Table K. How versus why medical care expenditures rise¹.

How medical care expenditures rise	Why medical care expenditures rise
Economy-wide factors
1. General inflation	1. Monetary policies; fiscal policies relating to taxing, spending, and debt management; supply-side shocks such as energy price increases, food price increases caused by world-wide droughts, Social Security tax rate increases, and minimum wage increases; productivity changes; and monopoly powers of firms and unions over prices and wages.
2. Aggregate population growth	2. Birth rates, death rates, in-migration, out-migration.
Health sector-specific factors
3. Growth in per capita patient visits or per capita patient days	3. Factors influencing the demand for and supply of medical care services: Third-party payments which partially or totally insulate patients from the true total cost of services (demand-side factor). Fee-for-service and cost-based reimbursement systems (piecework payment plans) that lack incentives to provide care in the least expensive manner (supply-side factor). Application of modern techniques of finance, management, and information systems to improve efficiency and effectiveness. Product innovative technologies that increase demand for the existing pool of patients and enlarge the potential patient base by expanding the diagnostic and therapeutic procedures and techniques to cover diagnoses and disease conditions that previously were outside the scope of such procedures and techniques. Shifts in the diagnostic case-mix and in the age-sex composition of the population. Increases in real income. The psychological factor that achieving satisfaction in all other areas of life (material and nonmaterial) is conditional on and affected by one's subjective feeling of health status. If a person is not feeling well, other satisfactions are typically diminished and, in some cases, eliminated. Availability of beds and health manpower.
4. Changes in the nature of services and supplies provided per visit or per patient day (product innovation, intensity of services, amenities, and so forth)2	4. Generally, the same factors as in (3) above; however, the relative importance of particular factors may differ.
5. Medical care price increases relative to general price inflation (GNP deflator)	5. This measures change in medical care prices relative to overall prices in the economy. It captures the interplay of (1) demand-pull inflationary forces (such as changes in deductibles and coinsurance); (2) cost pressures specific to the industry; (3) supply-side pricing behavior; (4) supply-side productivity behavior, and so on. In general, medical care prices increase faster than the GNP deflator. During periods of high growth in commodity and energy prices, the differential between medical care prices and economy-wide prices usually narrows. In addition, when overall price increases in the economy decelerate, medical care price increases typically decelerate with a marked lag. Generally, the same factors as in (3) cause the differential rates of price increase; however, the relative importance of particular factors may differ and, in some cases, the sign of the factor may differ. For example, increasing the number of dentists relative to population in a given geographic area may cause dental prices to rise more slowly than would otherwise be the case and to expand utilization of dental services in the geographic area. In other words, expanding the supply of dentists, all other things constant, may have a negative impact on price increases, but a positive impact on visits and intensity of services per visit.

¹Martin Feldstein (1971) has made this distinction between how vs. why medical expenditures have risen. For analyses accounting for expenditure growth using the how approach, see M. Feldstein (1971, 1981); Klarman et al. (1970); and Mushkin (1979).

²This factor is calculated as a residual by deflating current dollar expenditures per visit or per patient day by a relevant price index. This yields growth in real services or intensity per visit or per day. Since the five measured components (general inflation, aggregate population growth, growth in per capita visits or days, medical care price increases relative to general price inflation, and growth in total expenditures) are each subject to sampling variability and measurement error, it is important to interpret the residual category with caution. For example, if through unpackaging or unbundling of services (that is, separating services and procedures into finer components) and billing individually for each service or procedure, it may result in greater total revenues for a fixed volume and mix of services. Thus, effective price increases are greater than shown by National price measures, which do not reflect such unbundling or unpackaging. If the National price index (not reflecting unpackaging) is used to calculate the residual, it will result in lower price increases and higher residual growth than if the true (unbundled) price increases were used.

SOURCE: Bureau of Data Management and Strategy, Health Care Financing Administration.