ECON 850 Health Economics Gilleskie Lecture 1: Introduction What is economics? What is health economics?

Consumer: – demand for health – production of health – medical care consumption – demand for health insurance Producer: – supply of medical care – supply of health insurance – hospitals and physicians – pharmaceutical industry Government: – equity and efficiency – government intervention – government regulation – comparative health care systems – health system reform

We would like the health care market to be in a state of allocative efficiency, or Pareto optimality. Pareto improvement Given a set of alternative allocations and a set of individuals, a movement from one allocation to another that can make at least one individual better off without making any other individual worse off is called a Pareto improvement. Pareto efficient or Pareto optimal An allocation of resources is Pareto efficient or Pareto optimal when no further Pareto improvements can be made. If an economic system is not Pareto efficient, then it is the case that some individual can be made better off without anyone being made worse off.

Fundamental Theorems of Welfare Economics 1st welfare theorem: Under certain regulatory conditions (many buyers and sellers, full information, costless transactions, free entry and exit, etc.,) every competitive equilibrium is a Pareto Optimal allocation. 2nd welfare theorem: With the correct redistribution of income (or reallocation of resources) any Pareto optimal point can be achieved by a competitive equilibrium.

Conditions that disrupt the 1 st and 2 nd welfare theorems: – Market is non-competitive – Access to information is restricted or prohibitively costly – Good or service is not marketable or no market exists – Increasing returns or externalities, public goods How is the medical care market different from most markets we study as economists? – Unpredictable and irregular demand – Supplier is advisor – Product uncertainty – Different supply conditions – Unusual pricing practices – Barriers to information – Object of social concern

1. Unpredictable and irregular demand Medical care is not something you can choose not to purchase. Medical care services are demanded when there is a departure from the normal state (i.e., illness, or in an emotional state). People would like to avoid illness (and hence, participation in the medical care market). But, this is not the case for all medical services. We must consider the type of treatment.

2. Supplier is advisor The seller of the good or service is the one recommending that good or service. “ Say ahhh!” We must trust the physician about whether to consume his good or not. Doctor is giving advice about use or continued use, but it should be in the patient's best interest.

3. Product Uncertainty Uncertainty as to the quality of the product. Uncertainty due to inexperience (especially with severe illnesses). Uncertainty due to lack of knowledge as to the consequences of purchase. But, what is the standard of quality?

4. Different supply conditions Restrictions to the profession by licensing. High costs and limited entry to medical school. Advertising affects supply of services, drugs. But, should the government be involved in supply of medical care?

5. Unusual Pricing Practices Extensive price discrimination by income. Barriers to advertising. How should we model physician’s pricing behavior?

6. Barriers to information About costs of treatment Solutions? Insurance against medical care costs. (Problems?) – moral hazard – adverse selection – administrative costs – pooling of unequal risks Barring some types of care. Ask friends or colleagues. About effects of treatment

7. Object of social concern Some believe medical care is a right. Some believe we need programs to take care of those who can't take care of themselves. Some are concerned about communicable diseases. Some believe individuals may not be the best judge of what is good for them.