Basics In Health Economics
Seminar Topic: Basics in Health economics
Moderator : Garg Sir
Presenter: Ranjana
Date: 15/12/2011
Framework:
A. Definition
B. The tools of economics
1. Efficiency
Economics evaluation of efficiency
Discounting in economic evaluation
2. Equity
3. The market concept
4. The nature of demand
5. Interaction of supply and demand
6. Market failure in health sector
7. Functions of Health finance
Resource mobilization
Risk pooling
Resource allocation
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Definition:
Economics is the study of how individuals and societies choose to allocate
scarce
productive
resources
among
competing
alternative
uses
and
subsequently to distribute the 'products' from these uses among the members of
a society. Health care and health are universally seen as two important products
to which all societies commit productive resources. Health economics,
therefore, is the study of how scarce productive resources are allocated among
alternative uses for the care of sickness and the promotion, maintenance and
improvement of health. It further includes the study of how health care and
health-related services, their costs and benefits, and health itself, are distributed
among individuals and groups in society.
Resources- In a strictly academic sense, productive resources are the basic
inputs to production—the time and abilities of individuals; raw materials such as
land and natural resources (air, water, minerals, etc.); transformations and
accumulations of these into capital (facilities, equipment, etc.); and knowledge of
production processes (technologies).
In this definition, money is not a resouce because it cannot be used by itself to
produce something. In a more common use, the term covers financial resources
as well as productive resources.
A fundamental problem facing all societies—and the reason that economics
exists as an area of study—is that productive resources are scarce. SCARCITY
means that there are not, and can never be, enough resources to satisfy all
human wants and needs. This observation is acutely clear everyday when it
comes to matters of illness and health, but it is equally true of other areas of
human activity. There exists a constant conflict among alternative uses of
productive resources, and a constant need to choose among alternative
allocations.
Therefore, economists define the real cost of an activity (for example, provision
of hospital services) as the other outputs that must be given up (for example,
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other health services such as immunizations, or non-health services or
commodities such as defense or vehicles) because productive resources are
committed to it. Economists refer to this important basic concept as
OPPORTUNITY COST. Policymakers in all societies face decisions about tradeoffs such as these on a daily basis.
Opportunity Cost in the Planning Problem: The Inter-Sectoral Dimension
Based on a preliminary analysis it quickly becomes clear that the request from
the Ministry of Defense for new aircraft, if granted, will virtually preclude all other
new initiatives. Wanting to ensure that Doreen’s committee is aware of the high
'opportunity cost' of this request, you begin to examine what could be done if that
Ministry’s request was reduced by half. Working with experts from the program
areas involved, and reading the research literature yourself, the team concludes
that a 50% reduction in the defense request could allow the achievement of a
10% increase in the national literacy rate or a 15% decrease in the number of
smokers in the country if new programs modeled on recent successful programs
elsewhere were introduced.
Another inter-sectoral example of the consequences of a specific decision about
health care funding is vividly illustrated in the Canadian province of Ontario. In
the 1990-91 fiscal year, the provincial government granted a $350 million budget
increase for hospital services. A public health researcher pointed out that these
funds could have been used to provide 70,000 publicly subsidized housing units
for low-income families or 547,000 publicly subsidized day care places for
children, both of which he considered to be alternative investments in health
(Labonte, 1990).
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1.
Efficiency
a.
Technical efficiency
b.
Cost effectiveness efficiency
c. Allocative efficiency
d. Pareto efficiency
e. Marginal analysis
i. Marginal cost
ii. Marginal benefit
f. Economic evaluation of efficiency
i. Cost effectiveness analysis
ii. Cost utility analysis
iii. Cost benefit analysis
iv. Discounting in economic evaluation
v. Willingness to pay
The primary criterion that economics uses to organize and conduct these
analyses is that of EFFICIENCY. The basic concept of efficiency, as the word is
understood in common usage by almost everyone, is quite simple: get the 'most'
out of scarce resources.
The three main elements of efficiency may be summarized in everyday language
as follows:
1. Do not waste resources;
2. Produce each output at least cost;
3. Produce the types and amounts of output which people value most.
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1. Technical Efficiency: The first element of efficiency above requires that for
any given amount of output the amount of inputs used to produce it is minimized
(the requirement may also be stated such that maximum output is produced from
any given combination of inputs). If this condition is not met, then it is possible
either to obtain more output through a different configuration of resources or to
release some of the resources to alternative uses without sacrificing any current
output. This element of efficiency is termed technical efficiency.
2. Cost-Effectiveness Efficiency: The second element of efficiency builds on
the first but takes into account the relative cost of different inputs. It requires that,
in addition to technical efficiency being attained, inputs be combined so as to
minimize the cost of any given output (alternatively, the requirement may be
stated such that output is maximized for a given cost). For example, if labor is
abundant and inexpensive relative to capital in one economy compared to
another, then least-cost production methods will employ relatively more labor in
the first economy. This element of efficiency is termed COST-EFFECTIVENESS
EFFICIENCY.
3. Allocative Efficiency The third element of efficiency links the supply of
outputs to the demand for them by extending the analysis to consider the
preferences and values of the members of society who consume the outputs. It
requires that in addition to the achievement of technical efficiency and costeffectiveness, resources be used to produce the types and amounts of outputs
which best satisfy people, i.e. which people value most highly. The term used by
economists to describe this all-encompassing concept of efficiency is
ALLOCATIVE EFFICIENCY. It is possible for an allocation of resources to be
both technically efficient and cost-effective but allocatively inefficient if producers
are supplying too much or too little of any good or service relative to consumers’
wishes. If mothers of young children want counselling services for behavioral
problems instead of frequent well-child check-ups, then allocative efficiency
might be improved by changing the mix of primary care services even if the wellchild examinations were being provided cost-effectively.
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In common language, then, efficiency means both 'doing things right' (technical
efficiency and cost-effectiveness), and 'doing the right things' (allocative
efficiency).
4. Pareto Efficiency: By necessity, statements about allocative efficiency involve
value judgements about what criteria will be used to judge whether a particular
resource allocation 'best satisfies' people, or is the 'most highly valued', or has
'too much or too little' of some goods and services. The standard criterion in
economics comes from a branch of economic theory known as welfare
economics. It is known as the PARETO EFFICIENCY criterion (named after a
19th-Century sociologist and economist Vilfredo Pareto), and states that
allocative efficiency has been attained when it is not possible to change the
allocation of resources to make any one person better off without making at least
one other person worse off (Boadway and Bruce, 1984).
There are at least two other important characteristics of efficiency based on
Paretian criteria (Culyer, 1985; Boadway and Bruce, 1984). Firstly, such a notion
of efficiency is individualistic; social 'welfare' is assumed to be a function only of
individual welfare, each individual is assumed to be the best judge of his or her
gains and losses, and individual welfare is assumed to depend only on the goods
and services the individual consumes. In the real world, however, all of these
assumptions are problematic. People care about the welfare of each other, their
social groups, and their communities
Economists define the MARGINAL COST of an output to be the additional cost
incurred in producing the last (or next) unit of that output. Similarly, the
MARGINAL BENEFIT is the additional benefit obtained by consuming the last
(or next) unit of an output. In an efficient world, marginal cost and marginal
benefit are equal for each output, although they may vary across outputs.
In other words, the value of the extra benefit that individuals and societies derive
from the last unit of any output consumed is just equal to the opportunity cost of
the resources (i.e. their value in their next best use) used up by producers to
create that unit of output. For example, if a hospital wishes to expand its kidney
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dialysis program, consideration of allocative efficiency would require that it not
expand past the point where the extra resources required (personnel, space,
supplies and equipment) would create more benefit in another of the hospital’s
programs.
Economic evaluation of efficiency
Economic evaluation is defined as 'the comparative analysis of alternative
courses of action in terms of both their costs and consequences' (Drummond, et
al., 1997). All elements in the definition are required for a study to be considered
a full economic evaluation
Cost-Effectiveness Analysis (CEA): In cost-effectiveness analysis the costs,
measured in money terms, are compared to the consequences in the physical
units of effectiveness that are natural to the program. For example, a malaria
prevention program might be evaluated in terms of the cost per case of malaria
prevented, while malaria treatment programs would be compared in terms of the
cost per case of malaria cured, or perhaps, the cost per malaria death averted.
Cost-effectiveness analysis addresses cost-effectiveness efficiency.
Cost-Utility Analysis: In cost-utility analysis (CUA) the consequences are
measured in QUALITY-ADJUSTED LIFE YEARS (QALYS), which attempt to
capture and reflect both the quantity of life years added by a health care program
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and the quality of life resulting from treatment. A QALY is calculated by
multiplying the number of life years added by a program by a standardized
weight between 0 and 1.0 that reflects the health-related quality of life during that
time, where 0 is weight given to immediate death and 1.0 is the weight given to
perfect health for a defined time period. The weights are measured by asking
relevant individuals which consequences they prefer and by how much, thereby
reflecting the value (or 'utility') people place on different health outcomes.
represents the quality of life during the additional years of life resulting from the
program.
The preference or utility scores are then used as value weights (quality weights)
to calculate QALYs as follows. Suppose that a dialysis treatment program
extends life by 15 years, but that the quality of life of an individual receiving
dialysis suffers both because of the treatment itself and a gradual decline in
health over that time.
If individuals valued the first 10 years at 0.75 on the above 0 - 1.0 scale, and the
last 5 years at 0.50 on the same scale, then we would say that dialysis generated
10.0 QALYs (10 x 0.75 + 5 x 0.50).
Cost-Benefit Analysis (CBA) In the third approach to assessing efficiency, costbenefit analysis, the consequences are measured and valued in monetary units,
most commonly by asking relevant individuals how much they would be willing to
pay to obtain the consequences: health improvement. This is most frequently
done using a method called CONTINGENT VALUATION. Hence, for the malaria
prevention and treatment program, or the dialysis program, the analyst would
describe to an individual both how many life years the program could be
expected to add and what their health would be during those years, and then ask
the person how much they would be willing to pay to obtain those health benefits.
In cost-benefit analysis both the costs and the consequences of a program are
measured in the same units, i.e. money units, and thus CBA is the only technique
that can determine in and of itself whether a program is worth doing (benefits
exceed the costs, generating positive net benefit). Note also that because the
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value of all consequences are expressed in money limits, it allows the
comparison of not only health programs that produce different consequences
(e.g. malaria and dialysis), but also health and non-health programs (e.g. malaria
prevention and a network of feeder roads), though there are significant practical
challenges involved in comparing such disparate programs.
In general, people prefer bad things (costs) to occur later, and good things
(health benefits) to occur earlier. As an example, suppose you could undertake
one of two programs this year, both of which have identical costs. The first
program averts 1000 deaths this year; the second program will avert 1000 deaths
in 50 years. Which program would you prefer? Most would prefer the first option.
This time preference into account by using DISCOUNTING. In discounting, all
amounts, costs or consequences that occur in future years are reduced by a
DISCOUNT FACTOR to convert them to their equivalent present value.
Discounting works much like the reverse of compound interest.
Components of economic evaluation
It is now recommended that the WILLINGNESS-TO-PAY (WTP) method be used
to convert health changes to their equivalent dollar amounts. WTP questions can
be asked in a number of different ways and these have different implications for
the analysis. Firstly, WTP questions can be asked regarding only the actual
health change achieved. Secondly, WTP questions can be asked for the whole
program (Global WTP), encompassing how much they are willing to pay to
achieve all of the consequences including health effects, savings in the health
care and other sectors, and other non-monetary consequences. It is important to
distinguish which type of WTP question is asked. If it is the former, then any cost
savings and the value of other, non-health effects must be added to the WTP for
the health effect; if it is the latter, the global WTP includes all relevant effects and
including any others will result in double-counting.
1. Equity
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For the purposes of operationalisation and measurement, equity in health can be
defined as the absence of systematic disparities in health (or in the major social
determinants of health) between social groups who have different levels of
underlying social advantage/disadvantage—that is, different positions in a social
hierarchy. Inequities in health systematically put groups of people who are
already socially disadvantaged (for example, by virtue of being poor, female,
and/or members of a disenfranchised racial, ethnic, or religious group) at further
disadvantage with respect to their health; health is essential to wellbeing and to
overcoming other effects of social disadvantage.
One way to look at distributional effects of production of goods and services is to
look at EQUITY. The term stands for social justice or fairness. This implies a
value judgment about what is 'fair'. Bravemann and Gruskin define equity in
Equity is not the same as EQUALITY. As we have established in the previous
paragraph, equity implies a value judgment about a situation—i.e. it is normative.
health as follows:
Two more concepts are relevant in a discussion of equity: 'horizontal' and
'vertical' equity. Horizontal equity refers to equal access to health care services
for all people with the same needs, regardless of location, gender, race and other
determinants. It looks at how well health services are distributed throughout
society. Vertical equity refers to the equal access to health services irrespective
of income
2. The market concept
For any market to function, you simply need three components:
1. Trading of a good or service;
2. Two independent players— - buyers, - sellers;
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3. A 'price' of the good or service that conveys information about its value— buyers’ willingness to pay = DEMAND, - sellers’ willingness to produce =
SUPPLY.
The nine conditions for competitive markets are as follows:
3. The nature of demand:
Need versus Demand:
When economists talk of demand in the market place, they are talking about
consumers who want something and are able and willing to pay for it.
When someone needs something and is willing and able to pay for it, that is
when ‘ need’ is translated into Effective Demand.
Demand, supply and price:
•
People DEMAND goods and services in markets through their ability +
willingness to pay
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•
Producers SUPPLY goods and services in markets in response to
DEMAND and PRICE
•
PRICE of a good or service conveys a great deal of information about
consumer and producer behavior
Demand curve
•
The relationship between demand for a good or service and it’s price is
almost always inverse or negative
•
Increase price and the quantity demanded will almost always decline
•
The demand curve is therefore almost always downward sloping
Demand for health consultations?
Average
Price
$
5
4
3
D = Demand ‘Curve’
2
1
200
500
800
1100
1300
Total
Quantity
Elasticity of demand:
The rate at which the demand for a good or service declines as price changes is
called the ‘price elasticity of demand’
•
Elastic demand = the demand changes a lot as price changes (e.g..,
movie tickets)
•
Inelastic demand = the demand changes a little as price changes (e.g..,
essential food items, essential medical attention)
Demand Shifters: Forces which shift the demand curve
To increase the demand for a good or service
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1. Lower it’ price
2. Lower the price of a complement
1. Increase the price of a substitute
2. Increase tastes for the good or service
4. Nature of Supply
How Producers Function
Profit – Any money a producer gets to keep from the sale of a good after all costs
to produce the good are met. All suppliers make use of fixed inputs – land or
buildings, as well as all variable inputs – labour and material to produce a
good.Fixed and variable inputs combined are called Production Function.
Producers only concern is to supply their goods at the lowest cost by minimizing
their use of fixed and variable inputs.
5. Interaction of Supply and demand
The progression of more suppliers coming into the market plus more households
dropping out of the market as prices creep upwards continues until both
producers and buyers arrive at an EQULIBRIUM MARKET PRICE AND
QUANTITY.
Consumers’ Surplus
Difference between the most that a consumer would have been willing to pay for
a product when a competitive market does not exist (or performing poorly) and
the amount he/she actually pays for it in a reasonably competitive market.
Producers’ Surplus
Difference between what the producer is paid supplying a good/service at the
equilibrium market price and the smallest amount they would have been willing to
accept
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Supplier –Induced Demand
eg: when physicians prescribe more treatment than is strictly necessary , taking
advantage of the gap of information between themselves and patients
6. Market failures
Recognizing that market failure and limitations of markets in promoting equity are
problematic, health economists have synthesized findings from research to
identify some major problems that need attention. These are:
1. Positive Externalities: Because some health goods and services benefit
people who are neither buyers nor sellers, they deserve to be promoted more
than competitive markets would naturally do. The most common example in the
health field is immunization for contagious diseases—where people who are not
presently being immunized will benefit by those who do pay for it. As the market
will tend to undersupply goods or services with positive externalities, there is a
role for government to supply these goods.
2. Public Goods: Because some goods and services beneficial to health—such
as clean air, or clean drinking water from rivers or lakes—are not willingly paid for
by individual consumers in competitive markets, they require a collective
mobilization of public revenues and expenditures for public health goods and
services. An example is government-sponsored research on new health
technologies and information campaigns to prevent HIV/AIDS.
3. Informational Asymmetry; Agency Issues; Supplier-Induced Demand
Because clients often do not fully understand health products and services, the
supplier/provider becomes the 'agent' for the patient. His interests may conflict
with those of the patient and he is able to exercise 'supplier-induced demand'.
This becomes increasingly problematic with the supply of more complicated
technologies (such as the need for an MRI), and the supply of more complicated
services (like surgeries). This can lead to oversupply of services, inefficient use
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of resources, and cost escalation. This reality places a premium on educating the
public or protecting them from exploitation.
4.Monopolies And Incomplete/Unsustainable Markets: Sometimes there are
only a few suppliers of some health interventions. In this case they can dictate
prices at which services or goods are delivered and this creates a problem for the
affordability and accessibility of health care. In addition, some parts of a country
may be too inaccessible, too remote, too sparsely populated, or too poor to
sustain a market for health goods and services. In such cases, religious missions
often set up hospitals and clinics and may be the sole charitable provider. In
other cases, government may take sole responsibility for financing and providing
health goods and services, for example, by establishing mobile clinics.
7. Functions of Health Finance
The main three functions of the Health Financing system are:
1. Resource Mobilization
2. Risk Pooling
3. Resource Allocation
1. Resource Mobilization
Resource mobilization looks at mechanisms for collecting money to be spent on
health. Generally there are five ways of collecting this money, which, in most
systems are mixed and matched in varying degrees depending on the values and
goals of the health system:
1. General Revenue — This comprises all taxes that feed into the budget of the
country. 2. Insurance Schemes — These can be social or private. The difference
is that social insurance schemes are initiated by the government and are
mandatory, while private insurance is usually voluntary and does not involve the
government other than in a regulatory role. 3. Community Financing — These
are financing schemes at the local level in which all or most inhabitants of a
certain community contribute to the financing of their local health care system.
The mechanisms are varied and will be dealt with on page 7 of this module. 4.
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Out-Of-Pocket (OOP) Payments and User Fees — These payments are all
made directly by the client (c.q. patient) to the provider.
5. External sources of financing — In addition to funds raised within the
country, governments also have the option to solicit funds from international
donor organizations such as the World Health Organization or the World Bank
(and many others) to fund their systems. This support can also take various
forms and will be explained on page 9 of this module.
It is important to realize that, apart from the external sources of finance, the
citizen of the country is the source for the money that comes into the health
system. Be it through taxation, paying health insurance premium or through
direct payments to providers, in the end it is the citizen who pays. Later in this
module we will consider these different payment sources and their effect on
horizontal and vertical equity.
Risk-pooling refers to the management of financial resources so that large,
unpredictable individual financial risks become predictable and are distributed
among all members of the pool. The pooling of financial risks is the core of
traditional insurance mechanisms
Five commonly recognized stages of risk pooling, arranged in a pyramid, from
maximal at the top to minimal at the bottom:
1. Unitary risk pool
2. Integrated risk pools
3. Fragmented risk pools
4. Private insurance
5. Out-of-pocket payments
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General revenue-based systems can take the form of a universal risk pool under
which the entire population has access to publicly provided services financed
through general taxes. An example can be found in the National Health Services
of the UK.
Summing up the strengths of this system:
• There is comprehensive coverage of the population.
• Adverse selection is prevented since everyone participates.
Resource allocation:
Allocation has three dimensions:
1. The goals dimension—Criteria of allocation (Why);
2. The institutional dimension—Recipient institutions (Who To);
3. The financial dimension—Forms of allocation (How To).
Organization And Management Of Care Consumption Institutions (OMCCS)
are the primary institutions involved in allocating resources. These institutions
need not provide care, but must ensure that care is provided.
OMCC functions can be carried out by a variety of institutions at national or
regional levels:
• Public administrations;
• Non-governmental organizations;
• Not-for-profit institutions;
• Possibly, for-profit institutions.
Provider payment method:
There are four major provider payment methods to handle their charges:
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1. Fee for service (ffs);
2. Capitation;
3. Salary;
4. Salary plus bonus.
Fee for service:
Under a fee-for-service mechanism, physicians are paid per patient visit or per
clinical activity such as a laboratory test or an injection. The incentive for the
physician with FFS is to maximize the number of visits that he can charge for.
This is the typical situation in which 'supplier-induced demand' will take place.
Because of the asymmetry of information between the physician and the patient,
some physicians will order more visits even when these are not warranted. This
leads to excessive use of services and an increase in costs for the health system
as a whole. The patient or the insurance company who pays on behalf of the
patient bears the entire risk of the treatment. The physician has no financial risk
whatsoever in these transactions.
A third issue is that FFS will lead physicians to recommend more costly
procedures for their treatment plan because they will net them more income. For
instance, gynecologists may recommend more C-sections for deliveries than
necessary because they can charge more for them.
Capitation:
With capitation, doctors get paid for each person that is registered as their
patient, whether they come for visits or not. A payment is fixed for all services
that a patient may use during a period of time, such as a month or a year.
Salary:
Salaries are based on a time period for employed physicians at a fixed rate,
regardless of how many patients they have, how many consultations they provide
or how expensive the services are.
Salary plus bonus:
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In order to increase the productivity under a salaried system, many employers
offer bonuses to their staff when they reach certain goals. These goals may be:
• Number of patients seen (China);
• Revenue generated for the larger organization in which they work, such as a
hospital (China);
• Patient satisfaction (USA).
Hospital payment method:
Payment methods for hospitals are:
1. Per-Admission
2. Diagnostic-Related Grouping (Drg)
3. Per-Diem
4. Line-Item Budget
5. Global Budget
1. Per admission:
Admissions are used as the unit of service. A fixed amount is paid for each
admitted patient, regardless of length of stay or amount of services provided.
With this system hospitals will try to reduce the length of stay per patient
because with a fixed amount of beds they will be able to admit more patients in
a given period. This leads to 'risk selection', as they will try to admit only
patients with less severe illnesses.
2. Diagnostic-related grouping:
To remedy some of the shortcomings of the per-admission payment, case mixadjusted payment schemes divide patients into disease and treatment
categories and pay more for those who cost more to treat. This is called the
Diagnostic-Related Grouping (DRG) method.
3. Per diem:
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This is a very common payment mechanism for hospitals. They are paid a fixed
rate per day of hospitalization, regardless of the actual services given or their
costs. The incentives for the hospital are to reduce costs and reduce tests and
procedures. They also want to keep patients in the hospital longer, especially
because the costs decrease as the patient is in the hospital longer.
4. Line- item budget
Here, the units of payment are the expense categories: salary, drugs, supplies,
transportation, etc. The amount budgeted per line-item is based on the mix of the
hospital’s case-load, the number of staff and past budgets. Once the funding
agency (the ministry of finance) has approved the budget, the provider (hospital
or clinic) has little discretion to switch funds across budget categories. This type
of budgeting provides an incentive for hospital directors to overestimate
budgetary needs and spend the entire budget.
5. Global budget:
This method sets an all-inclusive operating budget in advance. In addition, the
hospital needs to attain certain output targets, such as a certain number of
bed-days, outpatient visits, etc.. When these targets are not reached, the
hospital faces a penalty. The budget received is independent of number of
patients, length of stay or procedures performed
Contracting :
A contract is a written agreement between a buyer (here: the government) and a
seller (here: an NGO). The seller agrees to provide certain goods and services
and, in return, the buyer agrees to give the seller a certain amount of money. The
contract sets out the terms of that agreement: what the seller provides, what the
buyer pays for, delivery and payment dates, the time period of the agreement,
renewal provisions, penalties for non-performance, and processes to resolve
disagreements. A contract can provide a more detailed and flexible set of
incentives than a payment system. Contracts can cover management of services,
service delivery, private-sector services and others areas.
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