RESOURCE ALLOCATION & THE MARKET Demand, supply and the market Sources of failure in the market for health care The insurance system of funding health.

RESOURCE ALLOCATION & “THE MARKET”

• Demand, supply and the market

• Sources of “failure” in the market for health care

• The “insurance” system of funding health care

• Resource allocation in the absence of the “free” market - for discussion

DEMAND, SUPPLY AND THE MARKET

• 1. Concept of Demand (“buyers”)- demand curve

- influences on demand• 2. Concept of Supply (“sellers”)

- supply curve

- influences on supply• 3. Concept of the Market (“exchange”)

- interaction of d+s

- equilibrium (through price mechanism)

DEMAND• Consumers purchase those commodities

which, subject to their income constraint, maximise their utility

• “Demand” = willingness and ability to pay for a commodity at each

and every price, over a given period of time, subject

to all else being constant (ceterus paribus)

DEMAND CURVE

No. Mars Bars

Price$

1.50

2 40

2

D=MB

DETERMINANTS OF DEMAND

• (Full ) price of the commodity

• Prices of other commodities - compliments

- substitutes

• Consumer income/wealth

• Consumer “tastes” (need?)

INCREASE IN DEMAND

A B caused by fall in priceA C caused by increase in income

No. Mars Bars

Price$

1.50

2 40

2

D1

A

B

C

D

“ELASTICITY” OF DEMAND

• Price elasticity = % change in quantity demanded

% change in price• Shows responsiveness of demand to price• If : PE< 1 = inelastic

PE> 1 = elastic

PE = 1 = unitary elasticity

• Main determinant = availability of substitutes

PRICE ELASTICITY ILLUSTRATED

Q

P

P1

Qi

po

Qo` Qe

Dpe

Dpi

SUPPLY• Firms produce those commodities which,

subject to capacity, maximise their profit.• “Supply” = willingness and ability to

sell a commodity at each and every price, over a given period of time, subject to all else being constant (ceterus paribus)

SUPPLY CURVE

No. Mars Bars

Price$

1.50

2 40

2

S=MC

DETERMINANTS OF SUPPLY

• Price of the commodity

• Prices of factors of production (cost)

• State of technology

• Other “goals” of firm

INCREASE IN SUPPLY

A B caused by increase in priceA C caused by improved technology

No. Mars Bars

Price$

1.50

2 40

2

S

B

AC

S1

ELASTICITY OF SUPPLY

• Supply elasticity = % change in quantity supplied

% change in price

• Shows responsiveness of supply to price

• If: SE < 1 = inelastic

SE > 1 = elastic

SE = 1 = unitary elasticity

• Main determinant = flexibility in production

SUPPLY ELASTICITY ILLUSTRATED

Q

P

Po

Qi

P1

Qo` Qe

Si

Se

MARKET EQUILIBRIUM

No. Mars Bars

Price$

20

2

S=MC

D=MB

EXCESS SUPPLY

No. Mars Bars

Price$

2

20

3

1 3

A B

E

D

S

EXCESS DEMAND

No. Mars Bars

Price$

1

20

2

1 3

A B

E

D

S

NECCESSARY CONDITIONS FOR COMPETITIVE

MARKET

1 No barriers to entry or exit (large number of independent buyers and sellers)

2 Consumer bears costs and receives benefit

3 Consumer has perfect information on cost and benefits

WHY HEALTHCARE MARKETS “FAIL”

1. Uncertainty

2. Imperfect information and knowledge imbalance

3. Monopoly

4. Externalities

5. (Equity)

INFORMATION ASYMMETRY

Lack information on cost, effectiveness, benefits etc.

Not physically/mentally able to make

choice.

Leads to “agency relationship”.

Potential for “supplier-induced demand”.

IMPLICATION OF SID

Q

PS

D D1 D2

MONOPOLY

MONOPOLY = one producer who determines price and quantity

OLIGOPOLY = few producers who collude to set price. Engage in non -price competition

EXTERNALITIES

Positive eg. Vaccination

Negative e.g. Antibiotic Resistance

Quantity

Price$

20

2

S=MC

D=MPB

POSITIVE EXTERNALITY

4

4

MSB

1

EQUITY• The competitive market will yield a

distribution of commodities which is efficient.

• “Inequity” of distribution is NOT a “failure” of the market - it is not “designed” to achieve this.

• Equity is additional/alternative objective or a constraint

THE “INSURANCE” MARKET

Is a means by which a third party will pay for

care out of a central fund that individuals have

paid into; either by premium or taxation.

Is the “market” solution to uncertainty

concerning the timing and magnitude of

expenditure.

DEMAND FOR INSURANCE

Degree of risk aversion

Probability of requiring treatment

Cost of treatment

Premium “loading”

Income

SOCIAL REASONS FOR “INSURANCE”

1. Systematic transfer from low to high risk, young to old.

2. Systematic transfer of income from rich to poor.

ADVERSE SELECTION

Insurance may cover more high risk than low

risk individuals. If too many high risk cases are

covered, there will be excessive payouts, the

insurance company will lose money, premiums

will have to rise further, and the insurance

company will eventually close.

IMPORTANCE OF ADVERSE SELECTION IN “POOLING”

HEALTH RISK

1. Variation in individual cost extremely wide.

2. Significant proportion of variance in individual

cost is predictable.

3. High cost of insurers acquiring knowledge.

“SOLUTION” TO ADVERSE SELECTION

experience rating

exclusions and benefit ceilings

subsidisation of those “in need”

publicly financed health care systems

MORAL HAZARD

Once insured against “X”, “X” more likely to

occur.

Full insurance means money cost facing

consumer = zero.

Leads to “excess” demand - benefits from

resources used for providing health care

less that the benefits foregone from an

alternative use.

Quantity of HC

$ per unit of HC

Qo0

Po

D

Q1

Welfare loss

MC

D

MORAL HAZARD

“SOLUTION” TO MORAL HAZARD

use of co-payments or user charges

incentives to demand care from selected low-

cost providers (PPOs)

combining insurer with provider (HMOs)

use of primary care as “gateway” to services

non-price rationing (waiting lists)

Quantity of HC

$ per unit of HC

Qo0

Po

D

Q1

MC

D

Q2

P2

CO- PAYMENTS

Welfare loss

PUBLIC INTERVENTION

Subsidisation and/or regulation of private insurers.

Selective subsidies or provision of free services.

Public provision and/or social insurance coverage.