Unit 2 Learning Objectives In Chapter 5 of Essentials of Health Policy and Law, we will learn why it is important for health policymakers to be familiar with basic economic concepts, including: How economists make decisions Supply Demand Markets

Unit 2 Learning Objectives In Chapter 2 of Essentials of Health Economics, we will learn about: the role of economics in health care the use of economic models to explain phenomena the concept of the market and equilibrium

Economics and Policy Economics offers a framework to study the implications of individual decision making and help define the alternative mechanisms available to improve resource allocation Sound policy making is based on sound economic principles applied in a sensitive and uniform manner Lessons can be learned from basic economics lessons about human behavior and the way individuals make decisions, respond to incentives, interact with each other—and about the efficient allocation of scarce resources

What is Health Economics? Health economists examine a wide range of issues from the nature and production of health to the market for health and medical care to the micro-evaluation of interventions. The principal activity of economists outside of the United States is the evaluation of medical interventions.

What is Health Economics? The primary focus of United States health economists is the market for health care Factors affecting the demand for medical care include: socioeconomic factors of the population, patient demographics, access barriers, and the role of providers in determining the services to be provided The supply of health care encompasses a broad spectrum of economics on such topics as production theory, input markets, and industrial organization. Demand and supply intersect with one another to establish “market equilibrium.”

Why Health Economics is Important Understanding the economics of health care is important for a number of reasons: Health is important to us as individuals and as a society, and health care is one, though not the only, way of modifying the incidence and impact of ill health and disease. Economic analysis offers a unique and systematic intellectual framework for analyzing important issues in health care and for identifying solutions to common problems. As we know, the healthcare sector is very large, so the economics of health care are very important to us all.

Why Health Economics is Important (cont’d) Decisions about how health care is funded, provided, and distributed are strongly influenced by the economic environment and economic constraints: One good reason for understanding health economics is to engage in policy debates as an informed critic and as an informed citizen. Health economics is an application of economic theory, models, and empirical techniques to the analysis of decision making by individuals, healthcare providers, and governments with respect to health and health care.

Why Health Economics is Important (cont’d) Health economics is solidly based in economic theory. It also comprises a body of theory to help us understand the behavior of patients, doctors, and hospitals as well as the analytical techniques to facilitate resource allocation decisions related to health care. Health economics has evolved into a highly specialized field, drawing on related disciplines including epidemiology, statistics, psychology, sociology, operations research, and mathematics, in its approach.

Key Economic Concepts These terms will serve as unifying themes throughout the course: Scarcity addresses the problem of limited resources and the need to make choices Opportunity cost recognizes the role of alternatives Marginal analysis recognizes that choices are made at the margin, not on an all-or-nothing basis Self-interest is the primary motivator of economic actors The Market accomplishes its tasks through a system of prices, or “the invisible hand.”

Opportunity Cost The role of alternatives… The cost of any decision or choice made is measured in terms of the value placed on the opportunity foregone. Which option should be selected? For example: employers consider whether to provide health insurance to employees It is expensive to consider and implement health insurance plans (HR costs, premium costs, etc) All businesses are facing rising health care costs Implications to absenteeism and worker turnover? Yet, uninsured workers increase systemic costs. Salary adjustments to be made in lieu of insurance? Could the money have been better spent elsewhere, to greater effect? (Preventive care vs. interventional care?)

Marginal Analysis Choices are made at the margin, not on an all-or-nothing basis. Decision making is based on incremental benefits and cost of alternative(s). This concept relates to shifting or changing the resource mix to achieve best possible results. Marginal analysis is the process of identifying the benefits and costs of different alternatives by examining the incremental effect on total revenue and total cost caused by a small (one unit) change in the output or input of each alternative. Marginal analysis supports decision-making based on incremental changes to resources instead of one based on totals or averages.

Key Economic Concepts Supply and demand serve as the foundation of economic analysis Pricing and output decisions are based on forces underlying these two economic concepts. Competition forces resource owners to use their resources to promote the highest possible satisfaction of society: consumers, producers, and investors Efficiency measures how well resources are being used to promote social welfare Market failure arises when the free market fails to promote efficient use of resources by either producing more or less than the optimal level of output Sources of market failure include: natural monopoly, oligopoly, externalities of production or consumption, and public goods

Demand Demand: the quantity of goods and services that a consumer is willing and able to purchase over a specified time Common demand shifters Price Of the original good Of a substitute good Of a complementary good Income Quality (actual or perceived)

Demand (cont’d) Demand elasticity: the percentage change in the quantity demanded resulting from a 1% change in price or income. If a product is elastic, a change in price/income will result in an equivalent or greater change in demand If a product is inelastic, demand for the good is not sensitive to a change in price/income. (Do you think that health care is, overall, elastic or inelastic?)

Supply Supply: the amount of goods and services that producers are able and willing to sell at a given price over a given period of time Common supply shifters Input costs Sale price Number of sellers Change in technology

Supply (cont’d) Suppliers are driven to maximize profit. In a competitive market, profit is maximized at the level of output where marginal cost equals price. “Equilibrium” exists in the market when there is a balance between the quantity supplied and the quantity demanded.

Equilibrium

Supply (cont’d) Supply elasticity: the percentage change in quantity supplied resulting from a 1% increase in the price (or other variables, such as inputs) of buying the good/product. If the quantity demanded or supplied changes a lot when the price changes a little, it is said to be elastic. If the quantity changes little when the prices change a lot, it is said to be inelastic. If a product is elastic, a change in price (or other variables) will result in an equivalent or greater change in supply If a product is inelastic, supply of the good is not sensitive to a change in price (or other variables)

Health Insurance and Demand Health insurance acts as a buffer between the consumer and cost of health care goods and services Goods and services cost the consumer less than the charged price because of the presence of health insurance Moral Hazard: Because a consumer does not pay the full cost of a good, the consumer may purchase more than goods than he would otherwise purchase without insurance.

The Use of Economics in Healthcare Economic Modeling: In microeconomics, the assumption of rational behavior establishes a consistent framework for individual decision making: Decision makers, motivated by incentives, pursue their self-interest. These could be individual households and firms and government agents -- or specific markets. In macroeconomics, studies are conducted on a broad level, involving allocation of scarce resources, production, distribution and consumption of goods and services.

Economic Modeling (cont’d) Choices in the health economy are made at two levels: Individual actors must decide the best course of treatment or services to consume Policy makers must decide on the best course of action for the entire community 

Economic Modeling (cont’d) The framework of this analysis assumes rational behavior on the part of decision makers: Firms maximize profits given technology and the costs of the resources; and consumers maximize utility or satisfaction from consuming various amounts of goods and services given limited income and the prices of goods and services considered The optimal consumption of goods and services occurs when the marginal benefit (MB) from consumption (i.e., the additional benefit received from consuming the next unit of the good or service) equals the marginal cost (MC) of consumption (i.e., the additional cost of consuming the next unit of a good or service)

Summary The central tenets of economics can be summarized below: Resources are relatively scarce related to wants: Striking a balance between scarce resources and unlimited wants involves making choices. Medical decisions involve costs and benefits. It is important to strike a balance between incremental benefits and costs.