Health Economics TutorialKrishan 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

0102030405060708090

100110120130140150160

0 1 2 3 4 5 6 7Number of chocolates eaten

Utility

Indifference curves

Kinder Bueno

Kit Kat

U2

U1

Y1=7

Y2=5

Y3=9

X1=5 X2=8

X3=10

b

c

a

X415

Y4=3

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

Maximising utility when constrained by a budget

Kinder Bueno[Good X]

40

20 40

Kit Kats[Good Y]

U2

U1

Y1

Y2

X1 X2

ed

0

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

•Firms - Minimise costs of production + maximise profit

•Profit = Total Revenue (TR) – Total Cost (TC)

•Profit Maximisation: oMarginal Cost (MC) = Marginal Revenue

(MR) •Diminishing marginal product – same

principle as diminishing marginal utility•Meaning that...

Lecture 2 + 3

0102030405060708090

100110120130140150160

0 1 2 3 4 5 6 7Number of Workers Hired

Quantity of output

Number of doctors0

Q200

Number of

nurses

Q200

A

B

0

A

B

Number of outpatientprocedures

Number of inpatient procedures

INPUTS!

What’s the least number of workers you can get away with treating 200 patients.

OUTPUTS!

What’s the max number of procedures you can do with a fixed number of workers

Marginal Rate of Technical Substitution

k

i

k

i

i

kki MPx

MPx

xQx

Q

x

xxMRTSx

,

...eh?!

• Think of it as the supply side version of marginal rate of substitution that you get with the utility curves early on.

b

b

a

a

b

a

b

aab p

MP

p

MP

p

p

MP

MPMRTS

0

Q0

Q0

Maximising output to a budget constraint

Q1

Q1

Q2

Q2

D1

Number of nurses

Number of doctors

N1

D*

N* E

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

Number of visits

Price per visit

dWO

dWI

“Effective” demand

“Nominal” demand

5

$50

$300

10

$150

15

$25

Supply•Supply – producers•SHIFT vs MOVEMENT – CREWS •Complements, Raw materials,

Expectations for future, Weather, Substitutes.

Market PricePrice

0 1 2 3 4 5 6 7 8 9 10 11 12Quantity

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

Demand

$20

Price

0

Supply

Demand

Quantitydemanded

Quantitysupplied

Excess

Quantity4

$700

10

$500

7

Price

0 Quantity

Supply

Demand

Quantitysupplied

Quantitydemanded

1.50

10

$2.00

74

Shortage

Price

0 Quantity

Supply

Initialequilibrium

D

D

2.00

7

New equilibrium$2.50

10

Price

0 Quantity

Demand

Newequilibrium

Initial equilibrium

S1

S2

2.00

7

$2.50

4

SurplusPrice

0 Quantity

Supply

Demand

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 fail...

ElasticityP rice e las tic ity o f d em an d =

P ercen tag e ch an g e in q u an tity d em an d ed

P ercen tag e ch an g e in p rice

$5

4

Quantity

Demand

1000

Price

Quantity0

Price

$4 Demand

Demand tends to be more elastic:•the larger the number of close substitutes.•if the good is a luxury.•the more narrowly defined the market.•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!)

Elasticity of supply...graphs look the same at both extremes•Ability of sellers to change the amount of the good•Time period

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

0

£

D = AR

QM

PM

Q

S=MCA

Pc

D

C

Qc0

£

D = AR

QM Q

S=MC

Pc

D

C

Qc

Monopoly Perfect Competition

MR

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.

Bottom line: Monopolies fail to allocate resources efficiently

ExternalitiesThe 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 consumptione.g. production of electric cars

QAEquilibrium Output

P

Equilibrium Price PA

Consumer Surplus

Total Gain to Other People

Deadweight Social Loss

Producer Surplus

QB Economically Efficient Output

Q

B

MPB

MSB

MPC = MSC

A

Negative Externality in productione.g. production of cigarettes

Quantity

Price/ Cost

B

A

D (MPB/MSB)

S (MPC)

MSC

Economically Efficient Output Equilibrium Output

QB QA

EquilibriumPrice PA

Social Cost

Deadweight social loss

This is what is meant by MARKET FAILURE!

Pareto EfficientIn a Pareto efficient economic allocation, no one can be made better off without making at least one individual worse off. MSC = MSB

Pareto ImprovementA change to a different allocation that makes at least one individual better off without making any other individual worse off.

Internalizing an externalityAltering 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!

TaxPrice = Private Cost = Social Cost

D = Private Benefit

Social Benefit

QS QP

Price + TAX = Private Cost = Social Cost

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...

B

MSB= MPB

MSC

QB

£5

£3

Q

A

P

MPC

QA

Tax

£1.5

You influence the consumer to make him feel the extra social cost of smoking cigarettes and therefore change the amount he demands

• Full information Full information – but asymmetric information oPatients know better about their risks and behaviouroDoctors know better about treatmentoInsurers - 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

• ImpersonalImpersonal – but relationship based on trust• SelfishSelfish – but concerns beyond self-interest – agency relationship

oDoctor’s own interestsoSupplier induced demand

• Private goodsPrivate goods – but public goods and externalities• Many buyers and sellers Many buyers and sellers – but monopolies• Free entry Free entry – but professional entry requirements• Homogenous products Homogenous products – but product differentiation

Lecture 6 – Market Failure in Healthcare

Price

Quantity (eg. patient visits

Demand

Supply

P

Q

P1

Q1

Supply1

Price

Quantity (eg. patient visits

Demand

Supply

P

Q

Supply1

PS

QS

DemandS

Q1

P1

Price

Quantity (eg. patient visits

Demand

Supply

P

Q Qs

Supply1

DemandS

P1

Q1

Price

Quantity (eg. patient visits

Demand

Supply

P

Q

P1

Q1

Supply1

DemandS

Ps

Qs

Price

Quantity (eg. patient visits)

P

Q

P1

Q1

Observed dataBefore and after the shock in Supply

Price

Quantity (eg. patient visits

Demand

Supply

P

Q

Supply1

P1

Q1

Demands

P2

Q2

Can be consistent with SID!

Price

Quantity (eg. patient visits

P

Q

P1

Q1

But also with a more elastic demand with no SID!

Supply

Supply1

Demand

Price

Quantity (eg. patient visits

Demand

Supply

P

Q

P1

Q1

Supply1

Demands

Ps

Qs

Can only be sure ifQ and P both rise

Fairness in HealthcarePublic 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>0Cost 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 alternativeIn CEA – it could be the cost per Kg of weight lost In CUA – it could be the cost per QUALYThreshold – maximum willingness to pay per unit of benefit

Comparing ICER to a threshold

(-)

Dif

fere

nce

in c

ost

s (+

)

Activity never acceptable

(-) Difference in effects (+)

Activity always

acceptable

At Rc, activity unacceptable

At Rc, activity

acceptable

At Rc, activity

acceptable

At Rc, activity unacceptable

Rc -Threshold

E

C

EFFECTSEFFECTS

COSTCOSTICER

BA

BA

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 expensivee.g. Robotic surgery

Technology that decreases outcomes but is cheapere.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

£100

.5

.5

Expected Value of Node = (0.5x500)+(0.5x100) = 300

You use this to work out the ICER of your interventionYou have to do it twice – once using QALYs and once using COST

E

C

EFFECTSEFFECTS

COSTCOSTICER

BA

BA

Decision Tree

Intervention

No Intervention

Accept

Do not Accept

Transmission

No Transmission

Transmission

No Transmission

Transmission

No Transmission

P=0.95

P=0.05

P=0.07

P=0.93

P=0.26

P=0.74

P=0.74

P=0.26

Treatment cost 1500

0

1500

0

1500

0

Intervention cost 800

800

0

0

0

0

Expected cost= (0.07 × 2300) + (0.93 × 800) = 161+744=905905

Expected cost= [0.26 × 1500) + (0.74 × 0)=390 390

Expected cost= (0.95 × 905) + (0.05 × 390) = 859.75+19.5=879.25 879.25

390

Intervention

No Intervention

Accept

Do not Accept

Transmission

No Transmission

Transmission

No Transmission

Transmission

No Transmission

P=0.95

P=0.05

P=0.07

P=0.93

P=0.26

P=0.74

P=0.74

P=0.26

Expected outcomes= (0.07 × 5) + (0.93 × 40) = 0.35+37.2=37.5537.55

Expected cost= [0.26 × 5) + (0.74 × 40)=30.9 30.9

Expected cost= (0.95 × 37.55) + (0.05 × 30.9) =37.217537.2175

30.9

QALYS 5

40

5

40

5

40

Decision tree

ReferencesMarisa Miraldo – Health Economics Slides 2012-13

Thank you to Marisa for providing us with great examples and teaching