Health Economics
Lecture 1
Economic models fit well with choices made by experienced decision makers (or for
simple goods). The idea of optimization is excellent tool to improve decision making
that is not optimal, so models can help us in formulating hypotheses that can be
tested on data of use for policy makers and managers in firms.
Economics is the study of agents’ choices; any group or individual that makes choices
(individuals, parents, firms). Agents try to optimize; they try to choose the best
available option:
1. This concerns a comparison of the benefits versus costs associated with the
action.
2. Making a choice: what does it give you and what does it costs (money costs, time
costs, value of alternative options).
Confronting marginal gains in utility (given relative preferences) with marginal costs
(given prices, income, wealth) gives you the demand curve for a good.
Simple model of consumption Q:
1. U(Q) = 1/(1-alfa)*Q(t)1-alfa
2. Cost = P * Q(t)
3. Budget = I(t) – P * Q(t)
4. Marginal benefit = Marginal cost, dU/dQ = P.
Demand curve --> Demand influenced by preferences, consumer income, prices
other goods and own good. Demand reflects the willingness to pay. Slope versus
elasticity to measure responsiveness. The flatter the curve, the more price sensitive.
Inelastic demand = changes in P does not cause an effect in Q found in healthcare.
Marketing strategies rely on understanding consumer value for products:
1. Total consumer value is aggregate of the maximum amount a consumer is willing
to pay at different quantities.
2. Total expenditure is the per-unit market price times the number of units
consumed.
3. Consumer surplus is the extra value that consumers derive from a good but do
not pay for.
An increase in price creates a loss in consumer surplus
Firms face the production problem: how many product to produce, given that
consumer demand varies with prices and given the production costs and given the
structure of the market. For this we use the assumption of profit maximization, this
leads to firm specific supply curves that are upward sloping.
In the aggregate these individual and firm choices determine the demand and supply
on the market and there is an equilibrium where supply equals demand. This
equilibrium condition holds for all markets and brings us to macroeconomic
outcomes (driven by individual choices). Disturbances in one market can therefore
also affect other market outcomes (oil price changes).
If there is a surplus the forces of demand and supply put downward pressure on
price.
If there is a shortage the forces of demand and supply put upward pressure on price.
Competitive market equilibrium: Qd(Pe) = Qs(Pe).
, The government can collect a commodity tax, by taxing sellers for every unit sold or
by taxing buyers for every unit bought.
The tax has the same effects whether it is ‘paid’ for by sellers or by buyers, who
ultimately pays a tax is determined by the laws of supply and demand.
The government intervenes for reasons of efficiency & equity. Concerning efficiency,
no justification for intervention on efficiency grounds if standard assumptions hold:
1. Perfect competition: economic agents must be price takers and have equal
power satisfied with large # firms & consumers and no entry barriers; no
monopoly, no such things as discrimination and corruption.
2. Complete markets: complete markets provide all goods and services for which
individuals are prepared to pay a price that covers the production costs
markets generally fail to supply public goods (non-excludability: free riding);
some risks are uninsurable; capital markets may not always provide loans
(student loans: students cannot provide physical or financial collateral).
3. No market failures: external effects costs: too much will be produced public
goods (taxation or regulation is a solution).
4. Perfect information: consumers may have imperfect information about quality of
a good preferences may not be well defined. Consumers may have imperfect
info about price (budget constraint) easy to find right price for some products,
less so for things like car repair (regulation). Imperfect info about the future
future outcomes that are too distant and uncertain (pensions).
The state may also intervene for reasons of social justice/equity and paternalism.
Market outcomes may be efficient, but maybe not desirable.
Equity:
1. Horizontal equity: equal right for equal need.
2. Vertical equity: redistribution from rich to poor.
Three questions relevant when intervention is necessary:
1. Can the market solve the problem itself?
2. If not, what kind of intervention is needed?
3. Would the intervention be cost effective? Is intervention improvement upon
(inefficient) market outcome?
i. Macro (in)efficiency (cost explosions)
ii. Micro efficiency (efficient division of resources)
iii. Incentives (adverse effects on behavior.
Types of interventions:
1. Regulation: quality consumption/health care; quantity schooling (minimum
years), price minimum wage.
2. Finance: involves subsidies/taxes that affect prices (public transport,
pharmaceutical products, pollution or congestion taxes, social health insurance).
3. Production: 1 & 2 modify market outcomes, but government can also take over
supply of services (national defense, health care in some countries, primary &
secondary schools).
4. Income transfers: housing benefits, child benefits, social security benefit.
The welfare state: state involvement in cash and in-kind benefits
(unemployment/disability/old age) and provision of health care, education, and
other welfare services.
, There are differences between implementation of welfare states (Anglo-Saxon vs
Europe), however, countries face same challenges considering economic and
demographic changes.
Just after World War II: high growth rates, very low unemployment, welfare state
‘created’ in this period.
Growth in welfare states spurred since shocks in 1970’s. However, also lower growth
rates, substantial increases in unemployment rates, lower participation rates (older
workers; retiring earlier). Strong believe that incentives of welfare state institution
were important for developments in (un)employment, with consequences for
organization of welfare state.
In addition, demographic changes; fewer people are born, and people live longer
(life expectancy developments).
Consequences of aging for:
1. Health care provision and cost increases:
i. Extension or compression of morbidity?
ii. Preferences of cohorts? (Income?)
iii. Technological advances faced by cohorts?
2. Pension costs have also been increasing:
i. Trend towards early retirement aggravates problem.
ii. Specifics of pension system important (PAYG or funded, where PAYG
more affected by aging). When funded: defined benefit vs defined
contribution.
3. Functioning of the labor market.
4. Housing, transport, infrastructure, etc.
The distinction between the Scandinavian, Continental Europe, and Anglo-Saxon
welfare state is based on replacement rates and eligibility conditions for pensions,
sickness, disability & unemployment benefits.
Key feature of Scandinavian model is the extensive role for Active Labor Market
Policies.
Care expenditure varies considerably across countries, but countries have in
common that care expenditure rise over time.
A theoretical argument for intervention in health care market has to do with
efficiency. One condition is perfect information, individuals are not perfectly
informed, meaning that they cannot make informed choices.
Reasons people are not perfectly informed about medical care:
1. People are unknowingly ill and often ignorant about types of treatment and
outcome of each treatment.
2. The info comes from provider of services (trustworthy?).
3. It is usually possible to buy additional information, but with medical care:
i. Information is technically complex
ii. Cost of mistake irreversible and high
iii. No time to shop around
iv. Consumers lack knowledge to weigh opinions.
v. Emotions can be strong when it comes to healthcare.
This all leads to individuals poorly informed on quantity and quality of health care:
information & info-processing problem.
Lecture 1
Economic models fit well with choices made by experienced decision makers (or for
simple goods). The idea of optimization is excellent tool to improve decision making
that is not optimal, so models can help us in formulating hypotheses that can be
tested on data of use for policy makers and managers in firms.
Economics is the study of agents’ choices; any group or individual that makes choices
(individuals, parents, firms). Agents try to optimize; they try to choose the best
available option:
1. This concerns a comparison of the benefits versus costs associated with the
action.
2. Making a choice: what does it give you and what does it costs (money costs, time
costs, value of alternative options).
Confronting marginal gains in utility (given relative preferences) with marginal costs
(given prices, income, wealth) gives you the demand curve for a good.
Simple model of consumption Q:
1. U(Q) = 1/(1-alfa)*Q(t)1-alfa
2. Cost = P * Q(t)
3. Budget = I(t) – P * Q(t)
4. Marginal benefit = Marginal cost, dU/dQ = P.
Demand curve --> Demand influenced by preferences, consumer income, prices
other goods and own good. Demand reflects the willingness to pay. Slope versus
elasticity to measure responsiveness. The flatter the curve, the more price sensitive.
Inelastic demand = changes in P does not cause an effect in Q found in healthcare.
Marketing strategies rely on understanding consumer value for products:
1. Total consumer value is aggregate of the maximum amount a consumer is willing
to pay at different quantities.
2. Total expenditure is the per-unit market price times the number of units
consumed.
3. Consumer surplus is the extra value that consumers derive from a good but do
not pay for.
An increase in price creates a loss in consumer surplus
Firms face the production problem: how many product to produce, given that
consumer demand varies with prices and given the production costs and given the
structure of the market. For this we use the assumption of profit maximization, this
leads to firm specific supply curves that are upward sloping.
In the aggregate these individual and firm choices determine the demand and supply
on the market and there is an equilibrium where supply equals demand. This
equilibrium condition holds for all markets and brings us to macroeconomic
outcomes (driven by individual choices). Disturbances in one market can therefore
also affect other market outcomes (oil price changes).
If there is a surplus the forces of demand and supply put downward pressure on
price.
If there is a shortage the forces of demand and supply put upward pressure on price.
Competitive market equilibrium: Qd(Pe) = Qs(Pe).
, The government can collect a commodity tax, by taxing sellers for every unit sold or
by taxing buyers for every unit bought.
The tax has the same effects whether it is ‘paid’ for by sellers or by buyers, who
ultimately pays a tax is determined by the laws of supply and demand.
The government intervenes for reasons of efficiency & equity. Concerning efficiency,
no justification for intervention on efficiency grounds if standard assumptions hold:
1. Perfect competition: economic agents must be price takers and have equal
power satisfied with large # firms & consumers and no entry barriers; no
monopoly, no such things as discrimination and corruption.
2. Complete markets: complete markets provide all goods and services for which
individuals are prepared to pay a price that covers the production costs
markets generally fail to supply public goods (non-excludability: free riding);
some risks are uninsurable; capital markets may not always provide loans
(student loans: students cannot provide physical or financial collateral).
3. No market failures: external effects costs: too much will be produced public
goods (taxation or regulation is a solution).
4. Perfect information: consumers may have imperfect information about quality of
a good preferences may not be well defined. Consumers may have imperfect
info about price (budget constraint) easy to find right price for some products,
less so for things like car repair (regulation). Imperfect info about the future
future outcomes that are too distant and uncertain (pensions).
The state may also intervene for reasons of social justice/equity and paternalism.
Market outcomes may be efficient, but maybe not desirable.
Equity:
1. Horizontal equity: equal right for equal need.
2. Vertical equity: redistribution from rich to poor.
Three questions relevant when intervention is necessary:
1. Can the market solve the problem itself?
2. If not, what kind of intervention is needed?
3. Would the intervention be cost effective? Is intervention improvement upon
(inefficient) market outcome?
i. Macro (in)efficiency (cost explosions)
ii. Micro efficiency (efficient division of resources)
iii. Incentives (adverse effects on behavior.
Types of interventions:
1. Regulation: quality consumption/health care; quantity schooling (minimum
years), price minimum wage.
2. Finance: involves subsidies/taxes that affect prices (public transport,
pharmaceutical products, pollution or congestion taxes, social health insurance).
3. Production: 1 & 2 modify market outcomes, but government can also take over
supply of services (national defense, health care in some countries, primary &
secondary schools).
4. Income transfers: housing benefits, child benefits, social security benefit.
The welfare state: state involvement in cash and in-kind benefits
(unemployment/disability/old age) and provision of health care, education, and
other welfare services.
, There are differences between implementation of welfare states (Anglo-Saxon vs
Europe), however, countries face same challenges considering economic and
demographic changes.
Just after World War II: high growth rates, very low unemployment, welfare state
‘created’ in this period.
Growth in welfare states spurred since shocks in 1970’s. However, also lower growth
rates, substantial increases in unemployment rates, lower participation rates (older
workers; retiring earlier). Strong believe that incentives of welfare state institution
were important for developments in (un)employment, with consequences for
organization of welfare state.
In addition, demographic changes; fewer people are born, and people live longer
(life expectancy developments).
Consequences of aging for:
1. Health care provision and cost increases:
i. Extension or compression of morbidity?
ii. Preferences of cohorts? (Income?)
iii. Technological advances faced by cohorts?
2. Pension costs have also been increasing:
i. Trend towards early retirement aggravates problem.
ii. Specifics of pension system important (PAYG or funded, where PAYG
more affected by aging). When funded: defined benefit vs defined
contribution.
3. Functioning of the labor market.
4. Housing, transport, infrastructure, etc.
The distinction between the Scandinavian, Continental Europe, and Anglo-Saxon
welfare state is based on replacement rates and eligibility conditions for pensions,
sickness, disability & unemployment benefits.
Key feature of Scandinavian model is the extensive role for Active Labor Market
Policies.
Care expenditure varies considerably across countries, but countries have in
common that care expenditure rise over time.
A theoretical argument for intervention in health care market has to do with
efficiency. One condition is perfect information, individuals are not perfectly
informed, meaning that they cannot make informed choices.
Reasons people are not perfectly informed about medical care:
1. People are unknowingly ill and often ignorant about types of treatment and
outcome of each treatment.
2. The info comes from provider of services (trustworthy?).
3. It is usually possible to buy additional information, but with medical care:
i. Information is technically complex
ii. Cost of mistake irreversible and high
iii. No time to shop around
iv. Consumers lack knowledge to weigh opinions.
v. Emotions can be strong when it comes to healthcare.
This all leads to individuals poorly informed on quantity and quality of health care:
information & info-processing problem.
