To be able to analyze the impact of Obamacare, or the Affordable Care Act, that was passed in 2010, let's first take a look at the impact of subsidies, excise subsidies, on healthcare consumption and consumer welfare. The fundamental point we'll make here. Is that it's better to give people lump sum transfers, and leave the choice how to spend the money in their hands, based on their preferences, than to subsidize a particular product such as healthcare. There'll be a dead weight loss relative to a lump sum transfer if we use excise subsidies. Let's see why. And by the way, on healthcare, businesses a subsidy has existed since the 1940s. Largely provided by businesses, and then also through the government through Medicare and Medicaid. And the way businesses started providing the subsidy, it's a great example of the law of unintended consequences. There were price ceilings on what you could pay labors during World War two. to try to keep the price of labor from rising too rapidly. And so what companies ended up doing is finding other ways they could attract workers to their particular business during a period where labor was scarce. And so certain companies, like the Kaiser shipbuilding company, decided to offer free medical care, or reduced prices on medical care. This grew in practice the benefits weren't taxed. it kept spreading, and then there were some questions in Washington, should we tax these benefits or not? But by this time, so many people were receiving the benefits, there was too big of a push back. And that subsidized through no taxes being applied on corporate-sponsored healthcare benefits has created a subsidy for healthcare consumption. Now let's take a look at the impact of subsidies, and why they're inferior to lump sum transfers. Let's look in particular at the case of healthcare. All other goods and outlays on them on the vertical axis. The original budget line is AZ, where the consumer ends up buying H1 units of healthcare nine in this particular situation. And the price of healthcare in this situation, is $5 per unit. For each $5 drop in outlays in other goods, we get, reach $5 less spent on other goods, we get one more unit of healthcare. And we can see that because if we give up all $100 on outlays on other goods, we can end up at the other extreme of 20 units of healthcare being bought. Now, what if the government says, look. We're going to subsidize through, perhaps not taxing corporate benefits, or providing such a subsidy directly. To ensure that the price of health care is $3 per unit as opposed to $5. The budget line pivots from AZ to AZ prime. The consumer's optimal point changes from W to W prime. And instead of the original nine units of healthcare being bought, 15 units are now bought. How much does the government end up paying for those 15 units? The government provides $2 per unit in the form of a subsidy. So the amount of the subsidy across all 15 units is $30. 15 units times a $2 per unit subsidy. And the way that gets reflected in the graph is the height difference between W prime and T. W prime is what, consumers actually end up paying, $3 per unit on the new budget constraint. T is the original market price, the $5 per unit. The underlying cost of healthcare. Government covers the difference between the rest. W prime to T prime. Now, if we provided the same exact subsidy. But instead of saying it has to be spent on healthcare. But to, provided it as a lump sum grant. We can show why this consumer would be better off. So say we took the subsidy of WT, W prime T, and provided it as an income effect purely, and just shifted out the original budget constraint by that, by that vertical distance of W prime T. So, with the extreme we could give this consumer $30 that could be spent on other goods, a point A prime as opposed to original $100 that could be spent if only other goods were purchased. A lump sum subsidy would shift the entire budget constraint to A prime Z double prime. The same $5 initial cost of health care gets preserved, but now it's purely an income affect. The consumer would be better off under such a lump sum transfer. Would be able to attain W double prime on a difference curve U3. And the fundamental point is that, giving freedom of choice to the consumer to follow his or her own preferences. And letting him or her make that trade off, is better than trying to tilt consumption. Trying to introducing a substitution effect, as oppose to just providing a direct income effect. The same dollar expenditure gets a consumer further out on their indifference curve map. Let's look what this means in the form of measuring consumer surplus with demand curves and the cost consumers pay. When we reduce the price from $5 per unit to $3 per unit through the subsidy. The added consumer surplus is the blue area. P, E, B, P prime. How much does the government though end up paying to produce that increase in consumer surplus? It's the rectangle, P, C, B, P prime. It's both the blue area of consumer surplus that's generated, but also, the additional cost, the additional triangle, ECB. because, for all 15 units, the government has to pay a height of $2 per unit times 15 units. So it's the entire rectangle. So this subsidy, this excise subsidy produces what economists call a dead weight loss. The expenditure is higher than it needs to be to produce that increase in consumer surplus. A lump sum subsidy. A direct transfer of the blue area, P, E, B, P prime, could accomplish the same mission. The same increase in consumer surplus, but at lower cost. We wouldn't sacrifice that red triangle. So, fundamentally, it's the same way of showing that for the same expenditure, we can get more consumer surplus or achieve the same gain in consumable surplus at lower expenditure. Lumps sum transfers will do the work more effectively And that's something to keep in mind as we'll turn next to analyzing Obamacare. During discussions on the legislation, a lot of talk about, how do we bend the cost curve? How do we reduce expenditures on healthcare? Fundamentally, Obamacare will end up raising expenditures on healthcare. Because it provides subsidies, as we'll see, for greater healthcare consumption. It will also create deadweight losses along the way, and we'll see why. So, the impact will be the exact opposite of what the legislation purportedly was designed to do. To bend the cost curve, among other things. Studies that have been done, consumers are very, are much more sensitive than you'd think, to having to have skin in the game in having to pay their own healthcare expenditures. The leading study done by Rand, for example, indicates that for 50% copays up to some catastrophic limit, individuals will end up spending 67% less on insurance coverage than if there is no copay. Or, or, sorry. Not insurance cover. Overall medical care. And 72% less on hospital care. When they have more skin in the game, and they have to pay half of any expense out of their own pocket. The subsidies, however, if anything, move us away from having skin in the game, and that's why, instead of bending the cost curve down, it's, Obamacare will, it will end up bending the cost curve up.
