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-ornothing 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.