, Chapter 2: Using Economics to Study Health Care Issues
This chapter introduces the basic economics model of supply and demand and examines
its use in the study of health care issues. A discussion of the principles of optimizing
behavior sets the stage for the development of the model of demand and supply. A
discussion of the theory of the firm follows, contrasting perfect and imperfect
competition. Supply- and demand-side imperfections are also discussed.
Chapter Outline
a. The relevance of economics in health care
1. Critical assumptions in economics
2. The scientific method
3. Model building
4. Problem solving
5. Marginal analysis
b. Economic optimization
c. Demand and supply
1. The law of demand
2. Price elasticity of demand
3. The law of supply
4. Equilibrium
d. The competitive model
1. Theory of firm behavior
2. Price Ceilings and Price Floors
3. The Impact of an Excise Tax
4. Welfare implications
a) Consumer surplus
b) Producer surplus
e. Imperfect competition
1. Supply-side imperfections
2. Demand-side imperfections
f. Summary and conclusions
Profile: Kenneth J. Arrow
Issues in Medical Care Delivery Back-of-the-Envelope
Rhetoric in Economics Using Game Theory to Study
Economic Behavior
Positive and Normative Analysis
How to Survive Supply and
Demand
Is “Safe” Sex Really Safe?
1
,Chapter Objectives
1. Explain the use of economics as a framework for studying health care issues.
2. Understand the limits of economics in explaining behavior in medical care markets.
3. Recognize the importance of incentives in explaining individual behavior.
4. Examine the basic economic model of demand and supply, including the concepts of
equilibrium and elasticity.
5. Understand and apply the model of firm behavior in medical markets.
Opening Video
Adam Smith Needs Revision
A Beautiful Mind (2001)
Distributed by Universal Pictures
Produced by Karen Kehela-Sherwood, Todd Hallowell, and Brian Grazer
Directed by Ron Howard
Based on a biography by Sylvia Nasar
Screenplay by Akiva Goldsman
Cast:
Russell Crowe as John Nash, schizophrenic mathematician
Adam Goldberg as Sol, graduate student and classmate of Nash
Josh Lucas as Hansen, graduate student and classmate of Nash
Anthony Rapp as Bender, graduate student and classmate of Nash
Jason Gray-Stanford as Ainsley, graduate student and classmate of Nash
Synopsis:
John Forbes Nash, Jr., a socially challenged graduate student at Princeton, is able to solve
problems that challenge the greatest minds of the era. Eventually, Nash published “The
Bargaining Problem,” became interested in game theory, and in 1994 won the Nobel
Prize in Economics. Later in life, Nash developed paranoid schizophrenia. Much of the
story is about his battle with the mental disorder.
Scene:
Scene 5, ”Governing Dynamics” starting at 19:00 (2 minutes, 45 seconds, adult content)
While Nash and his fellow graduate students relax in a local bar, five co-eds (4 brunettes
and a blonde) enter the bar. Nash and his friends discuss the appearance of the five
women standing in front of them and plot their strategy. Hansen recalls the lessons of
Adam Smith on competition: individual self interest serves the common good. Ainsley
replies that it’s every man for himself. Nash has an epiphany: Smith needs revision. His
theory is incomplete. The best strategy is one of cooperation. If they all go for the
blonde, they block each other and offend the other women. They all leave unhappy. If
they all go for a different brunette, they will all leave with a date…a date being the object
of the game. What is a prisoner’s dilemma? Is this scene a good example of a prisoner’s
dilemma?
2
, Although this is not a prisoner’s dilemma per se, Nash observed that sometimes the
cooperative outcome is superior to competitive outcome, where everyone plays their
dominant strategy in a non-cooperative game. Each player in the game has the incentive
to defect by going for the blonde (which makes this a non-cooperative game), but if all
cooperate and go for one of the brunettes, each player should leave with a date. In a
prisoner’s dilemma, two players will reach a “Nash Equilibrium” where both decide to
defect, where they could have done better by cooperating. The “best response” strategy
leads both players to defect and results in the worst outcome.
Teaching Suggestions
Consider breaking out your class into groups of 3-5 students. Each group will discuss
for 5-10 minutes the following: What do I hope to get out of this class. Students with
different backgrounds will have different expectations. It is good to know what
students want before you get too far into the course. I use this breakout technique
throughout the semester, calling it 3x3 or 5x5—meaning groups of 3 for 3 minutes or
groups of 5 for 5 minutes.
Students, especially those without an economics background, seem to enjoy a class
discussion of “How to Survive Supply and Demand.” Most have good intuition and
just need to be reassured that it is useful in an economics class.
A brief graphical discussion of optimization is a good way to introduce the concept of
the flat-of-the-curve in medical care delivery. This is a good way for students to
remember both concepts.
Depending on your class make-up, you may spend a lot or a little time on this chapter.
Students without much economics should focus on supply and demand. If you have
mostly economics majors, focus on the impact of price floors, price ceilings, and
excise taxes. The latter is especially important since most health care reform
legislation has as its major funding vehicle some form of excise tax on tobacco.
If you have more advanced students, you may want to spend some time discussing the
statistical appendix at the end of this chapter. While most of my advanced students
have had a class in econometrics, even they seem to appreciate the review.
Suggested Approaches to End-of-Chapter Questions
1. a) Classifying tobacco as an addictive substance will cause the demand curve to
shift to the left; price and quantity will go down.
b) Raising the excise tax on tobacco products is shown by a leftward shift in the
supply curve; prices will rise and quantity will fall.
c) Destruction of the tobacco harvest is depicted by a leftward shift in the supply
curve; prices will rise and quantity will fall.
d) Settlement of the lawsuit will increase the cost of making tobacco products
available to consumers. This is depicted by a leftward shift in the supply
curve; prices will rise and quantity will fall.
e) The information raises the cost of drinking coffee. When the cost of a
substitute increases the demand for cigarettes rises. This is depicted by a
rightward shift in the demand curve; price and quantity rise.
3
This chapter introduces the basic economics model of supply and demand and examines
its use in the study of health care issues. A discussion of the principles of optimizing
behavior sets the stage for the development of the model of demand and supply. A
discussion of the theory of the firm follows, contrasting perfect and imperfect
competition. Supply- and demand-side imperfections are also discussed.
Chapter Outline
a. The relevance of economics in health care
1. Critical assumptions in economics
2. The scientific method
3. Model building
4. Problem solving
5. Marginal analysis
b. Economic optimization
c. Demand and supply
1. The law of demand
2. Price elasticity of demand
3. The law of supply
4. Equilibrium
d. The competitive model
1. Theory of firm behavior
2. Price Ceilings and Price Floors
3. The Impact of an Excise Tax
4. Welfare implications
a) Consumer surplus
b) Producer surplus
e. Imperfect competition
1. Supply-side imperfections
2. Demand-side imperfections
f. Summary and conclusions
Profile: Kenneth J. Arrow
Issues in Medical Care Delivery Back-of-the-Envelope
Rhetoric in Economics Using Game Theory to Study
Economic Behavior
Positive and Normative Analysis
How to Survive Supply and
Demand
Is “Safe” Sex Really Safe?
1
,Chapter Objectives
1. Explain the use of economics as a framework for studying health care issues.
2. Understand the limits of economics in explaining behavior in medical care markets.
3. Recognize the importance of incentives in explaining individual behavior.
4. Examine the basic economic model of demand and supply, including the concepts of
equilibrium and elasticity.
5. Understand and apply the model of firm behavior in medical markets.
Opening Video
Adam Smith Needs Revision
A Beautiful Mind (2001)
Distributed by Universal Pictures
Produced by Karen Kehela-Sherwood, Todd Hallowell, and Brian Grazer
Directed by Ron Howard
Based on a biography by Sylvia Nasar
Screenplay by Akiva Goldsman
Cast:
Russell Crowe as John Nash, schizophrenic mathematician
Adam Goldberg as Sol, graduate student and classmate of Nash
Josh Lucas as Hansen, graduate student and classmate of Nash
Anthony Rapp as Bender, graduate student and classmate of Nash
Jason Gray-Stanford as Ainsley, graduate student and classmate of Nash
Synopsis:
John Forbes Nash, Jr., a socially challenged graduate student at Princeton, is able to solve
problems that challenge the greatest minds of the era. Eventually, Nash published “The
Bargaining Problem,” became interested in game theory, and in 1994 won the Nobel
Prize in Economics. Later in life, Nash developed paranoid schizophrenia. Much of the
story is about his battle with the mental disorder.
Scene:
Scene 5, ”Governing Dynamics” starting at 19:00 (2 minutes, 45 seconds, adult content)
While Nash and his fellow graduate students relax in a local bar, five co-eds (4 brunettes
and a blonde) enter the bar. Nash and his friends discuss the appearance of the five
women standing in front of them and plot their strategy. Hansen recalls the lessons of
Adam Smith on competition: individual self interest serves the common good. Ainsley
replies that it’s every man for himself. Nash has an epiphany: Smith needs revision. His
theory is incomplete. The best strategy is one of cooperation. If they all go for the
blonde, they block each other and offend the other women. They all leave unhappy. If
they all go for a different brunette, they will all leave with a date…a date being the object
of the game. What is a prisoner’s dilemma? Is this scene a good example of a prisoner’s
dilemma?
2
, Although this is not a prisoner’s dilemma per se, Nash observed that sometimes the
cooperative outcome is superior to competitive outcome, where everyone plays their
dominant strategy in a non-cooperative game. Each player in the game has the incentive
to defect by going for the blonde (which makes this a non-cooperative game), but if all
cooperate and go for one of the brunettes, each player should leave with a date. In a
prisoner’s dilemma, two players will reach a “Nash Equilibrium” where both decide to
defect, where they could have done better by cooperating. The “best response” strategy
leads both players to defect and results in the worst outcome.
Teaching Suggestions
Consider breaking out your class into groups of 3-5 students. Each group will discuss
for 5-10 minutes the following: What do I hope to get out of this class. Students with
different backgrounds will have different expectations. It is good to know what
students want before you get too far into the course. I use this breakout technique
throughout the semester, calling it 3x3 or 5x5—meaning groups of 3 for 3 minutes or
groups of 5 for 5 minutes.
Students, especially those without an economics background, seem to enjoy a class
discussion of “How to Survive Supply and Demand.” Most have good intuition and
just need to be reassured that it is useful in an economics class.
A brief graphical discussion of optimization is a good way to introduce the concept of
the flat-of-the-curve in medical care delivery. This is a good way for students to
remember both concepts.
Depending on your class make-up, you may spend a lot or a little time on this chapter.
Students without much economics should focus on supply and demand. If you have
mostly economics majors, focus on the impact of price floors, price ceilings, and
excise taxes. The latter is especially important since most health care reform
legislation has as its major funding vehicle some form of excise tax on tobacco.
If you have more advanced students, you may want to spend some time discussing the
statistical appendix at the end of this chapter. While most of my advanced students
have had a class in econometrics, even they seem to appreciate the review.
Suggested Approaches to End-of-Chapter Questions
1. a) Classifying tobacco as an addictive substance will cause the demand curve to
shift to the left; price and quantity will go down.
b) Raising the excise tax on tobacco products is shown by a leftward shift in the
supply curve; prices will rise and quantity will fall.
c) Destruction of the tobacco harvest is depicted by a leftward shift in the supply
curve; prices will rise and quantity will fall.
d) Settlement of the lawsuit will increase the cost of making tobacco products
available to consumers. This is depicted by a leftward shift in the supply
curve; prices will rise and quantity will fall.
e) The information raises the cost of drinking coffee. When the cost of a
substitute increases the demand for cigarettes rises. This is depicted by a
rightward shift in the demand curve; price and quantity rise.
3
