Chapter 2: The Role of Economics

Learning Objectives In this chapter, you will learn about: the role of economics in health care the use of economic models to explain phenomena the concept of the market and equilibrium

Economics and Policy Economics can offer a framework to study the implications of individual decision making and help define the alternative mechanisms available to improve resource allocation Sound policy making is based on sound economic principles applied in a sensitive and uniform manner Lessons can be learned from basic economics lessons about human behavior and the way individuals make decisions, respond to incentives, interact with each other—and about the efficient allocation of scarce resources

What is Health Economics? Health economists examine a wide range of issues from the nature and production of health to the market for health and medical care to the micro-evaluation of interventions The principle activity of economists outside of the United States is the evaluation of medical interventions

What is Health Economics? The primary focus of United States health economists is the market for health care Factors affecting the demand for medical care include: socioeconomic factors of the population, patient demographics, access barriers and the role of providers in determining the services to be provided The supply of health care encompasses a broad spectrum of economics on such topics as production theory, input markets, and industrial organization. Demand and supply intersect with one another to establish market equilibrium

Why Health Economics is Important Understanding the economics of health care is important for a number of reasons Health is important to us as individuals and as a society, and health care is one, though not the only, way of modifying the incidence and impact of ill health and disease Economic analysis offers a unique and systematic intellectual framework for analyzing important issues in health care and for identifying solutions to common problems Healthcare sector is very large

Why Health Economics is Important Third, decisions about how health care is funded, provided, and distributed are strongly influenced by the economic environment and economic constraints One good reason for understanding health economics is to engage in policy debates as an informed critic Health economics is an application of economic theory, models, and empirical techniques to the analysis of decision making by individuals, healthcare providers, and governments with respect to health and health care

Why Health Economics is Important Health economics is solidly based in economic theory, but it also comprises a body of theory developed specifically to understand the behavior of patients, doctors, and hospitals, and analytical techniques developed to facilitate resource allocation decisions related to health care Health economics has evolved into a highly specialized field, drawing on related disciplines including epidemiology, statistics, psychology, sociology, operations research, and mathematics in its approach

Key Economic Concepts These terms will serve as unifying themes throughout the course: Scarcity addresses the problem of limited resources and the need to make choices Opportunity cost recognizes the role of alternatives Marginal analysis recognizes that choices are made at the margin, not on an all-or-nothing basis Self-interest is the primary motivator of economic actors The Market accomplishes its tasks through a system of prices, or the invisible hand

Key Economic Concepts Supply and demand serve as the foundation of economic analysis Pricing and output decisions are based on forces underlying these two economic concepts. Competition forces resource owners to use their resources to promote the highest possible satisfaction of society: consumers, producers, and investors Efficiency measures how well resources are being used to promote social welfare Market failure arises when the free market fails to promote efficient use of resources by either producing more or less than the optimal level of output Sources of market failure include: natural monopoly, oligopoly, externalities of production or consumption, and public goods

The Use of Economics in Healthcare Economic Modeling In microeconomics, the assumption of rational behavior establishes a consistent framework for individual decision making Decision makers, motivated by incentives, pursue their self-interest

Economic Modeling, continued The five basic steps in the scientific method are as follows: Every analyst begins with a hypothesis based on his or her perception of how the world works Analysts then observe the real-world phenomena A theory is then developed to explain behavior or the phenomena or predict future behavior These models are abstractions of reality that capture the influential features of the observed behavior The tests of hypotheses are then performed using gathered facts and data Rethinking the model: If the empirical evidence is contrary to the model and its hypothesis, then the analyst may rethink the theory being tested.

Economic Modeling, continued Model Building One of the main goals of economics is to understand, explain, and predict the actions of economic actors Microeconomic models examine the behavior of individual decision makers—individual households and firms and government agents—or specific markets Economic Optimization  When more than one alternative is available, the optimal choice produces an outcome that is most consistent with the decision maker’s stated objectives

Economic Modeling, continued Optimization is nothing more than determining the best action given the decision maker’s goals and objectives Constrained optimization takes into account scarcity of resources Choices in the health economy are made at two levels: Individual actors must decide the best course of treatment or services to consume Policy makers must decide on the best course of action for the entire community 

Economic Modeling, continued The framework of this analysis is the neoclassical model with its assumptions of rational behavior on the part of decision makers Firms maximize profits given technology and the costs of the resources; and consumers maximize utility or satisfaction from consuming various amounts of goods and services given limited income and the prices of goods and services considered The optimal consumption of goods and services is where the marginal benefit (MB) from consumption (i.e., the additional benefit received from consuming the next unit of the good or service) equals the marginal cost (MC) of consumption (i.e., the additional cost of consuming the next unit of a good or service)

Summary Central tenets of economics can be summarized below: Resources are relatively scarce related to wants To strike a balance between scarce resources and unlimited wants involves making choices Medical decisions involve costs and benefits It is important to strike a balance between incremental benefits and costs.