Health Economics Tutorial
Krishan Patel
Disclaimer
Objectives of this session
• Understand basic principles of economics
• Review and summarise the major topics which
form the basis of exam questions
• Discuss up to 3 topics of popular concern!
Structure
• Concepts in General Economics
▫ Basic Principles (opportunity cost etc)
▫ Markets (structure and forces)
▫ Market failures (externalities)
• Concepts in Health Economics
▫ Market for healthcare
▫ Economic evaluation
▫ Decision analysis
Options!
•
•
•
•
•
•
•
•
•
1) Basic Principles of Economics
2) Utility and Indifference Curves
3) Demand and Supply
4) Elasticities
5) Perfect Competition vs Monopolies
6) Externalities and Social Welfare Loss
7) Agency relationship & Supply Induced Demand
8) Economic Evaluation (CBA/CEA/CUA)
9) Decision Trees
Lecture 1
• Economics is based on a simple problem:
▫ Resources are scarce
▫ Human wants are infinite
• Trade off!
• Opportunity cost
▫ “The cost of the next best opportunity foregone.”
▫ Not literally a cost in terms of money
Jargon you need to know...
•
•
•
•
Economic Goods - scarce relative to our wants
Derived Demand
Utility
Diminishing marginal returns
Utility
160
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
0
0
1
2
3
4
5
6
7
Number of chocolates eaten
Indifference curves
Kit Kat
c
Y3=9
Y1=7
Y2=5
Marginal Rate of Substitution...
Basically if you were going to
reduce the amount of nurses,
how many more doctors would
you need to maintain the same
amount of utility
a
U2
b
U1
Y4=3
X1=5 X2= X3=10
8
X415 Kinder Bueno
Maximising utility when constrained by
a budget
Kit Kats
[Good Y]
40
Y1
Y2
d
e
U2
U1
0
X1
X2
20
40
Kinder Bueno
[Good X]
Utility Maximisation
• MUn/Pn = MUgp/Pgp (…wtf)
• MU/P means PRICE per unit of SATISFACTION
• Marginal utility means the utility you get from consuming one more
of the product
• If the MU/P for KitKats was cheaper than MU/P for Kinder Bueno,
you would buy more Kitkats because you could get more satisfaction
(utility)
• However, the more you have of something, the less added
satisfaction you get by having one more
• Marginal utility goes down...it becomes more expensive to get one
more unit of utility by having more Kitkat
• Eventually it will become the same price for a unit of utility...this is
utility maximisation
• MUn/MUgp = Pn/Pgp …Makes sense when you look at that graph
again
Lecture 2 + 3
• Firms - Minimise costs of production +
maximise profit
• Profit = Total Revenue (TR) – Total Cost (TC)
• Profit Maximisation:
o Marginal Cost (MC) = Marginal Revenue (MR)
• Diminishing marginal product – same principle
as diminishing marginal utility
• Meaning that...
Quantity of output
160
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
0
0
1
2
3
4
5
6
7
Number of Workers Hired
Q200
Number
of
nurses
INPUTS!
What’s the least number of
workers you can get away with
treating 200 patients.
A
B
Q200
Number of
outpatient
procedures
0
Number of doctors
B
A
0
Number of inpatient
procedures
OUTPUTS!
What’s the max number of
procedures you can do with a
fixed number of workers
Marginal Rate of Technical Substitution
Q
xk
xi MPxi
MRTSxi , xk  


xi Q
MPxk
xk
...eh?!
• Think of it as the supply side version of marginal rate of
substitution that you get with the utility curves early on.
MPa pa
MPa MPb
MRTSab 



MPb pb
pa
pb
Maximising output to a budget constraint
Q0 Q1 Q2
Number
of nurses
N1
N*
E
Q2
Q1
Q0
0
D*
D1
Number of
doctors
Demand
• Demand – consumers
• How much consumers are WILLING and ABLE
to buy at any given price
• SHIFT vs MOVEMENT – PIRATE
• Population, Income, Related goods, Alternative,
Tastes and fashion, Expectations
• Normal vs Inferior good
Co-insurance
Price per
visit
dWI
“Nominal”
demand
$300
$150
dWO
“Effective”
demand
$50
$25
5
Number of visits
10
15
Supply
• Supply – producers
• SHIFT vs MOVEMENT – CREWS
• Complements, Raw materials, Expectations for
future, Weather, Substitutes.
Market Price
Price
Supply
Equilibrium
Equilibrium price
$20
Equilibrium
quantity
0
1
2
3
4
5
6
7
8
9
Demand
10 11 12 13
Quantity
Price
Supply
Price
Supply
Excess
$700
$500
$2.00
1.50
Shortage
Demand
0
4
Quantity
demanded
7
10
Quantity
Quantity
supplied
Price
Demand
0
4
Quantity
supplied
7
10
Quantity
Quantity
demanded
Price
S2
S1
Supply
$2.50
New equilibrium
2.00
New
equilibrium
$2.50
Initial equilibrium
2.00
Initial
equilibrium
D
Demand
D
0
7
10
Quantity
0
4
7
Quantity
Surplus
Price
Supply
Consumer
surplus
Producer
surplus
Demand
Quantity
0
In an ideal world the price set by the market would prevail because this is
where we maximise “surplus.” However, there are reasons why markets
Elasticity
Price elasticity of demand =
Price
Percentage change in quantity demanded
Percentage change in price
Price
Demand
$5
4
$4
0
100
Quantity
0
Demand
Quantity
Demand tends to be more elastic:
Elasticity of supply...graphs look
•the larger the number of close
the same at both extremes
substitutes.
•Ability of sellers to change the
•if the good is a luxury.
amount of the good
•the more narrowly defined the market.
•Time period
•the longer the time period.
Cross price elasticity: Substitutes and Complimentary goods (prescriptions &
consultations)
Income elasticity of demand: Inferior and Luxury goods
(Healthcare has an income elasticity of >1 ...therefore it is a luxury good...discuss!)
Perfect Competition – Perfect Market
1. Full and perfect information – everyone knows everything about all the
products
2. Impersonal transactions – buyers and sellers have no relationships/bonds
3. Private goods – only the person consuming the good is affected by it; they pays
all the social costs and gain all the social benefits
4. Selfish motivation – utility gained from consumption is for the individual
only. Suppliers just want to make money.
5. Many buyers and sellers – no single buyer or seller can influence the market
price
6. Free entry/exit – anyone can come into and out of the market with ease
7. Homogenous products – all products within the market are identical
8. No externalities – nobody else is affected by the production and consumption
Monopoly vs Perfect Competition
The invisible hand of the market leads to an allocation of resources that
makes total surplus as large as it can be. Because a monopoly leads to an
allocation of resources different from that in a competitive market, the
outcome must, in some way, fail to maximize total economic well-being.
£
PM
£
D
D
S=MC
S=MC
A
C
C
Pc
Pc
D = AR
D = AR
0
QM MR Qc
Monopoly
Q
0
QM
Qc
Q
Perfect Competition
Bottom line: Monopolies fail to allocate resources efficiently
Externalities
The price and quantity demanded by a perfect market takes into account all the
effects on everyone. Therefore the price and quantity is at the SOCIAL OPTIMUM
i.e. Social Cost = Social Benefit
However, we don’t care about others when we buy and sell things. We just care
about our own costs and benefits i.e. Private Cost = Private Benefit
Examples:
•Air pollution from a factory
•The neighbor’s barking dog
•Late-night stereo blasting from the dorm room next to yours
•Noise pollution from construction projects
•Health risk to others from second-hand smoke
•Talking on cell phone while driving makes the roads less safe for others
All these things mean that other people are being affected by the consumption of
our products. If our drive was for the economy to be perfectly efficient, then we
should take these things into account when we decide what to consume and at
what price.
If you look at the effect of this on a demand and supply graph...
Positive Externality in consumption
e.g. production of electric cars
P
Deadweight
Social Loss
Total Gain to
Other People
MPC = MSC
B
Equilibrium
Price PA
Consumer
Surplus
A
MSB
Producer
Surplus
MPB
Equilibrium Output
QA
QB
Q
Economically
Efficient Output
Negative Externality in production
e.g. production of cigarettes
Price/ Cost
MSC
Social
Cost
Deadweight
social loss
B
S (MPC)
A
Equilibrium
Price PA
D (MPB/MSB)
QB
Economically Efficient Output
QA
Equilibrium Output
Quantity
This is what is meant by MARKET FAILURE!
Pareto Efficient
In a Pareto efficient economic allocation, no one can be made better off without
making at least one individual worse off. MSC = MSB
Pareto Improvement
A change to a different allocation that makes at least one individual better off
without making any other individual worse off.
Internalizing an externality
Altering incentives so that people take account of the external effects of their
actions.
e.g. Subsidies to persuade companies to produce more or taxes to persuade
people to consume less.
Correcting the failure!
Price + TAX = Private
Cost = Social Cost
Tax
Price = Private Cost =
Social Cost
D = Private Benefit
Social Benefit
QS
QP
Cigarettes smoked per day, Q
Read about the methods other than taxation... Command-and-control
policies and Market-based policies
Read about the advantages and disadvantages of each method...
Another way of drawing it...
MSC
P
MPC
B
£5
£3
A
Tax
£1.5
MSB= MPB
QB
QA
You influence the consumer to make him feel the extra social cost of smoking
cigarettes and therefore change the amount he demands
Q
Lecture 6 – Market Failure in Healthcare
•
Full information – but asymmetric information
oPatients know better about their risks and behaviour
oDoctors know better about treatment
oInsurers - Asymmetry between patients and insurance and providers:
•Averse selection (only high risk may buy insurance) – banding/compulsory
•Consumer Moral hazard (people act differently after getting insured) – no
claims bonus/consumer contribution
•Producer Moral hazard (producer knows all costs will be covered so it becomes
inefficient at using its resources) – regulation/prospective reimbursement
•
•
•
•
•
•
Impersonal – but relationship based on trust
Selfish – but concerns beyond self-interest – agency relationship
o Doctor’s own interests
o Supplier induced demand
Private goods – but public goods and externalities
Many buyers and sellers – but monopolies
Free entry – but professional entry requirements
Homogenous products – but product differentiation
Price
Supply
Price
Supply
Supply1
P
Supply1
P
PS
P1
P1
DemandS
Demand
Demand
Q
Q1
Quantity (eg.
patient visits
Q1 QS
Q
Quantity (eg.
patient visits
Price
Price
Supply
Supply
Supply1
Supply1
P
Ps
P
P1
P1
DemandS
DemandS
Demand
Q
Q1 Qs
Quantity (eg.
patient visits
Demand
Q
Q1
Qs
Quantity (eg.
patient visits
Observed data
Before and after the
shock in Supply
Price
P
P1
Supply
Price
Can be consistent with
SID!
Supply1
P
P1
P2
Demands
Demand
Q
Price
Q1
Quantity (eg.
patient visits)
Can only be sure if
Q and P both rise
Supply
Q
Price
Q2 Q1
But also with a more elastic demand with no SID!
Supply
Supply1
Ps
P
Quantity (eg.
patient visits
Supply1
P
P1
P1
Demands
Demand
Demand
Q
Q
Q1
Qs
Quantity (eg.
patient visits
Q1
Quantity (eg.
patient visits
Fairness in Healthcare
Public Good – (street lights, vaccinations)
non rival (one person consuming doesn’t affect another persons ability to
consume) and non excludable (can’t give it to some and not others) – free rider
problem
Merit Goods – (health care)
Would be under produced if left to the free market mechanism alone.
If health care can’t be allocated according to the market mechanism, then how
do you decide who get’s what...
Sum-ranking – ‘the greatest happiness principle’
e.g. maximise population health, happiness, wellbeing
Maximin – ‘the difference principle’
e.g. give priority to those whose health is worse
Egalitarianism – equal distribution (goods, utility ?)
•Fair Innings – everybody entitled to a normal span of life at a reasonable level
of quality
How to distribute a tax
A tax is….
•
proportional if the tax revenue increases by the same proportion of the
increase in the subjects’ income: VAT (?)
progressive if the tax revenue increases by a proportion larger than the rate
of increase of income: income tax
•
regressive if the tax revenue increases by a proportion smaller than the rate
of increase of income: lump sum
•
Lecture 7
Cost Benefit Analysis – Weighs up the costs and benefit of an option but uses
money as the principle unit. Can’t quantify in monetary terms the benefit of a lot of
health care treatments. Therefore, there is limited role for CBA.
Decision to accept if: TB > TC
TB-TC=NB>0
TB/TC>1
To take into account of the value today of future streams of costs and benefit
NPV>0
Cost Effectiveness Analysis – Weighs up an outcome based on a unit of benefit e.g.
Amount of weight lost, amount of asthma free days, improvement of eyesight in
dioptres.
It can only compare procedures with the same unit of outcome.
Cost Utility Analysis – Converts an outcome into a standard unit of benefit (utility)
e.g. QUALY or DALY
ICER – Used to compare the cost effectiveness of an intervention compared to its
next best alternative
In CEA – it could be the cost per Kg of weight lost
In CUA – it could be the cost per QUALY
Threshold – maximum willingness to pay per unit of benefit
Comparing ICER to a threshold
COSTA  COSTB
C

EFFECTSA  EFFECTSB E
At Rc, activity
unacceptable
(-) Difference in costs (+)
ICER 
Activity never
acceptable
Rc Threshold
At Rc,
activity
acceptable
At Rc, activity
unacceptable
Activity
always
acceptable
At Rc,
activity
acceptable
(-) Difference in effects (+)
When it’s not such a clear cut
decision...
•
•
•
Decision rule:
∆C/∆E < Rc the activity is cost effective
∆C/∆E > Rc the activity is not cost effective
•
•
•
Decision rule:
∆C/∆E >Rc the activity is cost effective
∆C/∆E < Rc the activity is not cost effective
Technology that improves
outcomes but is more
expensive
e.g. Robotic surgery
Technology that decreases
outcomes but is cheaper
e.g. Stool screening rather
than colonoscopy
Minimum cost saving
willing to accept to forgo
1 unit of outcome
QUALYs
•
•
Combines:
– quality of life (QOL)
– length of life (LOL)
Values health states over a period of time
– Perfect health: 1
– Death: 0
QALY= QOL x LOL
•
2 years with health quality of 0.5 = one-year of optimal health (QOL=1)
•
Time Trade Off: If someone is indifferent between two states and one of them is
QOLA = 1 then you can work out the value of QOLB
•LOLA * QOLA = LOLB * QOLB
•QOLB = LOLA / LOLB
•
Standard gamble – varying probabilities to tell you how much a certain state of
health is worth to someone
•
•
Alternatives differ with respect to their timing – have to apply discounting.
Lower weight to costs and outcomes in the future discounted compared to those
which occur in the present.
Lecture 8 - Decision Trees
£500
.5
.5
Expected Value of Node = (0.5x500)+(0.5x100) =
300
£100
You use this to work out the ICER of your intervention
You have to do it twice – once using QALYs and once using COST
ICER 
COSTA  COSTB
C

EFFECTSA  EFFECTSB E
Decision Tree
Transmission
Treatment cost
1500
Intervention cost
800
P=0.07
Accept
Expected cost= (0.07 × 2300) + (0.93 × 800) =
161+744=905
905
P=0.95
No
Transmission
879.25
Intervention
0
800
Expected cost= (0.95 × 905) + (0.05 × 390) = 859.75+19.5=879.25
P=0.93
Transmission
390
P=0.26
1500
0
Expected cost= [0.26 × 1500) + (0.74 × 0)=390
Do not Accept
P=0.05
No
Transmission
Transmission P=0.74
0
0
1500
0
0
0
P=0.26
No
Intervention
390
No
Transmission
P=0.74
Decision tree
Transmission
QALYS
5
P=0.07
Accept
Expected outcomes= (0.07 × 5) + (0.93 × 40) =
0.35+37.2=37.55
37.55
P=0.95
No Transmission
Intervention
37.2175
P=0.93
40
Expected cost= (0.95 × 37.55) + (0.05 × 30.9) =37.2175
Transmission
30.9
P=0.26
5
Expected cost= [0.26 × 5) + (0.74 × 40)=30.9
Do not Accept
P=0.05
No Transmission
Transmission
P=0.74
P=0.26
No Intervention
40
5
30.9
No Transmission
P=0.74
40
References
Marisa Miraldo – Health Economics Slides 2012-13
Thank you to Marisa for providing us with great examples and
teaching