HEALTH ECONOMICS Lecture 2: Markets

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HEALTH ECONOMICSLecture 2 Markets
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Key concepts in economics

• Last week
• Scarcity
• Opportunity costs
• Margin
• This week
• Markets
• Supply
• Demand

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Outline

• Market experiment
• Break
• Theory of demand and supply
• Application to health care

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Aim of experiment

• Become acquainted with the mechanisms of a small
  working market
• Learn to apply the concepts of competitive supply
  and demand to a simple market
• Learn to draw supply and demand curves
  corresponding to given market data
• Begin to understand the benefit of having an
  abstract theory for predicting the effects of
  changes in the environment

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Apple market

• Check your Personal Information Sheet to find out
  whether you are a demander or a supplier of
  apples in Session 1
• To make a sale, find somebody who might be
  willing to make a deal with you
• You can negotiate in any way you wish
• When you reach agreement on a price, fill out a
  sales contract
• Your objective is to make as much profit as
  possible
• One with the most profit wins a nice box of
  chocolates!

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Profit - supplier

• If you are a Supplier, the sheet will tell you
  what your Seller
• Cost is
• Example if you have a Seller Cost of 10
• If you sell your box of apples for a price of
  16, you will make a profit of 16-106.
• If you sell your box of apples for a price of
  30, you will make a profit of 30-1020.
• If you sell your box of apples for a price of 7,
  you will make a loss of 3.
• If you do not sell, your profit is zero.

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Profit - demander

• If you are a Demander, the sheet will tell you
  what your Buyer
• Value is
• Example if you have a Buyer Value of 40
• If you buy a box of apples for a price of 16,
  you will make a profit of 40-1624.
• If you buy a box of apples for a price of 30,
  you will make a profit of 40-3010.
• If you buy a box of apples for a price of 45,
  you will make a loss of 5.
• If you dont buy any apples, your profit is zero.

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Rules

• You can negotiate in any way you wish
• You dont have to reveal your Seller Cost or
  Buyer Value
• When you reach agreement on a price, fill out a
  sales contract
• In any single round of trading, you are not
  allowed to buy or sell more than one box of
  apples, but you can choose not to trade if no
  profitable trades are available.
• Sales prices will be displayed
• Each market session can have several rounds. In
  each round within a session you have the same
  Buyer Value or Seller Cost.

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Remember

• You cannot buy or sell more than one box of
  apples in a round
• You do not have to make a trade. It is better to
  make no trade than to trade at a loss.
• Each pair of traders should turn in only one
  sales contract for their transaction
• Please return to your seat after you have traded
  and turned in a sales contract

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Theory of markets
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Free market approach

• One solution to scarcity is to let people buy the
  health care they want, that is, have a free
  market for health care
• For example cosmetic surgery
• A man can have a facelift, a nose correction and
  his eyes tightened up. His whole face can be
  rebuilt for a third of the cost of the front end
  of an expensive care respray (The Guardian, 1991)

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Markets

• The term is used to describe any process of
  exchange between buyers and sellers
• A market is a mechanism which permits the
  transfer of goods and services between consumers
  and producers without the need for Government
  intervention
• Markets work by information to consumers and
  producers being conveyed by market signals.
  Market signals are prices and quantities of
  goods and services provided.

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• Demand indicates
• at different prices, the amount of a good a
  consumer is
• willing to buy in a certain time period, whilst
  holding other
• factors (like income and prices of other goods
  constant)
• and
• the maximum amount a consumer is willing to pay
  for
• additional units of a good in a certain time
  period, whilst
• holding everything else constant.

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Demand function

• Qif(Pi, Y, Pj, Pk, , Pz, T, E)
• Where
• Qi the amount of good i demanded in a
  particular period
• Pi the price of good i in the same period
• Y income
• PjPz prices of other goods
• T tastes in the same period
• E host of other factors

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Demand curve
Price
D
Quantity per time period
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Demand curve
Price
P2
P1
D
Quantity per time period
Q2
Q1
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Shifts in demand curve
Price
D1
D
Quantity per time period
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Demand for tonic water
Price
D
Quantity tonic per year
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Fall in the price of gin (complement)
Price
D1
D
Quantity tonic per year
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Fall in the price of whisky (substitute)
Price
D
D1
Quantity tonic per year
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Individual demand

• Behind the notion of demand is the concept of
  utility
• Utility is a number that represents the level of
  satisfaction that the consumer derives from a
  particular good
• Individual tries to maximize utility given his or
  her budget constraint

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Diminishing marginal utility
Utility
Quantity of mars bars
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Elasticity

• Elasticity is the responsiveness of demand for a
  commodity to changes in factors that affect
  demand
• Price elasticity tells us how responsive demand
  is to changes in price.

change quantity demanded
change in price
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Application of demand theory

• Demand function for prescription drugs
• NHS data 1979-1985
• Does demand behave according to economic theory?
• Ryan M and Birch S. (1991) Charging for health
  care evidence on the utilisation of
• NHS prescribed drugs. Social Science and Medicine
  33 681-687.

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NHS charge per item
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Utilisation (demand)
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Demand function

• Qif(Pi, Y, Ps,GP, M, L, Tr)
• Where
• Qi the amount of prescriptions per month
• Pi prescription charge
• Y income
• Ps price of over the counter drugs
• GP no of GPs (supply side effects)
• M morbidity
• L limited list
• Tr trend

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Results

• Demand for drugs is a function of price
• Price elasticity -0.109
• 10 increase in prescription charge will result
  in a 1.09 reduction in utilization
• Price of substitutes, limited list and the trend
  variable all influence demand

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Supply function

• Qsif(Pi, Pcapital, Plabour,Pland, T)
• Where
• Qi the amount of good i supplied in a
  particular period
• Pi the price of good i in the same period
• Pcapital price of capital
• Plabour price of labour (i.e. wages)
• Pland price of land
• T technology

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Supply curve
Price
S
P2
P1
Q2
Quantity per time period
Q1
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Shifts in supply curve
Price
S
S1
Quantity per time period
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The market
Equilibrium
Price
S
PE
D
QE
Quantity per time period
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P1lt PE Excess demand
Price
S
PE
P1
D
QS
QE
QD
Quantity per time period
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P1 gt PE excess supply
Price
S
P1
PE
D
QE
QD
Quantity per time period
QS
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Invisible hand

• Free market will automatically produce an
  equilibrium price and quantity
• Very powerful allocation system
• Adam Smith referred to this as the invisible
  hand

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Case study

• 1991 Introduction of internal market in the NHS
• Separation of roles of purchasers and providers
  of health care
• Purchasers health authorities and GPs
• Providers hospital trusts
• Aim improve efficiency through increased
  competition

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Evidence

• Cost weighted activity index
• 1980-81 to 1990-1991 2.3
• 1991-92 to 1995-1996 4.1
• Productive efficiency (divide by change in real
  resources)
• 1980-81 to 1990-1991 1.5
• 1991-92 to 1995-1996 2.0
• Le Grand J (1999) Competition, cooperation, or
  control? Tales from the British National Health
• Service. Health Affairs 18 27-40

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Evidence

• Incentives were too weak and constraints too
  strong
• Health authorities could not retain surpluses
• pricing polices of trusts were strictly controlled

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Conditions perfect market

• Numerous small producers with no market power
• No restrictions on potential producers entering
  the market
• Perfect knowledge
• No externalities

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Externalities

• Externalities are spillovers from other peoples
  production or
• consumption of commodities which affect an
  individual
• in either a negative or a positive way but which
  are out of the
• individuals locus of control
• Example
• Chemicals factory dumping waste into river
  killing the fish
• Externality (cost) for fisherman
• This is not taken into account by factory when
  deciding on how much to produce

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Summary next week

• Markets
• Demand
• Supply
• Conditions perfect market
• Next week
• Do these conditions hold for health care?
• If not, what are the implications?
• Different health care systems
• Performance of health care systems