Micro-economic Tools for

Health Economics

Abdur Razzaque Sarker MHE (Health Economics), MSS (Economics)

Health Economics and Financing Research Group

ICDDR,B

and

PhD Fellow in Strathclyde University, UK

Email: razzaque.sarker@gmail.com

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Outline:

• Scarcity and opportunity cost • Efficiency • Demand • Supply • Market Equilibrium • Elasticity • Consumer Theory: Indifference Curve ,Utility and

Budget Constraint • Production Possibility Frontier • Supplier Induced demand

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Scarcity and Opportunity Costs

Scarcity means that there are not, and can never

be, enough resources to satisfy all human wants

and needs.

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Opportunity Cost: The cost of the foregone opportunity

Real cost of an activity (for example, provision of hospital services) as the other outputs that must be given up (for example, other health services such as immunizations, or non-health services or commodities such as defense or vehicles) because productive resources are committed to it.

Scarcity and Opportunity Costs

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Efficiency is an instrumental concept, it is always necessary

to specify clearly the outcome being sought or the ‘output’

being produced.

Efficiency

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Efficiency……!!!!!!!!!

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Elements of Efficiency

Do not waste resources

Produce each output at least cost

Produce the types and amounts of output that people

value most

These are the three main elements of efficiency

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Elements of Efficiency

Do not waste resources

Produce each output at least cost

Produce the types and amounts of output that people

value most

Production

Efficient Resource Allocation

Consumption

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Elements of Efficiency

Do not waste resources

Produce each output at least cost

Produce the types and amounts of output that people

value most

Production

Efficient Resource Allocation

Consumption

Supply and Demand

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Elements of Efficiency

Do not waste resources

Produce each output at least cost

Produce the types and amounts of output that people

value most

Technical Efficiency Cost-effective

efficiency Allocative Efficiency

Technical efficiency requires that for any given amount of output, the amount of inputs

used to produce it is minimized (e.g. hospital…??)

It requires that, in addition to technical efficiency being attained, inputs be combined

so as to minimize the cost of any given output

Resources be used to produce the types and amounts of outputs which best satisfy

people

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Allocative Efficiency

Example…!!

If mothers of young children want counseling services

for behavioral problems instead of frequent well-child

check-ups, then allocative efficiency might be improved by

changing the mix of primary care services even if the well

child examinations were being provided cost effectively

If producers are supplying too much or too little of any

good or service relative to consumers' wishes it leads to

allocative inefficieny

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Doing the right things

Doing things right

Elements of Efficiency

Do not waste resources

Produce each output at least cost

Produce the types and amounts of output that people

value most

Technical Efficiency Cost-effective

efficiency Allocative Efficiency

Efficiency means both 'doing things right' (technical efficiency and cost-effectiveness), and 'doing the right things' (allocative efficiency) Pareto Efficiency..?????

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Demand

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Demand :How much of a good a consumer is ready to buy at a certain price, holding other things constant.

Factors affecting demand of a good:

Good’s own price

Income of the consumer

Price of related goods

Tastes/preferences

Various sociological factors

Factors outside human control, such as the weather

Law of demand

• The law of demand states that; the higher the price of a good the lower the quantity demanded

• If Price increases then Quantity demanded decrease

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Demand Schedule

Price Quantity demanded

30 TK/KG 6 KG

40 TK/KG 4 KG

50 TK/KG 3 KG

60 TK/KG 2 KG

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Deriving a Demand Curve

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Downward sloping demand

curve

Price

4 3 6 2

60

50

40

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Quantity demanded

Demand Curve shows the relationship between the

price of a good and quantity demanded of the good

Movement Vs Shift of Demand Curve

• We move along the demand curve only when the price of the good changes

Demand curve shifts because of:

• Change in income

• Change in price of a substitute

• Change in price of a complement

• Change in tastes and preference

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Other Economic Factors Affecting

Demand

• If income increases, then at any given price, consumer is willing and able to purchase more q

18 q0 q1

Price

P0

DO D1

Physician Visits

Other Economic Factors Affecting Demand

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Substitutes - Goods which satisfy the same needs of the

consumer and therefore can replace each other in use

e.g. Coke and Pepsi

e.g. Butter and Jam

e.g. CNG gas and Petrol

Other Economic Factors Affecting

Demand

• e.g. Coke and Pepsi

• If price of Coke increases, D for Pepsi___

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P

D0 D1

Demand for Pepsi

Demand for Pepsi----

Other Economic Factors Affecting Demand

Complements -

• Two goods are complementary if using more of good A

requires use of more good B.

• When two goods are consumed together

e.g. left shoe and right shoe e.g. DVD players and DVDs e.g. Tea and Sugar e.g. Car and Petrol

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Other Economic Factors Affecting

Demand

• If Price of petrol become cheaper, consumption or demand for car increases___

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2. Complements

P petrol

D0 D1

Quantitiy of petrol demanded

Price of car falls

(Price of petrol unchanged)

Supply:

The amount of a good, a producer/seller is ready to sell at a given price, holding other things constant.

Factors affecting supply of a good:

• The price of the good

• Technology

• Price of input

• Gov’t policies and regulations

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Supply

Law of Supply

• All other factors remaining unchanged; as the price of a good increases, the quantity of the good offered by a supplier increases and vice versa.

• Price increases quantity supplied increases

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Supply Schedule

Price Quantity Supplied

30 TK/KG 2 KG

40 TK/ KG 4 KG

50 TK/ KG 6 KG

60 TK/KG 8 KG

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Deriving a Supply Curve

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Supply curve shows the relationship between price

and quantity supplied of a good; ceteris paribus

Price

P1

P0

q0 q1

Supply curve is upward sloping

Other Economic Factors Affecting Supply

• If price of factors of production (land, labor, capital) increases i.e. cost of production increases, then at any given quantity, producer charge more prices.

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1. Cost of production

q0

Price

P0

SO S1

Physician Visits

P1

Other Economic Factors Affecting Supply

• If technology improves, then at any given price, producer will be willing to sell more

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2. Technological Improvement

q0

Price S0

Physician Visits

P0

q1

S1

The market

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Quantity per time period

Price

D

S

PE

QE

Equilibrium

P1> PE [excess supply]

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Quantity per time period

Price

D

S

PE

QE QS QD

P1

If there is Excess Supply in the market then there will be an downward

pressure in price and price will decrease until it reaches the equilibrium

P1< PE [Excess demand]

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Quantity per time period

Price

D

S

PE

QE QS QD

P1

If there is ED in the market then there will be an upward pressure in

price and price will increase until it reaches the equilibrium

Elasticity – the concept

If price rises by 10% - what happens to demand?

We know demand will fall

HOW MUCH?

3 Possibilities-

1. By more than 10%?

2. By less than 10%

3. Not more or not less than 10%

That means in the first cases the responsiveness is more. And........

Elasticity measures the extent to which demand will change

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If demand changes a lot when the price changes, we

say that demand is relatively elastic

If demand changes only slightly when price increases,

we say it is relatively inelastic.

Elasticity of Demand

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Elasticity

Price (£)

Quantity Demanded

10

D

5

5

6

Govt decides to lower price to attract utilization

Not a good move!

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Elasticity

Price (£)

Quantity Demanded

D

10

5 20

Govt. decides to reduce price to increase usages

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Good Move!

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Elasticity

When we see an elasticity larger than -1 it is elastic

demand, meaning a change in price has a relatively large

impact on demand

If the elasticity is between 0 to -1, it is inelastic demand –

the percentage change in demand is smaller than the

percentage change in price

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Consumer theory

• The consumer will choose the best bundle he can afford

• The theory has two parts:

– What do we mean by best bundle

– What a consumer can afford

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Consumer Preference

• Three assumptions:

– Completeness: Consumer can clearly describe his preferences over different bundles . He is able to clearly say whether he is indifferent between two bundles A and B or whether he prefers one over another .

– Transitivity: If A is preferred to B and B is preferred to C, then A must be preferred to C.

– Non-satiation : More is always better.

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Preference Map

• Preference Map: If a consumer’s preferences/ behavior satisfies this three assumptions then we can put his preferences into a graph. Preference map is a graphical representation of a consumer’s preference. It is the collection of all indifference curves.

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Indifference Curve

• Indifference curve is the combination of all consumption bundles among which the consumer is indifferent.

2

1

1 2

IC1

Movie

pizza

A

B

C

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Properties of Indifference Curve

• Consumer always prefers higher indifference curve (further from the origin).

• Indifference curves are downward sloping

• Any two indifference curves can not cross each other.

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Marginal Rate of Substitution

• The MRS measures the amount of one product a consumer must be given to compensate for giving up one unit of the other.

• The slope of the Indifference curve is MRS= -

• MRS is not constant, it varies over the indifference curve

• As we move down along the IC, MRS falls.

2

1

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Budget Constraint

• The budget constraint indicates the set of bundles the consumer can afford with a given income

• Slope of the budget constraint to the right is Pc/Pb, and measures how much beef must be sacrificed to get one more pound of chicken

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Consumer Equilibrium

• To maximize satisfaction given a budget constraint, the consumer will seek the highest attainable indifference curve

• Consumer will choose the point at which indifference curve is tangent to the budget line.

• In the diagram to the right, point A on indifference curve U2 represents the best the consumer can do

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Production Possibility Frontier

• A curve that shows which alternative combinations of commodities can just be attained if all resources are used; it is thus the boundary between attainable and unattainable commodity combinations.

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Production Possibility Frontier

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Externalities

• Externality—Actions of one party make another worse/better off, yet the first party does not bear these costs or receive these benefits

• Negative Externality – Second hand smoking, spread of a contagious disease by a person who rides a public bus, driving while intoxicated and injuring another

• Positive Externality –using a condom, deworming

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The Agency Relationship

A doctor-patient relationship is most frequently seen as one of agency

The patients (principals) are less informed than doctors (agents) about the relationship between healthcare and health.

The perfect agent physician chooses the health services as the patient himself would choose if only the patient possessed the information that the physician does.

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Imperfect Agency and Supplier-Induced Demand (SID)

Supplier-induced demand (SID) refers to the phenomenon of physicians deviating from their agency responsibilities to provide care for their self-interests rather than their patient interests

SID represents one of the major intellectual and policy controversies in health economics.

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Reinhardt Fee Test of Inducement

Q1 Q2 Q3 Q4

P4

P1

P3

P2

Utilization of

Healthcare

Price of

Healthcare

D1

D2

D3

S1

S2

References:

• Philip Jacobs (1991), The Economics of Health and Medical Care. Third Edition, Aspen Publishers Inc.

• S. Folland, A.C. Goodman and M. Stano (2000), The Economics of health and health Care, Macmillan, 3rd edn.

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Thanks