Instructions:To be answered in 2-4 well-written paragraphs

1.In this course, we've discussed a variety of ways that moral hazard affects the workings of our healthcare economy.Briefly discuss the range of issues created by moral hazard.

2.In some markets, like Cleveland, health care delivery has become consolidated into large health systems (like UH and the Clev Clinic).From the perspective of patients and payers, what are the pros and cons associated with health care consolidation?

Section IV:Computation Exercises (35 points total)

1.Pharmaceutical R&D (15 points)

Suppose a pharmaceutical firm just received a patent on a new chemical compound, which could be used in developing a new drug to control cholesterol. The pharmaceutical firm knows with certainty that it could develop the new drug in 14 years, with the stream of R&D costs given in the table below.If the project is undertaken, the firm expects to earn $100m annually from sales of the drug while the drug is under patent (i.e. through year 20).After that, it anticipates drug profits will fall to zero due to the entry of generic competitors.

a)Assuming the firm has a 10% discount rate, should the firm undertake the drug development project?(Provide the calculation results that support your answer.)

b)The firm has just found out that there is a current shortage of a key ingredient used to make the new drug.The shortage is only expected to be temporary, and is expected to have no effect on development costs, but is expected to increase the time to market by 1 year.How does this fact affect the firm's decision?(Provide calculation results.)

c)The FDA will usually grant patent extensions if a drug development project is delayed for reasons the drug developer cannot control.How would this fact affect the firm's decision?That is, if they knew they could get a one-year patent extension if the "development delay" in part (b) occurs, how is the firm's development decision affected? (Provide calculation results.)

Physician treatment incentives:

Assume six treatments exist to treat patients with a particular intestinal disorder.The expected health benefits (measured in dollars) from each treatment and the providers' cost of providing each treatment is listed in the table below.

Treatment

Health Benefit to Patient

(in $1000s)

Treatment Cost

(in $1000s)

A

26

10

B

50

20

C

66

30

D

78

40

E

84

50

F

87

60

Throughout this question, assume that physicians (not patients) determine the choice of treatment and that patients are fully insured.Also, assume physicians value the health of their patients half as much as their patients do.

a)Which is the efficient treatment for these patients?How much economic surplus is created from this choice?

b)If a physician operates as a "good agent" for their patient (i.e. always chooses the treatment the patient would want them to choose), which treatment would they choose?How much economic surplus is created from this choice?

c)Suppose physicians are paid an amount equal to the cost of treatment for whichever treatment the physician chooses to provide.Which treatment will the physician choose?How much economic surplus is created from this choice?

d)Suppose physicians are paid a fixed payment set to $35,000 regardless of the treatment they choose.Which treatment will the physician choose?How much economic surplus is created from this choice?

e)Is it efficient for physicians to act as "good agents" for their patients?