Health Economics

What is health economics?

The branch of economics concerned with issues related to the efficiency, effectiveness, value, and behaviour in the production and consumption of health and healthcare

Is healthcare an economic good?

An economic good is a good/service that provides value and utility to people, but is limited in supply: yes, HC is an economic good, but it’s fundamentally different than other kinds of economic goods

In what way is HC different from other economic goods?

1: Uncertainty in consumption and production: nobody knows when they might get sick

2: Demand for HC is a derived demand for H (health): people don’t actually want ‘healthcare’, they want to be healthy

3: Asymmetric Information and Supplier Induced Demand: consumers put trust in providers, so there is potential for providers to be motivated to get consumers to consume more than they need (not necessarily in public health, but definitely in private). This indicates the demand curve can be manipulated by the supply curve.

4: Extreme Consequences: poor healthcare can result in catastrophic/life-threatening consequences

5: Unique Externalities: both physical and psychic (altruism, caring) externalities indicate that individual HC utility functions are interdependent

6: Price Discrimination by Suppliers: HC providers are often characterised as acting in a price discriminating way, they have market power (eg, monopolies have their own prices)

What are examples of unique HC externalities?

Education, traffic, pollution, herd immunity

Why is it difficult to study HC using normal economic demand and supply analysis?

Normal economic demand and supply analysis posits that the individual is the best judge of her own preference (individualism, rationality), however, HC concerns people who are unconcious, insane, underage, in shock, terrified, etc, and also involve multiple externalities. Additionally, a ‘need’, such as HC, is separate from a demand, which is the notion of benefit to be had from consuming.

Compare and Contrast Positive vs Normative Economic Analysis

Positive = descriptive, what something is. Normative = prescriptive, how things should be. Eg: paying people for their kidneys would increase the supply, because a market based solution would be more efficient, but is it right to pay people for their kidneys?

What is the role of the government in HC?

Funding, regulation, provision (ownership)

What is the main HC problem facing NZ?

Limited resources: in 2023/2024, NZ spent $28.7 billion per year, which was 8% of GDP and 21% of government spending, or $5800 per person per year. We just don’t have enough resources to do whatever we want: not all health technologies can be provided, and not all patients can be treated. This means we have to prioritise and decide by what metric we determine who does and doesn’t get what treatments.

What are the three main levels of prioritisation in decision making?

1. Macro: how much of all of the money available to the government should be allocated to healthcare, in competition with eduction, roading, etc.

2. Miso: of the money allocated to health care, what should any given agency spend on any given treatment/what should they invest in?

3. Micro: clinicians deciding who should be treated and how

Describe the NZ Public Healthcare System?

1. Taxation-Based Spending: roughly 85% of NZ’s healthcare spending comes out of general taxes

2. GDP Allocation: the public HC system accounts for roughly 8% of NZ GDP, which is typical for OECD average

3. History: before the mid-20th century reforms, NZ HC was mostly decentralised, reliant on private practices or charitable entities

What is ‘health’?

1. Positive Definition: a complete state of physical and mental and social wellbeing (unrealistic, unattainable, immesurable)

2. Negative Definition: the absence of mortality, morbidity, disability

What is the Health Production Function?

H = f(HC, nutrition, food, exercise, environment)

Points of notice:

1. Increasing ‘healthcare’ increases ‘health’ at a diminishing rate: HC has diminishing marginal returns due to unnecessary treatments

2. There is a difference between the total and marginal products of healthcare - the total can be immense while the marginal experiences diminishing returns

3. Developed countries sit in the ‘flat’ of the curve, and have medicine that reflects that (more spending yields lesser improvement in health outcomes), where developing countries sit in the ‘steep’ of the curve (more spending yields more improvement in health outcomes)

4. Healthcare Policy cares mostly about marginal products - eg. is the money spent in improving lung cancer treatments better spent reducing smoking? Which has the greater effect on H?

In NZ, deaths from public infection where significantly reduced by…

1. Public Health Measures: immunisation, quarentines, water supplies, sewer systems, sanitation, food handling standards

2. Nutrition: introducing corn and potatos

3. Better Housing: improving ability to resist disease

4. Negligible effects seen in practioner-based HC

Medicine is a ‘skilled art’. What does this mean?

1. Too much HC can be bad: medical errors can cause death, the body is capable of healing itself (Iatrogenic illnesses = illnesses caused by medicine)

2. Mistakes can happen (eg. diagnosisng meningoccal in NZ)

3. Idiosyncracy is important: there is a wild variability in diagnosis and treatment decisions, both within countries and internationally

Describe the concept of ‘health capital’? [Grossman Model]

Health is a durable stock of human capital yielding utility (consumption) and healthy time for market and nonmarket activities (production.

1. Stock vs Flow: an individual inherits an initial stock of health that depreciates over time at rate delta (δ) and can be increased through gross health investments (I), such as medical care, diet, exercise, meaning health is both exogenous and endogenous

2. Health is demanded because sick time reduces earnings and productivity, where healthy time increases utility and wellbeing

3. Personal characteristics like formal schooling enhance an individual’s marginal efficiency in producing health, which lowers the ‘shadow price’ (estimated monetary value) of health capital

4. The demand for medical care is a derived demand: people don’t want medical care for medical care’s sake, they want to use it as an input to produce health

What are the 4 Quadrants in the Wagstaff Model?

1. Consumption Possibilities (tradeoff between H and other consumption C, containing indifference curves representing consumer preferences/wellbeing tangent, showing an optimal mix of health and general consumption)

2. Health Production Function (relationship between health inputs, eg medical care M and time T, and the resulting health stock H. Typically shows diminishing marginal returns)

3. Budget Constraint (how an individual’s income is allocated between purchasing health inputs and spending on other goods)

4. Reflection Line (a geometric mirror line used solely to transfer and reflect values between horizontal/vertical axes, containing no economic meaning of its own)

What else do we need to know about the health production function?

1. Assumption inputs (eg. housing) must be fixed or constant = if housing is improved, the function should go uo

2. Any changes other than a change in healthcare must mean the production function is shifting

3. Aging causes the production function to move down, as older people struggle to turn health into healthcare

4. If healthcare gets cheaper, the budget line pivots and moves down

If the price for HC falls, what happens to the Wagstaff model?

The welfare/production frontier (WPF, budget/healthcare line) shifts higher on the health access because the consumer can purchase more health inputs for the same budget and therefore their access to health increases with their higher indifference curve

If an individual experiences an increase in income, what happens to the Wagstaff model?

The budget constraint shifts outwards and the WPF shifts outwards, to show that the budget is bigger (individual can afford more) and the individual can attain a higher combination of health/general consumption

If an individual gets sick/health stock falls, what happens to the Wagstaff model?

The entire system shifts to a smaller equilibrium state: the WPF rotates downwards and away from the health axis (they can no longer achieve the same levels of health/consumption as before), the indifference curve is lower (direct drop in total utility, changes MRS, meaning when sick, an individual’s willingness to trade non-health consumption for health will change dramatically), and there is increased derived demand for medical care and healthcare inputs

What kinds of things does the Wagstaff model overlook?

1. Different types of healthcare may be substitutes or complements

2. There are different qualities of HC

3. Time and Travel Costs also impact budget constraints

4. ‘Consumer Income’ is not defined (transitory vs permanent)

5. Non-economic factors also influence HC, eg. socio-cultural demographics

6. The role of HC providers in consumer demand (principal-agent problems, supplier induced demand)

7. Most HC being free/subsidised to consumers

What is a sign of an educated consumer?

Higher consumption of healthcare and lower consumption of other general goods = higher indifference curve, greater health

What are the main kinds of healthcare insurance/subsidy?

1. Coinsurance: consumer pays x % of market price, insurer/gov pays the rest

2. Front-End Deductible: consumer pays the 1st $x, insurer/gov pays the rest

3. Rear-End Deductible: the insurer/gov pays the first $x, consumer pays the rest

Why do most governments fund or regulate healthcare?

• Due to failure of the invisible hand

  • Invisible Hand Theory: theoretically, resource allocations generated as a general equilibrium of a perfectly competitive economy are economically efficient (pareto optimal) and lead to socially desirable outcomes (the idea is that someone pursuing their own interest is more likely to promote the interests of society more effectively than when he intends to promote it)

    • However, this ‘invisible hand’ requires fully informed buyers and sellers, no externalities/public goods, and perfect compeition

    • Governments intervene where markets fail: this may increase efficiency, but also may make things worse

Normatively, why should the government intervene in HC markets?

• Governments should intervene because the inherent characteristics of H and HC cause market failures with dire consequences

  • Risk/uncertainty can cause insurance market failures

  • Externalities have large knock-on consequences to society at large

  • Information is almost always asymmetric

  • Suppliers have market power (they are not competitive price-takers, therefore there is no perfect competition)

Positively, why does the government tend to intervene?

• Regulation is often extended to industries that can otherwise be competitive

• There is a consistent desire by firms to enter regulated interest, because regulation tends to regulate in the firm’s interest, not the public’s

  • Firms desire to use regulatory processes as a protective device to shield themselves from competition, allowing them to earn super-normal profits

• ie. the government regulates because it benefits both firms and consumers (demand for regulation + supply of regulation = markets for regulation)

Why does regulatory capture disproportionately favour suppliers more than consumers?

• Regulatory capture occurs more often on the supply side than the demand side

  • Suppliers have concentrated interests and large financial stake in the regulatory outcome, so they are more likely to invest resources into lobbying, campaign contributions, etc, to shape regulation

  • Consumers (demand side) have diffuse interests, because they are vast in number so the impact of any specific regulation on any given individual is usually negligible. Consequently, citizens lack strong financial incentive to lobby against any policy/shape regulation

Why do private healthcare insurance markets often fail?

1. Natural Monopolies: high fixed costs and large economies of scale make a single provider more efficient than multiple competing firms (becoming a private healthcare provider is difficult), so one large insurance company is more likely to rule (nationalisation)

   1. Diseconomies of Scale: certain firms growing so large that average cost per unit begins to increase as output rises (eg. if a hospital gets too big, communication chains get longer, productivity tends to decrease, etc)

2. Moral Hazard: HC insurance changes incentives to avoid illness. Consumers may take less care to avoid ill health because they aren’t alone in shouldering the financial burden of it, and they may consume more HC when ill or injured, and these inefficiencies cause deadweight loss. People may also be reluctant to be insured because of high premiums.

   1. Moral hazard may be limited by: using GPs as a ‘gateway’, assessing how ‘risky’ a person is before insuring, no claims bonuses, and coinsurances to reduce deadweight loss

3. Adverse Selection: consumers know more about their behaviour than producers can, higher-risk individuals are more likely to buy insurance than a healthy person, which drives up the cost/premiums for everyone (suppliers have to raise premium to account for increasingly risky pool), so suppliers may reject certain ‘high risk’ buyers, meaning the government must step in as a last resort

   1. This is usually combated by price-discrimination, aka tailoring premiums to risk profiles

4. Externalities: markets often underproduce goods with positive externalities because private actors only look at their own personal gains, such as immunisation. We want these positive externalities to be internalised

   1. Internalisation can be acheived via:

      1. Pigouvian Subsidies: gov payments made to encourage economic activities that create positive externalities

      2. Coase Theorems: private bargaining + defined property rights + low transaction costs will allow for the beneficiaries of a positive externality to bargain (pay/bribe) producers to increase their output of a beneficial activity

What is the supplier-induced demand hypothesis?

• SIDs is the idea that doctors exert undue influence on the demand for their services by exploiting the informational asymmetry in the doctor-patient relationship or via principal-agent (gov-doctor) problems

  • Principal-agent problems: suppliers may choose the most effective treatment without regard to costs to insurers or governments

  • Informational Asymmetry: suppliers may act as profit-maximisers, inducing demand for their services

    • Evidence for this is observed as 1) an increasing supply of Drs is associated with an increased quantity of HC consumption and high prices, 2) areas with lots of doctors do not have lower-priced HC as expected

Why might SIDs not be true?

• Observational Equivalences: we can’t be sure that SIDs is causing changes to supply and demand curves and not some other force

  • If SIDs held true, Drs and their families would not use more healthcare than other people, but they do. Drs also tend to pay less. This indicates that they can and may induce demand, but that it doesn’t happen in a way that is automatic or unconstrained.

• Omitted Variable Biases: we can’t ever be sure we’re getting the whole picture

What can be done to combat SIDs?

1. Regulating supply (eg. medical school intakes)

2. Reducing consumer ignorance (fixing informational asymmetry)

3. Encouraging competitive behaviour amongst suppliers

4. Changing supplier financial incentives (eg. fee-for-service, aka paying for each individual procedure performed, vs capitation, aka paying a fixed regular amount per enrolled patient regardless of the care used)

5. Enabling malpractice suits and practice guidelines

In what ways does health insurance function as a ‘microeconomy’?

• Risk-pooling contract: individuals pay a predictable premium to protect against large/uncertain medical expenses

• Risk adversity: people don’t want to play games with their health, and when uncertain, individuals will seek to maximise expected utility

• ‘Actuarially Fair Premiums’: insurance prices that exactly equal the expected value of the loss being insured against with zero markup

• Expected Utility Hypotheses: When people make choices under risk or uncertainty, they choose the option that maximizes the expected (weighted average) value of their subjective satisfaction or "utility," rather than just maximizing the expected monetary value

• Certainty Equivalents: the guaranteed amount of cash an individual values to equally to a risky/uncertain outcome

• Insurance Loadings: extra fees added to base premiums when an insurer views you as higher-than-average risk.

Where does demand for health insurance come from?

Uncertainty with respect to illness/injury: 30% of NZ has private health insurance, which covers much of non-urgent and semi-acute health procedures, and it is likely that premiums will continue to rise as the population ages and HC costs increase. Insurers often exclude pre-existing conditions. Risk is quantifiable, but uncertainty is not.