HEALTH ECONOMICS II

DIPLOMA-HSM
 Economics - definition
• Best use of available resources against
competing demands - attain given
goals.
• Resources- six Ms
• Economics –macro; micro; managerial.
 Economics
• Macro - GDP; percentage expenditure; policy;
universal coverage; national programs; fund
allocation; budgeting; equality; equity; access etc

• Micro- cost per unit; utility; break even point;

cost of package etc

• Managerial tools to analyze for

microeconomics
 Health Economics-Defn
• A branch of economics concerned with
issues related to allocation of resources for
health and health care
• Also referred to as health financing
• Manpower, time and money key issues
• More money for health; more health for the
money!
 Why study Health Economics?
• Benefits of economic growth-well known
• Determinants of economic growth
– labour force
– Physical capital
– technological change
– the quality and quantity of labour (human capital)
• extent of education
• level of its health
• Healthier workers -work longer, more
productive
• Healthy children better learning abilities
& better educational outcomes
• Higher incomes permit better nutrition, better
health care and, presumably, achieve better
health
• Health Economy
 Why is health so important?

Prevention Nutrition Dying

Treatment Health Technolog
Paymen y
Sanitation Fertility
t
 What is human development?
• Difference between development and growth
• Development for us to achieve goals of humanity,
our own ambitions and what we are all about.
• For this we need education, health, social security,
comfort etc.
• HDI –more to life than income..GDP and HDI position
is not the same
Scope of Health economics

• Factors influencing health (other than

health care)
• Definition of health and its value
• The demand for health care
• The supply of health care
• Microeconomic evaluation at Treatment level
• Market Equilibrium
• Evaluation at whole system level; and,
• Planning, Budgeting and monitoring
mechanisms.
 Macro HE
• Who is covered
• What services are covered;
• How much of the cost is covered.
• How funds are to be raised and administered
• Broad picture –for direction

• Taskforce on Innovative International Financing for Health

Systems, US$ 44 per capita (unweighted) in 2009, ; US$ 60 per
capita by 2015
 Data on Macroeconomic Health
Expenditure Indicators-India
• Data now easily available
– Enables better understanding
– Policy direction
– Weightage
– Comparison across years and across ccountries
 Total Health Expenditure as % of GDP
India Total health expenditure (THE) % Gross Domestic Product
(GDP)
4.8

4.6

4.4
India Total health
4.2 expenditure (THE) %
Gross Domestic Product
4
(GDP)
3.8

3.6
1999 2001 2003 2005
2007 2009

http://apps.who.int/nha/database/ChoiceDataExplorerRegime.aspx
 Year wise Government vs Private
expenditure as % of THE
90

80

70

60
India General government
50
expenditure on health (GGHE) as
% of THE
40 India Private expenditure on
health (PvtHE) as % of THE
30

20

10

1999 2001 2003 2005 2007 2009

Total/Govt/Pvt expenditure on Health
3000000

2500000

2000000 Total expenditure on

health
1500000 General government
expenditure on health
1000000 Private expenditure on
health
500000

0
1999 2001 2003 2005
2007 2009
 Financing Agents

140,000.00

120,000.00

100,000.00

80,000.00

60,000.00 2001
2009
40,000.00

20,000.00

0.00
Ministry of Health Social security Private insurance Non-profit
funds institutions serving
households (e.g.
NGOs)
 Indian Scenario
• Total Health expenditure increasing
• Private sector 70-80%
• Insurance and Social security increasing
• Equity, access, responsiveness of
care
• Microeconomic policies can be planned
 Micro HE
• Study of how individual units of production
consumption and industry act and react to
change in the macro picture.
• Hospitals, patients, processes, machines, drug
s etc
Characteristics of Health Care Industry
• Capital Intensive
• Long gestation periods
• Dynamic, interactive, intangible
• Manpower Shortage
• High Obsolescence Costs
• Complex Business Model
– high risk environment involving human lives
– managing doctor &-corporate management
interface
 Managerial economics

• Resources- Highest output

• Objectives- Minimum Resources
• Objectives and resources-Highest utility
• Utility- capacity to satisfy human need.
• Tools to aid decision making
– Cost analysis
– Production analysis
– Utility Analysis
 Costs
• Opportunity Cost
• Sunk Costs
• Life cycle costs
• Incremental costs
• Marginal Costs
• Variable Costs, fixed Costs
• Direct costs, Indirect costs
 Analysis Tools
• Cost effectiveness
• Cost benefit
• Production Curves
• Equi marginal utility
• Indifference curves
• Time dimension
– Decisions in time
– Money value over time
 Managerial Health Economic Evaluations

• Cost Minimization Analysis

• Cost Effectiveness Analysis
• Cost Benefit Analysis
• Cost Utility Analysis
 Cost Minimization Analysis
• It is based on prior epidemiological findings.
The technique identifies the least cost
intervention.

• If health effects are known to be equal, only

costs are analyzed and the least costly
alternative is chosen.
 Cost Effectiveness Analysis
• Cost-effectiveness analysis (CEA) is a technique
for selecting among competing wants wherever
resources are limited.
• Developed in the military, CEA was first applied to
health care in the mid-1960s and was introduced
to clinicians by Weinstein and Stason in 1977
• CEA compares alternatives and measures (in
natural units) the primary objective of the
program (i.e. morbidity reduction, life years
saved, functional ability on a scale).
 Cost Effectiveness Analysis
• A new strategy is compared with current
practice (the "low-cost alternative") in
calculation of the cost-effectiveness ratio

• CE ratio = Cost of new strategy- cost of existing

strategy/ effectiveness of new-
effectiveness of old
 Cost Effectiveness Analysis
• Cost effective does not mean that the strategy
saves money

• CEA is only relevant if the new strategy is both

more effective and more costly

• For simplicity, we will assume that doing

nothing has no cost and no effectiveness.
 Cost Effectiveness Analysis
• To lengthen life in patients with heart disease-
aspirin and blockers vs the more
complex, more expensive, and more effective
(e.g., medication plus cardiac
catheterization, angioplasty, stents, and
bypass).

• CEA is about marginal/ incremental) costs and

benefits.
 Cost Benefit Analysis

• CBA estimates and totals up the

equivalent money value of the benefits
and costs to the community of projects.

• Jules Dupuit, a French engineer proposed

this in an article in 1848
 Cost Benefit Analysis
• All aspects of the project- positive or negative
must be expressed

• If benefits not expressable in rupees, some

value that the beneficiaries consider as good
must be considered

• Money must be expressed with time

 Cost Benefit Analysis
• Incost benefit analysis can be
objectives questioned.

• Establishing a service, a department, full time

employees etc
 Cost Utility Analysis
• It is a form of cost effectiveness analysis
• Preferred when there are multiple objectives of a
program, when quality of life is an important
outcome, and when quality of life and quantity of
life are both important outcomes.
• Allows comparison of different health outcomes
(prolongation of life, relief of suffering,
blindness) by measuring them all in terms of a
single unit — QALY.
 Cost Utility Analysis
• Limitation- QALY is partly subjective

• QALY should be
meaningful, valid, reliable, relevant to the
population in question
 UTILITY ANALYSIS

•Marginal utility
•Diminishing Marginal utility
•Equi Marginal utility
•Indifference Curves
 PRODUCTION ANALYSIS

• LAW OF VARIABLE PROPORTIONS

• LAW OF RETURN TO SCALE
• PRODUCTION ANALYSIS
– PRODUCTION POSSIBILITY ANALYSIS
– ISO-COST / ISO-QUANT ANALYSIS
 Problems of Economic Evaluation

• “Efficient is not always sufficient” as the sole

criterion for decision making.

• The economic evaluation techniques are used

inappropriately to impose judgments of
specialists on the whole community.
 Conclusion
• Study of Health Economics essential
for planning and evaluation
• While complex problems may be worked out
by experts, decision makers require a sound
understanding of health economics
fundamentals
• More health from the money and more
money for health- Economic
Imperative
Demand for Health
Care

1
 Outline
• Demand & purpose of demand analysis
• Need, want & demand
• Michel Grossman model of demand for
health
• Factors affecting demand for health
• Distinctive characteristics of health
sector
• Law of demand, demand schedule &
curve
• Economic factors that affect demand for
health
2
• Equilibrium of demand & supply
• Elasticity of demand
• Factors affecting elasticity of demand
 Demand
• Demand describes the behavior of
consumers. It does not mean the desire to
obtain something (Health care)

• The hungry man who can not pay for food

has no demand for it

• An individual’s demand for a good is the

various quantities of goods & services
that the consumer is willing and able to
buy at each specific price
3
 Demand for health care
• The major purpose of demand
analysis for medical care is to
determine those factors which on
the average, most affect a persons
utilization of medical services

• Demand analysis seeks to identify

which factors are most influential in
determining how much care people
are willing to purchase 4
 Need Vs. want
• A need is something that is necessary for
humans to live a healthy life.
• Needs are distinguished from wants
because a deficiency would cause a clear
negative outcome, such as dysfunction or
death.
• In economics, a want is something that is
desired.
• It is said that people have unlimited
wants, but limited resources.
• Thus, people cannot have everything they
want and must look for the best alternatives
5

which they can afford.

 Need versus
demand

Need Demand

Someone's subjective Objectively observable

as
idea behavior in the
market.
(may be based on a Money is a key factor.
formula applied "Demand" is also
called
objectively, but the "effective demand,"
choice
to use the formula was because it's expressed 6

someone's subjective only by spending

money.
idea.
 Need versus
demand…
• Health plans that focus on need
and ignore demand will face
under- or over- utilization of
service capacity

• If one believes quantity demanded

is too little or too much (e.g. under-
use or over- use of emergency
room) relative to need, then
quantity demanded must be
manipulated by changing,
– price or other costs to buyer, or 7

– demand through marketing or de-

marketing
 A model of demand
for medical care
• Consumer purchase goods and services
for the utility

• If the commodity demanded by consumers

is good health, then health can be
produced by goods and services purchased
in the market as well as by the time
devoted to preventive measures

• Demand for medical care is derived from

8
the more basic demand for health
 A model of demand
for medical care…
• According to Michel Grossman,
consumers have a demand for health
for two reasons:

– Health is a consumption commodity—it

makes the consumer feel better

– Health is an investment commodity—a

state of health will determine the 9
amount of time available to the consumer
for productivity
 Grossman’s demand model

Individual/client factors
[age, sex, education, occupation]

Health care resources

Environmental factors factors
(physical, economic, Demand
E.g. supply, access,
social, cultural) acceptability

Prepayment factors
E.g. private insurance, tax based health
Insurance, national health system,
Out of pocket payment
10
 Grossman’s demand model…
 According to this model every one
inherits a
stock of health when born

• Health depreciated overtime,

however an investment is required
to sustain health

• As peoples’ age advances there is an

increase in rate of illness and in the
utilization of health services.

• The stock of health can be sustained by

investment to maintain health., such as 11

use of health services and health

promoting activities
 Grossman’s demand model…

• A view of medical care demand

being derived from the demand
for health implies the following:
– increase in age result in an increase
in the rate at which the person’s
stock of health depreciates

– Over the life cycle people will attempt

to offset part of the increased rate of
depreciation in their stock of health by
increasing their expenditure on health
12
Grossman’s demand model…

– the demand for medical care

will increase with increases in
person’s income

– education may have a negative

effect on the demand for health
care, because more highly
educated people are presumed to
be more efficient in producing
health 13
Distinctive characteristics of
health sector
– Consumer ignorance

– Non-profit motive

– Large components of personal

service

– Restrictions on competition
14
Distinctive characteristics of
health sector…

– The uneven and unpredictable

incidence of illness

– External effects e.g. Herd

immunity

– Mixture of consumption and

investment elements 15
 Deriving a Demand
Curve for
institutional Visits
• Downward sloping demand curve for the
visits

Price

P1

P0

q1 q0

• Price changes lead to movements along D 1

6
curve
 Other Economic Factors
Affecting Demand
• The demand curve illustrates the effect
of changes in the price of the good on
quantity demanded holding all other
factors (income, prices of other goods)
constant.
• Changes in factors other than the price
of the good itself lead to shifts in the
demand curve.

1
7
 Other Economic Factors
Affecting
Demand…
1. Income
• If income increases, then at any given
price, consumer is willing and able to
purchase more q
Price DO D1

P0

1
q0 q1 Physician 8
Visits
 Other Economic Factors
Affecting
Demand…
2. Complements 2 or more goods which
- are consumed
together
• e.g. laser printers and toner
• cartridges
• e.g. sugar and milk?
e.g. contact lenses and optometrist
visits

1
9
 Other Economic Factors
Affecting
Demand…
2.
Complements
• e.g. contact lenses and optometrist
• visits
If contact lenses become cheaper,
demand for optometrist visits will
increase
Pric
Price of complement
e
falls

D0 D1

2
Optometrist 0
Visits
 Other Economic Factors
Affecting
Demand…
3. Substitutes - other goods which satisfy
same wants, or the
provide same
characteristics

• e.g. Doctor and Health

• Officer? Generic and brand
• name drugs Private and
public hospitals

2
1
 Other Economic Factors
Affecting
Demand…
3. Substitutes - other goods which satisfy
the same wants, or provide same
• characteristics
• e.g. generic and brand name drugs
If generic drugs in price, D for brand name will
decrease
Pric
Demand for brand name
e
drug falls

D1 D0

2
Brand name 2
drugs
 Equilibrium of supply and
demand
• Market equilibrium occurs when two
economic variables [supply and
demand] are in balance

• The market equilibrium comes at that

price and quantity where supply and
demand forces are in balance

• At such a price the quantity and amount

that buyers wish to buy is just equal to
the amount that sellers wish to sell

2
3
Equilibrium of supply and
demand…
• At the equilibrium, price and quantity tend
to stay
same as long as other things remain equal

• Equilibrium price and quantity come at

that level where the amount willingly
supplied equals the amount willingly
demanded.

• In a competitive market, this equilibrium is

• found at the or
No shortages no surplusofare
intersection supply and
found
demand curves.price.
at equilibrium 2
4
Equilibrium of demand and
supply

25
 Elasticit
y
• In economics elasticity refers to the ratio
of the relative change in a dependent
variable to the relative change in an
independent variable.

• A change in any of the demand

factors will cause a change in
quantity purchased of a good per
time period.

26
 Factors affecting
elasticity of
demand
• Price change
• Availability & price of substitutes
• Availability & price of complements
• Income change
• Nature of commodity
• Multiple uses
• Deferred consumption
• Position of the commodity in consumers
budget
27
 Elasticity of demand in heath
care
• Demand may be affected by factors
determined by the consumer, the
provider, the supply or location of
services

• Elasticity of demand relates quantity

demanded to the price of the goods or
services

• Cost to the consumer is a factor in

28
choosing to purchase goods or services
 Elasticity
Price
• A relatively flat demand
curve implies that a
small increase in price
leads to a large fall in #
visits demanded

# Visits
29
 Elasticity
…
Price
• In this case demand is
considered to be
relatively “elastic” with
respect to a change in
price

# Visits
30
 Elasticity
…
Price
• A relatively steep
demand curve implies
that a small increase in
price leads to a small
fall in # visits
demanded

# Visits
31
 Elasticity
…
Price
• In this case demand is
considered to be
relatively “inelastic”
relative to a change in
price

# Visits
32
 Elasticity…
Price Elasticity of Demand:

ED % D Q  % c h a n g
%  P
 einquantitydem % c
h a n g e i n p
ar ni cdvisits
ee d is -.6, a 10% increase in
• Example: If the elasticity of demand for
physician
price leads to a 6% decrease in the
number of visits demanded

33
 Elasticity…
•E D is expected to be negative. Thus, price
elasticities of demand are often
quoted in terms of absolute value

• The demand curve is inelastic if

• 0<|E |<1
D

• The demand curve is elastic if

1<|ED|<
34
 Elasticity...

% D Q Q Q
Q% P  P
P
P P Q

• If you are given a formula for a
demand curve, you can compute
the elasticity of demand for any
combination of price and quantity
along that demand curve 35
 Elasticity…
• Income elasticity of demand:

EY % D Q  % change i
 n%  qY u a n%t i t y c hd e m
• a n gIfethe
Example: i nelasticity
incom of e
demand for
a n d visits
physician e d is .1, a 10% increase in
income leads to a 1% increase in the
number of visits demanded

• For most types of medical care, EY

should be positive 36
 Elasticity
…
•determining
Price elasticity of demand is critical for
a health care manager’s total
revenue
TR = PQ D

• Demand theory tells us that P

QD

If demand for physician services is

inelastic, and if the price is raised, then
I % QD I < I 37

%%P I
 Total revenue will increase if price is
 Insurance

❏ The above demand analysis assumed

that the patient pays for care out-of-
pocket
How does insurance affect the demand for care?

1. Coinsurance - Patient pays only a

fixed % of the
cost of each visit (often C = .20)

e.g. If the visit costs $100 :

patient pays $20, insurance pays $80

38
 Insurance
…

Pric
e

cP

q qc #
Visits
• No insurance : consumer faces price P, makes q
visits
• With
make coinsurance
qc : consumer faces price cP, 3
wants
visits to 9
 Insurance
…

Pric
e

cP

q qc #
Visits
 Coinsurance leads to a demand of qc visits at
price P, shared by consumer and insurance
company
 Demand curve rotates clock 4
0
wise
Indemnity
Insurance
– Insurer pays a fixed amount for
each purchased service
• Insurer pays $150 for each overnight hospital
stay, and patient pays the rest

Price

$150

D1
D0

4
Visits 1
Estimating Demand for Medical
Care
• Quantity demanded will be
affected by:
– out-of-pocket price
– real income
– time costs
– prices of substitutes and
complements
– tastes and preferences
– state of health
– quality of care 42
 Empirical Evidence
• Demand primary
(preventio
for care services early
n,
treatment detection,
of disease) has been &
found to be price inelastic
– Estimates tend to be in the -.1 to -.7
10%  in the out-of-pocket
–range
A
hospital
price of
or physician services leads to
a 1 to 7% decrease in quantity
demanded
– Ceteris paribus, total expenditures on
hospital and physician services 43

increase with a greater out-of-pocket

price
 Empirical Evidence…
• Demand for other types of medical
care is slightly more price elastic
than demand for primary care

• Consumers should be more price

sensitive as the portion of the bill
paid out of pocket increases

44
 Out-of-Pocket Payments in the U.S.

1960 1980 1990 2003

National health expenditures $26. $247.3 $699. $1,678.9
($b)
9 5
% out of pocket 48.7% 24.4% 20.6% 13.7%
● Hypothesis: Consumers are more price
sensitive if they pay a larger % of the health
care bill

➨ The fall in the % of out-of-pocket

payments may explain the rapid rise in
health care costs 45
 Out-of-Pocket Payments…
Total Expenditures and % Paid Out-of-Pocket, 2003
$b
Hospital care $515.90 3.2%
Physician & Clinical Services 369.7 10.2%
Dentist Service 74.3 44.2%
Prescription Drugs 179.2 29.7%
● Hypothesis:
Nursing HomeConsumers
Care are more
110.8price
27.9%
sensitive if they pay a larger % of the health
care bill

➨ Higher hospital and physician expenditures

may be due to the low % paid out-of-pocket
4
6
 Empirical Evidence
• At the individual level, the
income elasticity of demand
for medical services is below
+1.0

• The travel time elasticity of

demand is almost as large as the
price elasticity of demand

• Little consensus on whether

hospital care and ambulatory 47

physician services are substitutes

or complements
 Applying Demand
Theory to
Real Data
• Demand analyses in health care
must take insurance/ exemption into
account

• Demand analyses are critical in

shaping managerial and public
policy decisions

48
Maslow’s
Theory of
Hierarchy of
Needs
Need
s
 Something that is necessary for an
organism to live a healthy life
 Deficiency would cause a clear
negative outcome - deficiency or
death
 Can be Objective/Physical or
Subjective
 Objective needs - food, shelter,
sleep
 Subjective needs – affection,
acceptance, self- esteem
Ten Fundamental Human
Needs
Protection
Idleness
affection

Creation

subsisten
c e
Understa
n
ding
transcen
d Participa
ence ti
freedo on
m Identit
y
The needs -
Meaning
Need Meaning (having things)
subsistence food, shelter, work
protection social security, health systems,
work
affectio friendships, family, relationships
n with nature
understandi literature, teachers,
ng policies, educational
participation responsibilities, duties, work,
rights
leisure games, parties, peace of
mind
creation abilities, skills, work, techniques
identit language, religions, work,
y customs, values, norms
freedom equal rights
Abraham
Maslow
 Professor of Psychology
 Columbia University
 Original thinker
Predecessors focused on the
abnormal and the ill
 Maslow focused on positive
qualities of
people

(April 1, 1908 – June 8,

1970)
Maslow’s Hierarchy of
needs
 Proposed in his paper – A Theory of
Human Motivation, in 1943
 Focuses on describing the stages of
growth in humans
 On study of exemplary people such as
Albert Einstein, etc, rather than
mentally crippled or mentally ill
The Hierarchal
Model
Being Need

Deficit

Needs
Physiological
Needs
Physiological
Needs
• Mostly, literal requirements for human
survival
• If not met, the human body cannot
function
• Metabolic needs – air, water, food, rest
• Clothing, shelter – needed by even
animals
• Could be classified as basic animal
needs
Safety
Needs
Safety
Needs
• Once physical needs are met, safety
needs take over
• Personal including emotional
• Health and well-being
• Financial, job security
• Safety of property against natural
disasters, calamities, wars, etc
• Law & order
Social
Needs
Social
Needs
• Need to love and be loved
• Need to feel a sense of belonging
and acceptance
• Small groups – clubs, office
teams, school/college houses
• Large groups – political parties, Sports
teams, facebook
Esteem
Needs
Esteem
Needs
• Need to be respected by others and
in turn respect them
• Sense of contribution, to feel self-
valued, in profession or hobby
• Lower - respect of others, the need for
status, recognition, fame, prestige, and
attention
• Higher - self-respect, the need for
strength, competence, mastery, self-
confidence, independence and
freedom
Self Actualization
Needs
Self Actualization
Needs
• What a man can be, he must be
• Intrinsic growth of what is already in a
person
• Growth-motivated rather than
deficiency- motivated
• Cannot normally be reached until other
lower order needs are met
• Rarely happens - < 1%
• Acceptance of facts, spontaneous,
focused on problems outside self,
without prejudice
Why do I need to know all
this Psychobabble?
Maslow’s Theory in
Practice
in Management
Products are formed and placed to
satisfy a category of
needs in marketing
as well as advertising
Maslow’s Theory in
Marketing/Advertising
• PN - wife/child-abuse help-lines, social
security benefits, Samaritans, roadside
recovery.
• SN- home security products,
insurance, life assurance, schools.
• EN- cosmetics, fast cars, home
improvements, furniture, fashion
clothes, drinks, lifestyle products and
services.
Supply of Health
and Medical Care
Outline
 Definition and Law of Supply.
 The health care production function.
 Cost production in health care.
 Factors determine price and quantity of
health care.
 Factors affecting Supply.
 Investment on healthcare.
 Health insurance and supply in healthcare.
 Market Equilibrium.
 Questions.
What is
“Supply
”?
Nature of the supply
Supply defined as :
⚫The total amount of a product
(good or service) available for
purchase at any specified
price in specific time period.
Nature of the supply
⚫Suppliers include hospitals,
which provide health care
directly, and medical
equipment and
pharmaceutical companies,
which provide inputs to the
healthcare production
process.
⚫ Supply curve : A graph showing the
relationship between the quantity
supplied of a good and its price when
all other variables are unchanged.
⚫
The supply provided by
producers will rise if the price
rises because all firms look to
maximize profits .
What is the 'Law Of Supply'
⚫Supply is the microeconomic law that
states that, all other factors being equal,
as the price of a good or service
increases, the quantity of goods or
services that suppliers offer will increase,
and vice versa.

⚫suppliers will attempt to maximize their

profits by increasing the quantity offered
for sale.
⚫ The supply curve slopes upward and to
the right, rising from southwest to
northeast.
⚫ In contrast, the demand curve slopes
downward.
⚫ The chart below depicts the law of
supply using a supply curve, which is
⚫ always upward sloping.
⚫
⚫
Each point on the
curve reflects a
direct correlation
between quantity
supplied (Q) and
price (P).
⚫ for example, that physicians would be
willing to offer ten office visits if the price
were $90 per visit. At a higher price, say
$100, more visits would be offered
The healthcare production function
⚫ A health production function describes the
relationship between combination of health
inputs, both medical and non-medical, and
resulting health output.

⚫ It shows how health inputs interact to produce a

particular level of health, and how health status
changes if health inputs used and their
combination change.
⚫ Typically we classify inputs into two
categories
- Capital
-Labor
Cost production in health care
There must be costs for health care services to
be produced, and these costs include effort,
material, resources, time and utilities
consumed, risks incurred, and opportunity
forgone in production.
Short Run Cost
⚫ Cost theory on the production theory of the medical
firm
identifies how total costs respond to changes in
output.

⚫ If we assume that the two inputs of personnel hours,

n, and capital, k “fixed”, the short run total costs,
STC, of producing a given level of medical output, q,
can be written as:
STC(q) = wn + rk
where w and r represent the wage for personnel and
the rental or opportunity costs of capital, respectively.

⚫ The equation above implies that the short run total

costs of production are dependent on the quantities
and prices of inputs employed.
Short Run Cost Curve
Factors Affecting the Position of the Short Run
Cost Curve
A variety of short run circumstances affect the
position of
the total cost curve (up or down) among
them are:

⚫ The prices of variable inputs.

⚫ The quality of care.
⚫ The patient case-mix .
⚫ The amounts of the fixed inputs.
Marginal cost and Marginal benefit
in health care
⚫ Marginal cost: is the incremental increase in a health
firm's input costs to produce one additional unit of
output. For example, to increase the capacity of a
hospital for sites to sleep in it requires a cost to build
a new rooms in the hospital that is the marginal cost.

⚫ Marginal benefit: is the incremental increase in a

benefit to a consumer caused by the consumption of
an additional unit of good. Marginal benefits
normally decline as a consumer decides to consume
more and more of a single health service.
Marginal cost and Marginal benefit
 Suppose we want to
explain
- “Why is the price of health care
higher in the United States
than in Europe?”
Supply and Demand offer two
possible answers
The prices can be high because demand is
high.

The prices can be high because the supply is

limited.
What factors determine the
price and quantity of health
care?
Supply side
⚫ The supply side is problematic. First of
all, some health-care suppliers have
significant market power.

⚫ So it is trickier to compare the price of

health care across countries because we
have to consider differences in market
power as well.

⚫ A bigger problem is that some health-care

suppliers, such as hospitals, are either
government- controlled or not-for-profit
institutions.
Government and prices
⚫ Health-care prices are not necessarily
determined by supply and demand.

⚫ The government has a significant influence

on prices: for example, the governments in
some countries set prices for
pharmaceutical products.

⚫ Prices may be determined by bargaining

between hospitals and drug companies
rather than by supply and demand.
Factors affecting supply include :
⚫ Exogenous determinants of supply; in other
words, factors that are held constant underlying
the supply curve.

⚫ Endogenous determinants of supply ; Price .

Technological change
Technological change
Input prices
Prices of production-related goods
Prices of production-related goods
Size of the industry
Weather
Taxation and Support of government
Sellers' expectations
Supply curve shifts towards right
⚫ Decrease in price of other goods.

⚫ Decrease in price of factors of production

(inputs).

⚫ Advanced and improved technology.

⚫ Favorable taxation policy (decrease in taxes).

⚫ Increase in number of firms.

⚫ Expectation of fall in prices in future.

⚫ Improvement in means of transport and

communication.
Supply curve shifts towards right
⚫ Decrease in price of other goods.

⚫ Decrease in price of factors of production

(inputs).

⚫ Advanced and improved technology.

⚫ Favorable taxation policy (decrease in taxes).

⚫ Increase in number of firms.

⚫ Expectation of fall in prices in future.

⚫ Improvement in means of transport and

communication.
Supply curve shifts towards left
⚫ Increase in price of other goods

⚫ Increase in price of factors of production

(inputs)

⚫ Complex and out-dated technology.

⚫ Unfavorable taxation policy (increase in

taxes).

⚫ Decrease in number of firms.

⚫ Expectation of rise in prices in future.

⚫ Poor means of transport and

communication.
Factors affecting supply
⚫ The healthcare sector
is made up of many
different
industries – from
pharmaceuticals and
devices to hospitals –

⚫ Investing in healthcare stocks can provide

generous returns, but it is also tedious due
to the many factors affecting stock prices.

⚫ Investments in this sector are affected by

many variables, including positive
trends and negative trends.
Positive
trends
include:
⚫ the aging population.

⚫ people living longer with chronic disease.

⚫ obesity and diabetes epidemics.

⚫ technological advances.

⚫ the global reach of disease.

⚫ personalized medicine(separates patients into

different groups, with medical decisions, practices.. etc).
Negative trends
include:

⚫ a single-payer
system

⚫ the uninsured

⚫ cost controls

⚫ consumerism
The size of the supply response differs
across types of services,

⚫ While the expansion of health insurance

coverage :

 Did not increase the numbers of clinics and

nurses.

 The number of beds increased.

 No significant increase in hospitals.

 The total supply of physicians and nurses was

limited by the capacity of medical and nursing
schools.
⚫ Effect only on the number of beds! Why?

because it is less costly for existing

hospitals to add beds than for new
hospitals .
⚫ Also, the total supply of physicians and
nurses was limited by the capacity of
medical and nursing schools.
⚫ it takes years to be a typical specialist,
physician, practitioner !
Market Equilibrium
⚫ Demand and supply intersect with one
another to establish market equilibrium.

⚫ A situation where the price in a given

market is such that the quantity demanded
is equal to the quantity supplied.
Market Equilibrium
Excess Supply or Surplus
⚫Excess Supply
At a given price, the excess of
quantity supplied over quantity
demanded.

⚫Price of the good will fall as sellers

compete with each other to sell more
of the good than buyers want.
Excess Supply
Excess Demand or Shortage
⚫Excess demand
At a given price, the excess of
quantity demanded over
quantity supplied.

⚫Price of the good will rise as buyers

compete with each other to get more
of the good than is available
Excess Demand
Changes in Equilibrium
Increas No Decreas
Situation e in Change in e in
Deman Demand Demand
d
Increase in Supply Price  ? Price Decrease Price  Decrease

Quantity  Quantity Quantity  ?

Increase Increase

No Price  Increase Price  No Change Price  Decrease

change in
Supply Quantity  Quantity  No Quantity 
Increase Change Decrease

Decrease in Supply Price  Increase Price Increase Price ?

Quantity  ? Quantity Quantity 

Decrease Decrease
Market Failure
Market failure refers to the set
of
conditions underwhich a
market economy fails to allocate
resources efficiently.

But, due to various reasons market

when
mechanism is unable to make fair play or
interaction of demand and supply, that is the
situation of market failure.
At times when markets
fail to:

➢ Al ocate resources ef iciently.

➢ Provides goods beneficial to
➢ society.
Stop production and consumption of
harmful goods.
Market Failure can oc ur in a number
of ways:

❑Some products may be under

produced or not at al .
❑ Some good may be over produced.
❑The production or consumption
of some products af ects third
parties.
Market Failure
Examples:

𝗈 Pol ution, air, water,

𝗈 soil Traf ic
𝗈 congestion
𝗈 Deforestation and
loss of biodiversity
𝗈 Health problems associated with
𝗈 consumption of tobac o, alcohol and il
icit drugs
Depleted fish
stocks Global
Warming
Sources of
Market Failure
Sources of the market
failure:

➢ Market
imperfections
➢ Public Goods
➢ Externalities
➢ Inequalities
Market
imperfections
𝖲 Market
Power/Monopoly
➢ Inef

➢ iciencies

𝖲 Higher
Incomplete
Information
➢ prices
Imperfect knowledge of the market
can also cause market failure
➢ The lack of ful y informed decision
making might lead to the market
failure.
Market imperfections and Market failure

E1
P1
E0

P0

Q1
Q0
Public Goods
Types of Goods:

Private
Goodsi. Rival
ii. Depletabl
e
iii. Excludabl
e
Public Goods
i. Non – Rival
ii. Non – Depletable
iii. Non – Excludable
iv. Zero Marginal
Cost
Public
Goods
➢ Public goods includes the services
that are provided by the
government.
➢ Pure public goods have the fol
owing characteristics:
✓ Non ex cludability – everyone can consume
the goods whether they pay or not.
✓ Non rivalry in consumption –
consumption by one person doesn’t
reduce consumption for others.

Examples: street lighting, national

defence
Public Goods and Market
Failure
𝗈
• An individual can’t pay for public goods as
others can get the benefits from consumption
without paying which is the failure of market
mechanism.
𝗈 Private companies wil not supply
public goods as they don’t make an
economic profit on them.
𝗈 Thus, public goods are only supplied
by the government and financed
through taxation.
Externalities
 Externaliti
es

➢ A consequence of an economic
activities that are experienced by
➢ unrelated third parties.
Factors whose benefits (external
economies) and costs (external
➢ diseconomies) are not reflected in the
market price of goods and services.
Externalities are a los or gain in the welfare
of one party resulting from an activity of
another party, without being any
compensation for the losing party.
 Externaliti
(co n’
es
t)

➢ Externalities result from differences between

private and social costs or benefits
➢ Externalities can be positive or negative:
𝗈 Positive – 3rd parties benefit from the
production and/or consumption of goods
𝗈 and services.
Negative – 3rd parties bear spill over cost
from the production and/or consumption
of goods and services.
 Negative externalities

Negative externalities mean that social costs (have to

compensate) are higher so the new supply curve should be S1 and
equilibrium moved to P1.
External Costs /Negative
externalities

External costs created by busines es can

impact the environment in the
following ways:
𝗈 Urban blight – exces ive development and
inappropriate developments mean the
environment is visually lesattractive, los
𝗈 of farmland
Production and disposal of waste –
this could include an increase in litter
and rubbish from packaging
External Costs /Negative
externalities

𝗈 Use of energy – absorb the facilities of

future generation if people don’ t
adopt the sustainable energy plan.
𝗈 Pol ution
▪ Noise – from cars, lorries, factories
etc.
▪ Air – emis ions from cars and
delivery vehicles
▪ Land, Sea, Water
 Positive Externalities

If the business was supplying products ignoring social

benefits ( they get advantage) so that the initial supply
curve S1 shift to S.
External Benefits / Positive externalities

External benefits are advantages a busines

brings to the local community when it
locates its busines in a
particular area. These
benefits will be positive for the local
community.
• Emplo
Example s:
• yment
• Quality o
• f life
Pro viding a se
rvice Re g e ne
ratio n o f land
Externalities and Market failure

Externalities
can lead to market failure if the
pricing mechanism fails to account for
the social costs and benefi ts of
production.
I nequalities
Inequaliti
es
❖ In market economies, an individual’ s ability to
consume goods and services is dependent
on their income/wealth.
❖ An uneven distribution of income/wealth
within an economy can result in an
unsatisfactory allocation of resources and
❖ therefore market failure prevail.
In many developing countries, income
inequalityis great therefore resulting in
misallocation of resources.
In Summary
➢ Market imperfections can be
caused by monopolies, imperfect
market knowledge and factor
immobility which can result in
misal ocation of resources.

➢ Public goods are goods that are

provided by the government e.g.
street lighting.
➢ Externalities are caused
because of social
benefits/costs .
❑ Positive externalities occur where
social benefits are greater than
private benefits
❑ Negative externalities occur
where social costs are greater
than private costs

➢ Inequalities in wealth and

income distribution may
result in a
misal ocation of resources as
Types of
Market Failure
Types of market
failure
➢ Failure by the market structure
o Due to number of buyers and sellers
o Entry barriers (syndicate, licensing, etc)
o Natural monopoly or market power
(TŁe re is a lso e qual cŁance s o f pro viding tŁe g o o ds and se
rvice s at tŁe co mpe titive ra te s so tŁa t g o ve rnment inte
rve ntio n is ne ce ssary)

➢ Failure by incentives
oDue to externalities – difference in social
and private costs & benefits
Government’s
Response to
Market Failure
The Government

Ro le s o f tŁe
Go ve rnme nt:
Regulatory role
Al ocative role
Distributive role
Stabilisation role
 Regulatory Role

❑ Regulatory response to structure failure

i. Control over industry structure – by

antitrust policies, for instance, telecom
industry, diary industry, etc
i .Direct control – by fixing the quantity
and price of the products and services.
❑ Regulatory response to incentive failure
 Patent
It is the special right grant to the
producers to use or sale any
invention to any firm for the specific
period. The main objective is to
promote the invention and innovation.

Arguments on patent system

For Against
Important Less use
incentives Ineffectiv
Necessary e
incentives perversio
Invention n
disclosed
 Subsidy
The government also respond to the
market failure by providing subsidies
to the private business firm.

It may be two types:

Indirect Subsidy like : Direct subsidy like:

Construction of Special tax

road, Providing of treatment (ITC),
Maintenance cost Direct payment
etc etc
 Granting the operating rights
Incentives given to the regulated
firms to provide services in the public
interest. It is the grant provided by the
government to the firm to operate.

For instance, license of

media, banks, educational
institutions, etc
 Operating control
The control impose by
the government in order to limit
the activities of the business firm.
a.Control on environment pollution
b.Control on food products
c. Price control
d.Industrial work condition/Quality of
Work Life
e. Protection of minority groups
 Tax policy

The tax policies are like as

negative subsidies to limit the
unwanted activities in the market.

For instance, environmental

taxes for emission whereas ITC for
pollution control devices, etc.
 Allocative Role

The government must

determine how some resources
are allocated.

Collective goods such as roads,

education and health.
 Distributive Role

The free market outcome

results in an unfair distribution
of income, so the will
intervene to assure everyone
has a suffi cient income.

They do this through

benefits, state housing and
educational courses.
 Stabilisation Role

The government intervenes in

the market to ensure there is
steady growth.

They do this through

monetary and fiscal policy.
 Government Intervention
✓ Taxes
– a compulsory
payment to the government.

✓ Subsidy –a payment by
government to fi rms to keep
costs low.

✓ Transferpayments – a payment
made by the government with
nothing in return.
 Health
economics
presentatio
n
Topic :economic
evaluations
Learning
objectives
▶ At the end of this topic student should have to be
able to

 define economic evaluations

 Importance of the economic evaluations

 Mention different methods of the economic

evaluations
Introductio
n
What is economic evaluation?

▶ A way to identify, measure, evaluate, and

compare the costs and results of programs
and policies.

▶ Economic evaluation is the comparative

analysis or evaluation of the two or more
interventions in terms of their cost and
consequence .
▶ It is the evaluation or assessment of
different programs based on their input
given and results or outcomes generated .

▶ A powerful tool that can help users make

the most of resources, decide between
promising program options, and
demonstrate the benefits of your program
Introductio
n
▶ Resources are scarce, and consequently it is
necessary to have an economic evaluation of
various health care interventions. To allocate
resources in an efficient way, prioritization is
needed.

▶ different methods have been developed for

economic evaluation purposes to help guide
decisions and affect policy making.
Importance of economic
evaluation

▶ Economic evaluation enhances decision-making and

helps set health policy.

practitioners and evaluators need to be adept at

conducting
these analyses, because demand for them is growing.

▶ Economic evaluation help to prioritize the programs

and make
the best decision for optimal resource allocations.

▶ Economic evaluations are important tools for

assessing economic feasibility and efficiency of
health interventions .
Methods of the economic
evaluations
There are four main methods:

▶ Benefit-cost analysis (BCA)

▶ Cost-effectiveness analysis (CEA)

▶ Cost-utility analysis (CUA)

▶ Cost minimizing analysis (CMA)

Each of this analysis involves systematic identification

and measurement of the costs and consequences of the
interventions
1. Benefit-cost analysis
(BCA)

▶ CBA is a process for evaluating the merits of a

particular project in a systematic way in the
terms of cost and benefits of the project .

▶ Or is a widely used tool for making economic

decisions
about how to control pollution and manage
resources .
▶ Comparing the estimated
short and long term costs
( loses) with the estimated
benefits (gains)of the
proposal .
▶ CBA is used to answer the question whether the
given goal is worth pursuing.

▶ The cost side is determined in the same way as in

the application of the other analytical methods.
The benefit side, however, is now determined in
monetary units, which has the advantage that it is
possible to compare projects across sectors.
▶ The measurement of
benefits in the same unit
as costs is necessary to
assure possible
improvements in allocative
efficiency.
▶ CBA indicates whether a new intervention should
be introduced by determining the net b benefits of
the specific programmed, i.e., positive net

▶ benefits imply that social welfare would increase,

and the
programme should be introduced.
2.Cost-effectiveness
analysis (CEA)

▶ In this method of analysis ,cost is measured

against the effectiveness of the intervention .

▶ Or is a form of economic analysis that

compares the relative costs and outcomes of
different courses .
▶ Typically CEA is expressed in terms of a ratio
where the denominator is gain in health from
measure and the numerator is the cost
associated with the health gain .

▶ The most commonly measure is the quality

adjusted life
years ( QALY).
reach a specific goal
with a minimum of
resource use or how to
achieve as much as
possible for a given
budget. However, it is
not determined if it is
worth the cost trying to
reach this goal.
▶ A CEA measures the effect of an intervention in
natural units and tries to find the alternative that
has the lowest cost per unit measured. It is
distinguished from a CMA, by not only including the
cost side, but also by considering the amount of
output produced. Hence, a CEA is concerned d with
productive efficiency.
3.Cost-utility analysis
(CUA)

▶ Cost utility analysis is a form of the financial

analysis used to guide procurement decisions .

▶ The most common and well known application

of this analysis is in the pharm
economics ,especially health technology
assessments .
purpose of CUA is to
estimate the ratio between
the cost of the health
related intervention and
the benefit it produces in
terms of the number of
years lived in full health by
beneficiaries .hence it can
be considered a special
4. Cost minimizing analysis
(CMA)

In this method of analysis , costs of the two or

more interventions achieving identical outcome
is measured .

The intervention incurring the lowest cost is

then chosen.
▶ CMA is used when two interventions that are
being compared have the same outcome.

▶ In this situation it is only necessary to determine

the costs of each of the two interventions, and
compare them. The intervention which incurs the
lowest cost is then the one which would be most
rational to implement if the goal is to minimize
cost. The cost categories determined depend on
the chosen perspective
En
d