2. Economics 5550/6550 Lecture 3 Finishing Micro Tools

3. Production and Supply Let’s look a little at supply. Consider the function for output Q: Q = f (X 1, X 2, X 3,..., X n ), where we have numerous "factors of production.“ We’re going to discover that this is like utility, but it is easier, because we CAN measure quantity.

4. What would we like to know? What happens to Q if we increase X 1 ? We call this an output elasticity. What is an elasticity? Elas. = %Δ Q/ %Δ X 1 Elas = (Δ Q/Q)/(Δ X 1 /X 1 ) This is an output elasticity Production and Supply Do we expect it to be positive or negative???

5. If we decrease X 1, how much must we increase X 2 to keep Q constant? This gives us a substitution elasticity. Production and Supply X1X1 X2X2 QoQo Isoquant Expenditures Q1Q1

6. Use a hospital as an example. We have: –numerous types of labor, like … –numerous types of equipment, like … How do they substitute? Production and Supply X1X1 X2X2 Does this isoquant have a large or small substitution elasticity? What about this one?

7. Competitors and Monopolists A competitor faces a horizontal demand curve. Price Quantity Why? MC AC Here are the costs. What is the firm’s optimum? q* Profit MR

8. Competitors and Monopolists With competition, what do we see Price Quantity Entry! MC AC Price falls until profits equal 0. q* Profit q**

9. Monopolist Faces downward sloping demand curve. Price Quantity MC AC D MR Faces downward sloping marginal revenue (MR) curve.

10. Profit Monopolist Maximizes profit where marginal revenue = marginal cost Price Quantity MC AC D MR

11. Only theory? See this! September 3, 2014 A merger of three area health systems will capture about a third of Metro Detroit’s hospital revenue, without layoffs or closures. Beaumont Health System, Botsford Health Care and Oakwood Healthcare said Monday they’re joining to become one of the region’s largest health care systems. The $3.8 billion, not-for-profit company, which will be called Beaumont Health, is expected to garner about 30 percent of hospital revenues in the region, according to the Michigan Health Market Review, making it the area’s top health institution in terms of revenue. http://www.freep.com/article/20140903/BUSINESS06/309030132/new-beaumont-health-merger they say …

12. When the merger was announced about 18 months ago, one independent health market analyst said there are good and bad aspects of mergers such as the one announced Monday. “You have opportunities for... achieving efficiencies and economies of scale,” said Allan Baumgarten, publisher of Michigan Health Market Review. “It also enables them to make investments in information technology and improving systems for care management.” However, he added, there’s potential consumers who may have to shell out more to see a doctor. Only theory? See this! http://www.detroitnews.com/article/20140623/BIZ/306230072/Metro-Detroit-hospitals-merging-form-Beaumont-Health Ya think?

13. Price = Marginal Cost Economists like to use, what to us is, a fairly intuitive definition of economic efficiency, although it may not be such to noneconomists. In a broad sense we like to define efficiency in a manner such that resources are allocated in such a way that they could not be reallocated so as to make everyone better off.

14. Price = Marginal Cost Price is the amount that someone, in particular, the last person, would be willing to pay (presumably because it brought him/her well-being). Marginal cost is the amount that someone, in particular, the last producer, must pay in order to produce the good.

15. Price = Marginal Cost If P = MC, we're in a situation where essentially if someone was producing something himself, he/she will have produced just the right amount. If P>MC, then someone is willing to pay more than it costs to produce the good, and more should be produced. This is the problem that economists have with situations (often monopolistic) that lead to equilibria with Price > Marginal Costs. Efficiency is all about QUANTITY!

16. Fuchs, AER (1996) Victor Fuchs is a heavy hitter in health economics research. In 1995-96 he was President of the American Economic Association. Gave an address at the 1996 American Economic Association Meetings Talked about the 1993-94 Clinton Health Plan Debate

17. Characterized the health policy debate as “shallow” and “inconclusive.” Asked “What went wrong?” –Was the research inconclusive? –Did we not disseminate it appropriately? –Do we, as economists, differ in what we think is important? Reported a survey: Fuchs, AER (1996)

18. Question 3. U.S. should now enact some plan that covers the entire population. 7. U.S. should seek universal coverage. 19. In the long run, employers bear the primary burden of health insurance. Fuchs, AER (1996) Health Economists TheoristsPhysicians 62% agree 65% 68% 54% 56% 46% 13% 8% 43%

19. Why didn’t we convince others? 1. Health economists agree on “positive” questions, but have major disagreements about policy values. 2. We didn’t do very well in communicating our results to the public, or even to other economists. 3. With items like universal coverage, questions of “values” intrude on traditional economic analysis. Fuchs, AER (1996)

20. Next Time Chapter 3 -- How we use statistics in health economics.