HPI4001 – Economics of Healthcare
Case 1 – the economic approach of health care
Aims:
- Economy as a scientific discipline
- The economic approach of health and health care
- The past, present and the future of ‘health economics’ as a discipline
Some definitions:
- Economics
o Study of choices under conditions of scarcity
- Health economics
o Applied field of economics
o Study the choices/behaviour of individuals, health care providers, public and private
organizations, and governments in health decision-making
o Study how (scarce) resources are allocated to and within the health system
- Health care economics
o The subject of analysis is the health (medical) care industry, not health
Health economics – tension between:
- Limited financial possibilities (healthcare budget constraints)
- Clinical possibilities (new, expensive treatments/interventions/innovations)
Not enough resources to meet all of society’s needs
Choices have to be made
Efficiently allocate health care resources
Characteristics why health economics is different than economics:
1. The nature of demand – the demand for health care is a derived demand (for health)
o The most obvious distinguishing characteristics of an individual’s demand for medical
services is that it is not steady in origin as, for example, for food or clothing, but
irregular and unpredictable
2. Existence of externalities
3. Informational asymmetries between health care providers and patients
4. Product uncertainty - uncertainty with respect to both the need for and effectiveness of
health care
o Uncertainty as to the quality of the product is perhaps more intense here than in any
other important commodity. Recovery from disease is as unpredictable as is its
incidence
5. Supply conditions
o Entry to the profession is restricted by licensing. Licensing restricts supply and
therefore increases the cost of medical care
6. Pricing practices
o The unusual pricing practices and attitudes of the medical profession are well known,
extensive price discrimination by income (with extreme of zero prices for sufficiently
indigent patients) and, formerly, a strong insistence on fee for services against such
alternatives as prepayment
Some key economic concepts:
- Scarcity: tension between unlimited needs and limited possibilities to fulfil those needs
o Choices arise as a result of economic problem of scarcity
- Allocation of scarce resources among competing demands
, o Allocation: the division of things into shares or portions
- Utility: the satisfaction derived or expected to be derived from the consumption of goods
and services (subjective)
- Preference: the order that a person (an agent) gives to alternatives based on their relative
utility
- All resource uses have an opportunity cost (the cost of the best alternative option)
- Opportunity costs: a benefit, profit, or value of something that must be given up to acquire
or achieve something else
- Externalities: costs and benefits that our decisions to buy or not to buy impose on others
who are not a party to the transaction (negative or positive)
- Efficiency: an economic state in which every resource is optimally allocated to serve each
individual or entity in the best way while minimizing waste and inefficiency
- Allocative efficiency (Pareto efficiency/optimality): a distribution or use of resources
(allocation) in which no one can be made better off without making someone worse off
- Competition: a condition where different economic firms seek to obtain a share of a limited
good by varying the elements of the marketing mix (price, product, promotion, and place)
- If one or more of efficiency conditions are not fulfilled, then faced with a market failure
- Perfect competition: a state that is needed to get optimal allocation of resources. There are
certain conditions of a perfect competition. Failing one or more conditions means there is an
inefficient allocation of resources and a governmental intervention is needed
(Perfect) market/perfect competition:
1. Consists of many buyers and sellers (they can compete with each other)
2. All parties have perfect information
3. All parties sell identical products (homogenous product)
4. There are no entry or exit barriers (free entry to the market, no transaction costs)
5. Firms act independently of each other and aim to maximize profits
6. Firms can sell as many outputs as they want at the market price
Other key economic concepts:
- Moral hazard: a situation in which one party gets involved in a risky event knowing that it is
protected against the risk and the other party will incur the costs. It arises when both the
parties have incomplete information about each other.
- Transaction costs: the costs associated with exchange of goods or services and incurred in
overcoming market imperfections. Transaction costs cover a wide range, such as
communication charges, legal fees, informational cost of finding the price, quality, and
durability, etc., and may also include transportation costs. Transaction costs are a critical
factor in deciding whether to make a product or buy it.
Specific characteristics of health care and its government interference:
- Presence of externalities (e.g. smoking, vaccination)
o Government interference: smoking bans / national vaccination program
- High R&D costs
o Government interference: patent protection for drug innovation
- Market power (monopoly)
o Government interference: drug price regulation
- Nature of goods (e.g. collective goods such as public health program)
o Government interference: national vaccination program
- Uncertainty
o Government interference: health insurance (however, several problems such as
moral hazard, adverse selection, etc.)
, - Unexpected behaviour of the physician
o Governance interference: no advertising and pricing competition
Some challenges for the health care system:
- More demand for healthcare with rising healthcare expenditures challenges us to make
choices
- Medical and technological advancement challenges
- Healthcare regulatory challenges
- Increasing expectations from patients
- More healthcare demand puts the labour market under pressure and asks for innovations
Development and prospect of health economics
William’s diagram (most important subject of health economics) – the scope of health economics
Health economics is divided into eight distinct topics (the relationships will not be asked)
A What influences Occupational hazards; consumption patterns; education; income; etc.
health? (other than
health care)
B What is health? Perceived attributes of health; health status indexes; value of life;
What is its value? utility scaling of health
C Demand for health Influences of A + B on health care seeking behaviour; barriers to
care access (price, time, psychological, formal); agency relationship; need
D Supply of health Costs of production; alternative production techniques; input
care substitution; markets for inputs (workforce, equipment, drugs, etc.);
remuneration methods and incentives
E Micro-economic Cost effectiveness and cost benefit analysis of alternative ways of
evaluation at delivering care (e.g. choice of mode, place, timing or amount) at all
treatment level phases (detection, diagnosis, treatment, after care, etc.)
F Market equilibrium Money prices, time prices, waiting lists and non-price rationing
systems as equilibrating mechanisms and their differential effects
G Evaluation at whole Equity and allocative efficiency criteria brought to bear on E + F; inter-
system level regional and international comparisons of performance
, H Planning, budgeting Evaluation of effectiveness of instruments available for optimising the
and monitoring system; including the interplay of budgeting, workforce allocations;
mechanisms norms; regulation etc. and the incentive structures they generate
In his diagrammatic representation of health economics, Williams set out a research agenda to
encompass the disparate activities of those of us who have found ourselves ‘doing what health
economists do’. Central to this diagram are boxes C (demand for health care) and D (supply of health
care), symbolizing the economists’ focus on the market and the health economists’ focus on the
market for health care. Feeding into box C are boxes A (what influences health?) and B (what is
health? What is its value). Box E (micro-economic evaluation at treatment level) covers the range of
micro-economic techniques available for the evaluation of healthcare inventions. Williams comments
that this has been the area in which the bulk of work by British health economists has been
concentrated, involving collaboration with clinicians. Box F (market equilibrium) brings supply and
demand together in the analysis of how and whether markets for healthcare can work and of non-
price rationing systems. Box G (evaluation at whole system level) covers evaluation at whole system
level (a bird’s eye view of healthcare systems). Finally, box H (planning, budgeting and monitoring
mechanisms) covers the planning, budgeting and monitoring mechanisms of health services. In
describing health economics as a sub-discipline, Williams proposed that normative health economics
is about ensuring that benefits gained outweigh benefits forgone. He argues that the benefit to be
gained from healthcare is better health.
Weaknesses of William’s diagram
Boxes A (what influences health other than health care) and G (evaluation of whole system level)
have proved relatively unexplored territory. In the past of the healthcare economics many focused
on empirical analysis of supply and demand for healthcare. The Williams diagram does not explicitly
offer a box to cover the macro-economic evaluation of the economics of non-health sector policies
that influence health.
- Need for paradigm shift
- Research programmes needed to understand the evolution of economics and health
economics and current policy challenges
- Macro-economic evaluation of policies aimed to address the socioeconomic determinants of
inequalities in health, and policies which affect indirectly the health of society
The future of health economics – to meet new challenges, new theoretical, empirical and
methodological methods are needed:
- Behavioural economics
- Experimental economics
- From ‘health care economics’ to ‘health economics’
- Proper role of market and institutions
- More socioeconomic model
- More original data collection (big data)
Behavioural economics
- The incorporation of methods and theories from cognitive psychology when specifically
addressing individual economic decision-making
- Importance of psychological cognitive, emotional, cultural and social factors on the economic
decisions of individuals
Better account for individual decision-making by doctors, nurses, administrators, patients
and their relatives, and even politicians
Experimental economics
Case 1 – the economic approach of health care
Aims:
- Economy as a scientific discipline
- The economic approach of health and health care
- The past, present and the future of ‘health economics’ as a discipline
Some definitions:
- Economics
o Study of choices under conditions of scarcity
- Health economics
o Applied field of economics
o Study the choices/behaviour of individuals, health care providers, public and private
organizations, and governments in health decision-making
o Study how (scarce) resources are allocated to and within the health system
- Health care economics
o The subject of analysis is the health (medical) care industry, not health
Health economics – tension between:
- Limited financial possibilities (healthcare budget constraints)
- Clinical possibilities (new, expensive treatments/interventions/innovations)
Not enough resources to meet all of society’s needs
Choices have to be made
Efficiently allocate health care resources
Characteristics why health economics is different than economics:
1. The nature of demand – the demand for health care is a derived demand (for health)
o The most obvious distinguishing characteristics of an individual’s demand for medical
services is that it is not steady in origin as, for example, for food or clothing, but
irregular and unpredictable
2. Existence of externalities
3. Informational asymmetries between health care providers and patients
4. Product uncertainty - uncertainty with respect to both the need for and effectiveness of
health care
o Uncertainty as to the quality of the product is perhaps more intense here than in any
other important commodity. Recovery from disease is as unpredictable as is its
incidence
5. Supply conditions
o Entry to the profession is restricted by licensing. Licensing restricts supply and
therefore increases the cost of medical care
6. Pricing practices
o The unusual pricing practices and attitudes of the medical profession are well known,
extensive price discrimination by income (with extreme of zero prices for sufficiently
indigent patients) and, formerly, a strong insistence on fee for services against such
alternatives as prepayment
Some key economic concepts:
- Scarcity: tension between unlimited needs and limited possibilities to fulfil those needs
o Choices arise as a result of economic problem of scarcity
- Allocation of scarce resources among competing demands
, o Allocation: the division of things into shares or portions
- Utility: the satisfaction derived or expected to be derived from the consumption of goods
and services (subjective)
- Preference: the order that a person (an agent) gives to alternatives based on their relative
utility
- All resource uses have an opportunity cost (the cost of the best alternative option)
- Opportunity costs: a benefit, profit, or value of something that must be given up to acquire
or achieve something else
- Externalities: costs and benefits that our decisions to buy or not to buy impose on others
who are not a party to the transaction (negative or positive)
- Efficiency: an economic state in which every resource is optimally allocated to serve each
individual or entity in the best way while minimizing waste and inefficiency
- Allocative efficiency (Pareto efficiency/optimality): a distribution or use of resources
(allocation) in which no one can be made better off without making someone worse off
- Competition: a condition where different economic firms seek to obtain a share of a limited
good by varying the elements of the marketing mix (price, product, promotion, and place)
- If one or more of efficiency conditions are not fulfilled, then faced with a market failure
- Perfect competition: a state that is needed to get optimal allocation of resources. There are
certain conditions of a perfect competition. Failing one or more conditions means there is an
inefficient allocation of resources and a governmental intervention is needed
(Perfect) market/perfect competition:
1. Consists of many buyers and sellers (they can compete with each other)
2. All parties have perfect information
3. All parties sell identical products (homogenous product)
4. There are no entry or exit barriers (free entry to the market, no transaction costs)
5. Firms act independently of each other and aim to maximize profits
6. Firms can sell as many outputs as they want at the market price
Other key economic concepts:
- Moral hazard: a situation in which one party gets involved in a risky event knowing that it is
protected against the risk and the other party will incur the costs. It arises when both the
parties have incomplete information about each other.
- Transaction costs: the costs associated with exchange of goods or services and incurred in
overcoming market imperfections. Transaction costs cover a wide range, such as
communication charges, legal fees, informational cost of finding the price, quality, and
durability, etc., and may also include transportation costs. Transaction costs are a critical
factor in deciding whether to make a product or buy it.
Specific characteristics of health care and its government interference:
- Presence of externalities (e.g. smoking, vaccination)
o Government interference: smoking bans / national vaccination program
- High R&D costs
o Government interference: patent protection for drug innovation
- Market power (monopoly)
o Government interference: drug price regulation
- Nature of goods (e.g. collective goods such as public health program)
o Government interference: national vaccination program
- Uncertainty
o Government interference: health insurance (however, several problems such as
moral hazard, adverse selection, etc.)
, - Unexpected behaviour of the physician
o Governance interference: no advertising and pricing competition
Some challenges for the health care system:
- More demand for healthcare with rising healthcare expenditures challenges us to make
choices
- Medical and technological advancement challenges
- Healthcare regulatory challenges
- Increasing expectations from patients
- More healthcare demand puts the labour market under pressure and asks for innovations
Development and prospect of health economics
William’s diagram (most important subject of health economics) – the scope of health economics
Health economics is divided into eight distinct topics (the relationships will not be asked)
A What influences Occupational hazards; consumption patterns; education; income; etc.
health? (other than
health care)
B What is health? Perceived attributes of health; health status indexes; value of life;
What is its value? utility scaling of health
C Demand for health Influences of A + B on health care seeking behaviour; barriers to
care access (price, time, psychological, formal); agency relationship; need
D Supply of health Costs of production; alternative production techniques; input
care substitution; markets for inputs (workforce, equipment, drugs, etc.);
remuneration methods and incentives
E Micro-economic Cost effectiveness and cost benefit analysis of alternative ways of
evaluation at delivering care (e.g. choice of mode, place, timing or amount) at all
treatment level phases (detection, diagnosis, treatment, after care, etc.)
F Market equilibrium Money prices, time prices, waiting lists and non-price rationing
systems as equilibrating mechanisms and their differential effects
G Evaluation at whole Equity and allocative efficiency criteria brought to bear on E + F; inter-
system level regional and international comparisons of performance
, H Planning, budgeting Evaluation of effectiveness of instruments available for optimising the
and monitoring system; including the interplay of budgeting, workforce allocations;
mechanisms norms; regulation etc. and the incentive structures they generate
In his diagrammatic representation of health economics, Williams set out a research agenda to
encompass the disparate activities of those of us who have found ourselves ‘doing what health
economists do’. Central to this diagram are boxes C (demand for health care) and D (supply of health
care), symbolizing the economists’ focus on the market and the health economists’ focus on the
market for health care. Feeding into box C are boxes A (what influences health?) and B (what is
health? What is its value). Box E (micro-economic evaluation at treatment level) covers the range of
micro-economic techniques available for the evaluation of healthcare inventions. Williams comments
that this has been the area in which the bulk of work by British health economists has been
concentrated, involving collaboration with clinicians. Box F (market equilibrium) brings supply and
demand together in the analysis of how and whether markets for healthcare can work and of non-
price rationing systems. Box G (evaluation at whole system level) covers evaluation at whole system
level (a bird’s eye view of healthcare systems). Finally, box H (planning, budgeting and monitoring
mechanisms) covers the planning, budgeting and monitoring mechanisms of health services. In
describing health economics as a sub-discipline, Williams proposed that normative health economics
is about ensuring that benefits gained outweigh benefits forgone. He argues that the benefit to be
gained from healthcare is better health.
Weaknesses of William’s diagram
Boxes A (what influences health other than health care) and G (evaluation of whole system level)
have proved relatively unexplored territory. In the past of the healthcare economics many focused
on empirical analysis of supply and demand for healthcare. The Williams diagram does not explicitly
offer a box to cover the macro-economic evaluation of the economics of non-health sector policies
that influence health.
- Need for paradigm shift
- Research programmes needed to understand the evolution of economics and health
economics and current policy challenges
- Macro-economic evaluation of policies aimed to address the socioeconomic determinants of
inequalities in health, and policies which affect indirectly the health of society
The future of health economics – to meet new challenges, new theoretical, empirical and
methodological methods are needed:
- Behavioural economics
- Experimental economics
- From ‘health care economics’ to ‘health economics’
- Proper role of market and institutions
- More socioeconomic model
- More original data collection (big data)
Behavioural economics
- The incorporation of methods and theories from cognitive psychology when specifically
addressing individual economic decision-making
- Importance of psychological cognitive, emotional, cultural and social factors on the economic
decisions of individuals
Better account for individual decision-making by doctors, nurses, administrators, patients
and their relatives, and even politicians
Experimental economics
