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 $ 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 price A C caused by increase in income No. Mars Bars Price $ 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 $ 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 price A C caused by improved technology No. Mars Bars Price $ S B A C 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 $ S=MC D=MB

EXCESS SUPPLY No. Mars Bars Price $ A B E D S

EXCESS DEMAND No. Mars Bars Price $ A B E D S

NECCESSARY CONDITIONS FOR COMPETITIVE MARKET 1No barriers to entry or exit (large number of independent buyers and sellers) 2Consumer bears costs and receives benefit 3Consumer 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 P S 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 $ 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 Qo 0 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 Qo 0 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.