MHA710 | MHA710 Healthcare Economics Exam 3
v3 | Questions with Correct Answers and Expert
Explanation for Each Question | Louisiana State
University in Shreveport
1. In the context of the physician labor market, what does a high Internal Rate of Return (IRR)
for medical education suggest compared to other professional degrees?
A. The physician market is perfectly competitive with no barriers to entry.
B. Medical education is subsidized too heavily by the government.
C. Physicians are underpaid relative to their educational investment.
D. There may be significant barriers to entry or high costs associated with training.
Correct Answer: D
Expert Explanation: A high IRR suggests that the financial rewards for completing medical
school are significantly greater than the costs. This often indicates that supply is
constrained by barriers to entry such as limited medical school spots or licensing
requirements. Economists use this measure to compare the attractiveness of various career
paths over a lifetime.
2. Which hypothesis suggests that physicians may create their own demand for services when
their income falls below a certain level?
A. The Permanent Income Hypothesis
B. The Consumer Sovereignty Model
C. The Target Income Hypothesis
D. The Rational Choice Theory
Correct Answer: C
Expert Explanation: The Target Income Hypothesis posits that physicians have a desired
level of income and will adjust their clinical behavior to reach it. If reimbursements drop,
they may increase the volume of services provided to maintain their standard of living. This
is a classic example of supplier-induced demand in healthcare markets.
3. What is the primary economic characteristic of a ‘Medical Arms Race’ among hospitals?
A. Competition based on technology and quality rather than price.
B. Price wars to attract the most cost-conscious patients.
C. Collaboration between hospitals to reduce administrative waste.
,D. A decrease in the number of specialized services offered.
Correct Answer: A
Expert Explanation: In a Medical Arms Race, hospitals compete for patients and
physicians by investing in the latest expensive technologies and amenities. Because
insurance often insulates patients from the full cost, hospitals focus on quality signals
rather than price efficiency. This behavior historically led to duplicative services and higher
overall healthcare spending.
4. According to the Arrow-Lind Theorem, why might the government be better suited to
handle certain healthcare risks than private insurers?
A. The government is not profit-motivated and ignores transaction costs.
B. The government can spread risk across a much larger population of taxpayers.
C. Private insurers are incapable of calculating actuarial fair premiums.
D. Public programs are always more efficient than private market solutions.
Correct Answer: B
Expert Explanation: The theorem suggests that when risks are spread across a very large
number of people, the total risk cost to society approaches zero. The government can pool
the risk of the entire population, making it more efficient at handling massive or
catastrophic health risks. This principle supports the economic rationale for social
insurance programs like Medicare.
5. What does ‘Roemer’s Law’ signify in the hospital industry?
A. Hospital prices will always rise to match inflation.
B. The number of physicians is inversely proportional to hospital beds.
C. Hospitals must provide emergency care regardless of ability to pay.
D. A built bed is a filled bed, implying supply creates its own demand.
Correct Answer: D
Expert Explanation: Roemer’s Law suggests that in a system with extensive insurance
coverage, the supply of hospital beds directly influences the utilization rate. This implies
that as long as beds are available, physicians and hospitals will find patients to occupy
them. It is a fundamental concept in health planning and Certificate of Need (CON)
regulations.
6. In pharmaceutical economics, what is the primary purpose of granting patents to drug
manufacturers?
A. To ensure that all drugs are sold at the lowest possible price.
B. To allow the government to regulate the manufacturing process.
, C. To provide an incentive for R&D by allowing temporary monopoly power.
D. To prevent generic manufacturers from ever entering the market.
Correct Answer: C
Expert Explanation: Developing new drugs involves high fixed costs and high risks of
failure. Patents allow companies to recoup these R&D investments by charging prices
above marginal cost for a limited time. Without this protection, competitors could easily
copy the formula, leading to a market failure where no innovation occurs.
7. Which of the following describes a ‘Type II Error’ in the context of FDA drug approval?
A. Approving a drug that is actually harmful or ineffective.
B. Charging too much for a newly approved medication.
C. Rejecting a drug that is actually safe and effective.
D. Delaying the entry of generic substitutes after a patent expires.
Correct Answer: C
Expert Explanation: A Type II error occurs when the regulator fails to approve a beneficial
drug, thereby depriving patients of a valuable treatment. While a Type I error (approving a
bad drug) is more visible, a Type II error also has significant social costs in terms of lost
health. Balancing these two types of errors is a major challenge for the FDA.
8. How does the ‘Newhouse Model’ explain the behavior of non-profit hospitals?
A. They aim to maximize the number of low-income patients served.
B. They focus exclusively on minimizing costs to keep taxes low.
C. They behave identically to for-profit hospitals to ensure survival.
D. They maximize a utility function consisting of quantity and quality of care.
Correct Answer: D
Expert Explanation: Newhouse proposed that non-profit managers derive utility from
both the volume of patients treated and the prestige or quality of the institution. This leads
non-profits to produce higher quality than is technically efficient or required by the market.
This model helps explain why non-profit hospitals often invest in expensive, high-prestige
technology.
9. What is the economic definition of ‘Cost Shifting’ in hospitals?
A. Reducing hospital staff to lower the overall operating budget.
B. Charging private payers more to offset lower payments from public payers.
C. Moving patients from inpatient care to outpatient surgical centers.
v3 | Questions with Correct Answers and Expert
Explanation for Each Question | Louisiana State
University in Shreveport
1. In the context of the physician labor market, what does a high Internal Rate of Return (IRR)
for medical education suggest compared to other professional degrees?
A. The physician market is perfectly competitive with no barriers to entry.
B. Medical education is subsidized too heavily by the government.
C. Physicians are underpaid relative to their educational investment.
D. There may be significant barriers to entry or high costs associated with training.
Correct Answer: D
Expert Explanation: A high IRR suggests that the financial rewards for completing medical
school are significantly greater than the costs. This often indicates that supply is
constrained by barriers to entry such as limited medical school spots or licensing
requirements. Economists use this measure to compare the attractiveness of various career
paths over a lifetime.
2. Which hypothesis suggests that physicians may create their own demand for services when
their income falls below a certain level?
A. The Permanent Income Hypothesis
B. The Consumer Sovereignty Model
C. The Target Income Hypothesis
D. The Rational Choice Theory
Correct Answer: C
Expert Explanation: The Target Income Hypothesis posits that physicians have a desired
level of income and will adjust their clinical behavior to reach it. If reimbursements drop,
they may increase the volume of services provided to maintain their standard of living. This
is a classic example of supplier-induced demand in healthcare markets.
3. What is the primary economic characteristic of a ‘Medical Arms Race’ among hospitals?
A. Competition based on technology and quality rather than price.
B. Price wars to attract the most cost-conscious patients.
C. Collaboration between hospitals to reduce administrative waste.
,D. A decrease in the number of specialized services offered.
Correct Answer: A
Expert Explanation: In a Medical Arms Race, hospitals compete for patients and
physicians by investing in the latest expensive technologies and amenities. Because
insurance often insulates patients from the full cost, hospitals focus on quality signals
rather than price efficiency. This behavior historically led to duplicative services and higher
overall healthcare spending.
4. According to the Arrow-Lind Theorem, why might the government be better suited to
handle certain healthcare risks than private insurers?
A. The government is not profit-motivated and ignores transaction costs.
B. The government can spread risk across a much larger population of taxpayers.
C. Private insurers are incapable of calculating actuarial fair premiums.
D. Public programs are always more efficient than private market solutions.
Correct Answer: B
Expert Explanation: The theorem suggests that when risks are spread across a very large
number of people, the total risk cost to society approaches zero. The government can pool
the risk of the entire population, making it more efficient at handling massive or
catastrophic health risks. This principle supports the economic rationale for social
insurance programs like Medicare.
5. What does ‘Roemer’s Law’ signify in the hospital industry?
A. Hospital prices will always rise to match inflation.
B. The number of physicians is inversely proportional to hospital beds.
C. Hospitals must provide emergency care regardless of ability to pay.
D. A built bed is a filled bed, implying supply creates its own demand.
Correct Answer: D
Expert Explanation: Roemer’s Law suggests that in a system with extensive insurance
coverage, the supply of hospital beds directly influences the utilization rate. This implies
that as long as beds are available, physicians and hospitals will find patients to occupy
them. It is a fundamental concept in health planning and Certificate of Need (CON)
regulations.
6. In pharmaceutical economics, what is the primary purpose of granting patents to drug
manufacturers?
A. To ensure that all drugs are sold at the lowest possible price.
B. To allow the government to regulate the manufacturing process.
, C. To provide an incentive for R&D by allowing temporary monopoly power.
D. To prevent generic manufacturers from ever entering the market.
Correct Answer: C
Expert Explanation: Developing new drugs involves high fixed costs and high risks of
failure. Patents allow companies to recoup these R&D investments by charging prices
above marginal cost for a limited time. Without this protection, competitors could easily
copy the formula, leading to a market failure where no innovation occurs.
7. Which of the following describes a ‘Type II Error’ in the context of FDA drug approval?
A. Approving a drug that is actually harmful or ineffective.
B. Charging too much for a newly approved medication.
C. Rejecting a drug that is actually safe and effective.
D. Delaying the entry of generic substitutes after a patent expires.
Correct Answer: C
Expert Explanation: A Type II error occurs when the regulator fails to approve a beneficial
drug, thereby depriving patients of a valuable treatment. While a Type I error (approving a
bad drug) is more visible, a Type II error also has significant social costs in terms of lost
health. Balancing these two types of errors is a major challenge for the FDA.
8. How does the ‘Newhouse Model’ explain the behavior of non-profit hospitals?
A. They aim to maximize the number of low-income patients served.
B. They focus exclusively on minimizing costs to keep taxes low.
C. They behave identically to for-profit hospitals to ensure survival.
D. They maximize a utility function consisting of quantity and quality of care.
Correct Answer: D
Expert Explanation: Newhouse proposed that non-profit managers derive utility from
both the volume of patients treated and the prestige or quality of the institution. This leads
non-profits to produce higher quality than is technically efficient or required by the market.
This model helps explain why non-profit hospitals often invest in expensive, high-prestige
technology.
9. What is the economic definition of ‘Cost Shifting’ in hospitals?
A. Reducing hospital staff to lower the overall operating budget.
B. Charging private payers more to offset lower payments from public payers.
C. Moving patients from inpatient care to outpatient surgical centers.
