Are prices driving increases in Medicare spending? Even so, can the government set ‘good’ prices? – Healthcare Economist

According to a recent Health Affairs Perspective from Michael Chernew, the answer is ‘no’. In fact, physician and hospital prices may be too low.

Although much has been made of high prices contributing to high spending in the US, 5 spending growth in Medicare is not driven by price growth. In fact, inflation-adjusted Medicare physician fees have fallen more than 30 percent since 2001, and payment rates for hospitals have risen at rates below the growth of input costs, contributing to declining hospital margins for Medicare patients. Hospitals with a high share of Medicare patients are more likely to merge or close. The Medicare Payment Advisory Com-mission (MedPAC) now recommends above-current-law price updates for the physician and hospital payment systems.

Even so, selecting the ‘right’ price is very difficult in practice since creating prices in a non-market setting is highly problematic. Chernew writes:

Because of fixed costs, the average cost is often above the marginal cost. So if prices are set at the average cost, there remains an incentive for providers to increase volume to take advantage of the difference between the price and the marginal cost. If prices are set at the marginal cost, organizations with high Medicare volumes will have a hard time investing in needed capital and may be forced to merge or close.

Even if we know what the right price is, measuring price is highly problematic in practice.

Second, measuring cost is inherently challenging, particularly under dynamic conditions. Economies of scale and scope, changes in costs over time, allocation of indirect costs, and the responsiveness of costs to prices all make measuring the costs of efficient care provision inherently difficult

You can read the full article here.