The Importance of Relative Prices in Health Care Spending

At least since the publication of the important article “It’s the Prices, Stupid,”1 it has been known that the substantial gap in health care spending between the United States and other developed countries is largely because of differences in prices, not use of health care services. Moreover, even at higher price (and spending) levels, most health care outcomes in the United States are not superior to those of peer nations. These facts have motivated calls by some to regulate health care prices in the United States.

In doing so, caution is warranted. Putting aside challenges of establishing the correct overall price level, there is reason to be concerned about relative prices of health care goods and services. That is, at any absolute price level, the price of health care service A relative to the price of service B has important implications. For example, variable copayments across drugs (ie, a tiered formulary) drive greater use toward drugs that cost patients less relative to drugs with similar therapeutic effects that cost patients more.

According to Hayek,2 prices convey important signals. Prices guide firms when they make their production decisions and consumers as they allocate their budgets. In efficient markets, prices are the means by which supply and demand equilibrate. But when prices are pushed artificially high or held artificially low relative to one another (eg, through policy), the equilibria to which they lead are inefficient: too much of some goods and too little of others are produced and consumed. This is the case in the health care sector, where both overuse and underuse are widespread. In many cases, this is because of getting the relative prices wrong. For example, cost sharing for maintenance medications is associated with underuse of them by patients with chronic conditions, whereas advanced imaging for low back pain is overused, in large part because it is covered by health insurance.

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