Question1: Briefly describe opportunity cost citing one example within the healthcare market

Opportunity cost: The value of the next best choice that one gives up when making a decision. Also called economic cost

An opportunity cost is the cost of a missed opportunity. It is the opposite of the benefit that would have been gained had an action, not taken, been taken—the missed opportunity. This is a concept used in economics. Applied to a business decision, the opportunity cost might refer to the profit a company could have earned from its capital, equipment, and real estate if these assets had been used in a different way. The concept of opportunity cost may be applied to many different situations. It should be considered whenever circumstances are such that scarcity necessitates the election of one option over another. Opportunity cost is usually defined in terms of money, but it may also be considered in terms of time, person-hours, mechanical output, or any other finite resource.

Example:

An example of opportunity costs would be if Moi University decided to build a hospital on vacant land that it owns, the opportunity cost is some other thing that might have been done with the land e.g farming,renting,

Question2: Describe the term market equilibrium in healthcare and illustrate the concept by a diagram

Market equilibrium: Market equilibrium is a market state where the supply in the market is equal to the demand in the market.

• 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

• 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 intersection of supply and demand curves.

• No shortages or no surplus are found at equilibrium price.

Question3: In perfect competition a firm is only a “ price taker and not a price maker”. Briefly Discuss

In perfect market conditions (also called perfect competition) a firm is a price taker because other firms can enter the market easily and produce a product that is indistinguishable from every other firm’s product. This makes it impossible for any firm to set its own prices.

A price taker is a firm that cannot have any say in setting its own prices. A price taker simply has to accept the market price. This is in contrast to a price maker, which can have an influence over the price at which it sells its goods.

In perfect competition, there are two main reasons why a firm cannot get away with setting its prices above the market price. First, there is no difference between its product and that of every other firm in the market. . Second, if a firm were to succeed in setting a higher price, more firms would enter the market, attracted by the higher profits that were available. This would increase supply and drive down the price of the firm’s product.

( e.gPatient visits)

In perfect competition, firms sell homogeneous products and it is easy for a firm to enter the market. These two factors make it impossible for firms to set their prices above the market price. This makes them into price takers.

Question 4: Distinguish between perfect and imperfect agencies citing relevant examples

A perfect agent acts in such a way so as to maximize the utility of the consumer

An imperfect agent fails to maximize the utility of the consumer

Example: Perfect Agency

• The agent (health professional) combines their knowledge with the principal’s (patient’s) preferences to determine a choice that the principal (patient) would have chosen had they been thus informed.

• Doctor acts purely in the interest of the principal ie. acts to maximise the patient’s utility

Example: Imperfect Agency

• In practice, health providers (like other human beings!) are not perfect at putting the interests of others before their own interests

• The agent exploits the relative ignorance of the principal (patient) to achieve their own objectives

Explain with a suitable example of illustration(s) the concept of supplier induced demand in an imperfect agency relationship.

In health economics, supplier induced demand (SID) can be defined as the amount of demand that exists beyond what would have occurred in a market in which patients are fully informed.In healthcare, a physician acts as an agent on behalf of the patient (the principal) guiding them to make the best possible treatment decisions. This agency relationship is influenced by information asymmetry between a physician and a patient, where it is assumed that the physician has more knowledge about diagnostic and treatment options than the patient. Asymmetry of information can also be influenced by the physician's own clinical experiences, expertise, and professional judgment as sometimes a patient will request their physician's personal opinion to aid them in making a healthcare decision. A physician who is a "perfect agent" is one who would make recommendations for a patient that the patient would make for themselves if they had the same information. SID can occur because of a breakdown in this agency relationship and happens when a physician recommends or encourages a patient to consume more care than is required for their medical problem, for example, ordering tests

that the physician knows are not needed to make a diagnosis or ordering treatments that the physician knows will have minimal benefit.

Based on information from Folland, S., Goodman, A.C., & Strano, M. (2013). Chapter 15: The Physician's Practice in The Economics of Health and Health Care. Boston: Pearson.