Review of the Last Lecture
• Finished our discussion of insurance as a source of market failure in
the HC market
• Also discussed the case for public health insurance rather than
private.
• Today discuss the second source of market failure in the Healthcare
sector => externalities
317_L18, Feb 15, 2008,
J. Schaafsma
1
V.3. Second Source of Failure in The
Healthcare Market: Externalities
• Have noted that there are three sources of market failure in the health
care market: insurance, externalities, information asymmetry
• Have finished our discussion of insurance as a source of market
failure. We also noted that the health insurance market (as distinct of
the healthcare market) is also subject to market failure, and that there is
thus scope for public insurance.
• today begin our discussion of the second source of market failure in
the healthcare market (NB not the health Insurance Market):
externalities.
317_L18, Feb 15, 2008,
J. Schaafsma
2
Positive Externalities Diagram
and the Role of Subsidies
• positive externalities and market failure: SMB = (PMB + EMB) >
PMC when P = PMC (see diagram)
• the role of a subsidy to achieve efficient output (see diagram)
• If EMB is large and PMB is modest may need to “bribe” consumers
to reach socially efficient output (see diagram). Example?
• can also have negative externalities and market failure (e.g.,
pollution): impose a tax to achieve efficient output (won’t discuss)
• in general, efficiency requires SMB = SMC, or in absence of
externalities, PMB = PMC ///
317_L18, Feb 15, 2008,
J. Schaafsma
3
Relevance of Identifying the
Source of the HC Externality
• It is generally agreed that there is an externality in the
consumption of healthcare
• This externality motivates society to help pay for the healthcare
people consume
• however, society is willing to pay for only some types of
healthcare, not for all types. Question is: why?
• Reason: the nature of the externality determines what we will pay
for
• we thus need to carefully articulate the nature of the externality in
the consumption of healthcare.
317_L18, Feb 15, 2008,
J. Schaafsma
4
Two Possible Reasons for the
Externality in HC Consumption.
• two possible reasons for the externality from HC consumption:
1. Selfishness
2. Altruism
i) Utility specific altruism
ii) HS specific altruism
iii) HC need specific altruism
a) self-expressed HC need
b) paternalistic (third-party assessed HC need)
317_L18, Feb 15, 2008,
J. Schaafsma
5
Selfish Externalities
•
here no concern about well-being of others
•
only concern  fear of contagion
•
this is not the source of our interest in HC needs of others
•
REASONS:
1. Only small fraction of the HC we help others acquire is for
contagious diseases
2.
would deal with contagion through quarantine if less costly. ///
317_L18, Feb 15, 2008,
J. Schaafsma
6
The Basic Source of the Externality
in HC Consumption: HC is a need.
• HC often described as a “need” not a”want”
• want (is a subjective concept) determined by income, prices and
tastes; no ethical imperative that others should help a person satisfy
his/her wants
• HC need  relays 2 messages:
1. Objective, not subjective  HC requirement can be objectively
verified by a qualified third party (three parties: patient, taxpayer, HC
provider), i.e., HS  if HC consumed
2. Ethical imperative  need imposes a moral obligation on others
to supply the technically required HC, Health is a basic human right
/// 317_L18, Feb 15, 2008,
7
J. Schaafsma
Altruistic Externalities: Utility
Specific (all needs create an
externality, poor HS is a need)
• A’s level of satisfaction depends in part on B’s level of
satisfaction  if B better off for whatever reason, then A better
off, cet. par.
• interdependent utility functions where UB affects UA :
• UA = U[X1, … Xn, HCA, HSA(HCA); UB]
EXPLAIN
• Inadequate explanation of the externality:
if correct  subsidize B whenever UB drops, generally don’t
 should transfer wealth to B, let B max U, we don’t! ///
317_L18, Feb 15, 2008,
J. Schaafsma
8
Altruistic Externalities: HS Specific
(there is an externality only of the  in
utility is due to a  in HS)
• if the externality isn’t from UB affecting UA, when UB changes for
whatever reason, perhaps it derives from changes in UB due to
changes in HSB only.
• UA = U[X1, … Xn, HCA, HSA(HCA); UB(HSB)]
EXPLAIN
• not the reason for the externality we don’t necessarily act if UB 
due to HSB .
• If HSB  and there is no HC to address it we don’t transfer wealth to
compensate for the loss of utility ///
317_L18, Feb 15, 2008,
J. Schaafsma
9
Altruistic Externalities: selfexpressed HC Specific
• is the externality driven by a person’s self expressed HC needs?
• person is ill, and we feel good if that person can access the HC
the person feels is required.
• NOT QUITE the source of the externality  we are not willing
to pay for whatever HC B feels might help improve his/her HS
• we only feel obligated to B if we (society) believe the HC will
make a demonstrable difference to B’s HS. ///
317_L18, Feb 15, 2008,
J. Schaafsma
10
HC Specific Paternalistic
Altruism
• source of the externality in HC  society believes that there is HC
that will make a difference to a person’s HS and feels good if the
person can access it.
• only feel obligated to help person access HC we believe will make a
difference  altruism based on paternalistic assessment of HC needs.
• approved HC a merit good
•Merit good: a private good that society feels should be accessible to
all lack of income should not be a barrier to HC consumption. ///
317_L18, Feb 15, 2008,
J. Schaafsma
11
Implications of the Ethical Imperative
in the Concept of HC Needs
• ethical imperative from third party verifiable HC needs  we must
reduce barriers to HC
• capacity barriers  hospitals, HC, personnel, equipment
• geographical barriers  HC to be available in all parts of Canada
• social barriers  HC available regardless of social class, race etc.
• financial barriers: - subsidies to production
- publicly funded insurance
- community rated insurance
- subsidized health insurance premiums ///
317_L18, Feb 15, 2008,
J. Schaafsma
12