and are legally mandated to provide a number of community services. In theory, they are supposed to provide high quality, affordable medical care for entire communities. Unfortunately, they are often underfunded, underused, and difficult to staff. This phenomenon occurs because GFH’s are more commonly found in areas where socioeconomic status is low and disease prevalence is high. In addition to this, impoverished communities lack healthcare to properly utilize facilities in the health ecosystem around them.

Privately Funded Hospitals/Healthcare Conglomerates

Privately Funded Hospitals (PFHs), in theory, were created to fill gaps and cater to wealthier consumers or those without access to public hospitals. Today, companies like HCA, Community Health, and Lifepoint have created a massive industry around this concept. In comparison to their government funded counterparts, Privately Funded Hospitals are inordinately successful. Save for a few “designer” healthcare providers, PFHs, in some areas, tend to cost less and accept a far wider range of insurance providers than GFHs. They also often conduct institutional research, but more for data collection for pharmaceutical companies than for public health data like most GFHs would. 

Market Forces

With their high fixed capital costs and low variable costs, hospitals inherently must maintain a constant demand for their services. They do so by negotiating with insurance companies who, then, send patients towards a hospital where care is covered under a contract. Despite such negotiations, many times hospitals struggle to turn a profit even after turning to insurance. What happens next is a form of horizontal integration. Bigger and more profitable hospitals will buy smaller and struggling hospitals in order to expand their market. This integration creates a hospital system: a network of two or more hospitals or healthcare facilities. 

Insurance Companies

Insurance Companies are crucified in most discussions today. They represent a $1 trillion industry that most people feel directly targets the consumer. Federal programs like Medicare/Medicaid were created to make insurance more affordable. But, because the coverage in those programs is so limited, it made full-coverage medical insurance packages that much more valuable and inflated prices for the vast majority of consumers. 

The debate here boils down to whether insurance companies are overcharging for medicines and procedures. It’s generally accepted that they are. However, regardless of the morality behind medical insurance, it does have three benefits: 

  1. New technologies are immediately accessible 
  2. The size of the insurance industry is positively correlated with an increase in Americans receiving medical care
  3. Wasteful spending is greatly reduced. 

Two dynamics often discussed in the context of healthcare economics are moral hazard and adverse selection. Broadly speaking, moral hazard refers to a phenomenon in which there is a lack of incentive to guard against risk. In healthcare, moral hazard refers how people risk their health more when the cost of treatment is perceived as cheaper. This insulates people from the true cost of healthcare and consume more than necessary services. This results in risk-bearing by everyone involved. Conversely, avoidance of necessary services when individuals have to pay more is also an example of moral hazard.

Adverse selection in the insurance industry occurs when those that need care purchase health insurance while others abstain from doing so. An effort to redress this was made with the passage of the Affordable Care Act of 2010 which mandates that every individual purchase a healthcare plan. 

The Pharmaceutical Industry: R&D

Effectively, research and development is how the pharmaceutical industry seeks to improve the human condition. It is true that the last 2 decades have seen more medical innovation than ever before. However, it appears that American consumers are funding the vast majority of R&D for the entire globe. The global pharma industry is around $1.7 trillion, and of that, America represents $600 Billion; more than a third. The jury is still out on whether we’ve seen benefits this disparity in funding. But, the fact remains that health outcomes globally and domestically are higher than ever. 

Critics of PFHs and healthcare conglomerates have long railed against the idea of for-profit healthcare and rapidly rising prices. There’s no clear solution in sight today. But, alongside the rise in healthcare prices, we’ve seen a dramatic drop in cancer mortality rates, hundreds of thousands of new drugs for previously ignored diseases, and healthier communities overall. 

But there are caveats. While the federal government is often slammed for wasteful spending, it’s estimated more than a tenth of PFHs profits stem from wasteful and unnecessary treatments, artificially inflating the industry and costing the consumer more and more each year. However, PFHs are uniquely suited to provide treatments for dementia, a sector where GFHs fall far behind. With an aging population, it makes sense that the industry is so large.


The majority of healthcare economics lies in domestic policy. It’s fascinating to see how much American policy impacts healthcare practice across the globe. It’s an important field of economics that literally deals with issues of life and death. Understanding healthcare economics will help you navigate the political and economic conversation among the government and the private industry. As long as people need healthcare, there will always be a need for healthcare economics.

About the author

Rohan Gupta
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I am a freshman at Duke University with an interest in healthcare, medicine, and economics.

Neel Tangella
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I am a freshman at USC.