1. 317_L2_Jan 9, 20081 Review of the Last Lecture health, healthcare and their relationship, and the economics of healthcare Today: begin with the question: can economics be applied to healthcare? then begin section III of the course: The production of health./// Discussed some fundamental concepts in the economics of health care, such as:

2. 317_L2_Jan 9, 20082 Does Economics Apply to Health and HC? The Case for Not Often argued that economics doesn’t apply to health and HC: Reasons: 1) health is priceless! 2) Consumer rational choice not always possible (e.g. patient is incapacitated)! 3) HC is a medical/technical decision

3. 317_L2_Jan 9, 20083 Does Economics Apply to Health and HC? YES - Economic decisions are made at the margin: a little more of one good at the expense of another, e.g., water is priceless but not at the margin - scarce resources are used in HC, these resources have alternative uses, where are they best used? - rational choice by patient is often possible: e.g. in non-emergent HC -physician acts as agent when the patient is unable to choose rationally - individuals/society have limited funds and thus must make choices among competing objectives individually and communally Evidence of choice in HC: different approaches to treatment, demand elasticities are not zero.

4. 317_L2_Jan 9, 20084 Constrained Social Welfare Maximization Land Capital Labour Private goods Public goods HC goods HS Social Welfare

5. 317_L2_Jan 9, 20085 The Medical/Technical and Economic Views of over/under Utilization of HC. Two Views of appropriate HC utilization: 1. The medical/technical view 2. The economic view The medical/technical view: under-utilization occurs if more HC will improve HS (diagram) Why does the technical relationship between HS and HC (i.e. the response of HS to HC inputs) have an inverted U-shape, rather than leveling off (see diagram), i.e., why does the Marginal Physical Product (MPP) of HC become negative rather than just zero? Reason: declining MPP of HC and iatrogenic disease. ///

6. 317_L2_Jan 9, 20086 The Economic View of Over/under Utilization Under-Utilization occurs if it is possible to increase overall utility by reallocating resources from the production/consumption of non- HC goods to the production/consumption of HC goods. Over-Utilization occurs if it is possible to increase utility by reallocating resources from the production/consumption of HC goods to the production/consumption of non-HC goods. Under which approach (med/tech or economic) will the HC saturation point be reached first? Why? Hint: think marginal cost and marginal benefit of HC (Diagram) ///

7. 317_L2_Jan 9, 20087 Section III of the Course Outline: The Production of Health HS is a function of HC, lifestyle, environment, human biology Can draw a production function in two dimensions holding lifestyle, environment, human biology constant (see diagram) HS = HS(HC, Lifestyle, Environment, Human Biology(or Genetics)) The shape of the production function (see diagram): - average physical product (APP) +ve everywhere - marginal physical product (MPP) +ve, 0, -ve Changes in lifestyle, environment and human biology shift the function up or down: e.g. aging, better nutrition, lack of exercise.///

8. 317_L2_Jan 9, 20088 The Intensive and Extensive Margins in HC The intensive margin: more healthcare is applied to the same group of patients, e.g., - 60+ year old men are required to go for a full physical each year rather than once every other year The extensive margin: a HC good or service is applied to an expanded group of patients, e.g., - extending the requirement of a full physical exam every other year to include all 50+ year-old men rather than all 60+ year- old men Examples of the two margins (Table 3.1 in C. E. Phelps, 2003, p. 73, on an overhead transparency).///

9. 317_L2_Jan 9, 20089 Can the MPP of HC Be Negative at the Intensive Margin? The MPP of HC at the intensive margin will be negative if additional HC yields very little positive benefit for the group and continues to yield ever more negative side effects (Diagram). /// YES! Healthcare exerts both positive and negative effects (recall the concept of iatrogenic disease) For initial quantities of HC applied to an ill segment of the population the positive benefits will outweigh the negative side effects, thus the positive benefits of additional care for this group (intensive margin) will outweigh any negative side effects.

10. 317_L2_Jan 9, 200810 Negative MPP of HC at the Extensive Margin The MPP of HC can also be negative at the extensive margin This may occur if the population, to which a HC procedure is applied, is expanded to include an ever healthier group of people At the margin, the positive benefits from applying the HC to an ever larger proportion of the population will become less and less until finally the negative side effects outweigh the positive health effects and the MPP of HC at the extensive margin becomes negative. ///

11. 317_L2_Jan 9, 200811 Uncertainty About the MPP of HC At the Two Margins Extensive literature on the value of HC at the two margins e.g., frequency of preventative care visits to the dentist/optometrist cut-off age for prostate/breast cancer screening value of certain tests: PSA test for prostate cancer This uncertainty has led to variations in medical practice. There are substantial unexplained differences in the frequency with which many medical procedures are performed across geographic areas and across practitioners. Overhead transparency of high to low ratios for various HC procedures performed in 16 large community hospital markets (Phelps, 2003, Table 3.4, p.84).///