ECON 850
Health Economics
Lecture 1: Introduction
What is economics?
What is health economics?
Gilleskie
What is health economics?
• Consumer:
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• Producer:
demand for health
production of health
medical care consumption
demand for health insurance
• Government:
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equity and efficiency
government intervention
government regulation
comparative health care systems
health system reform
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supply of medical care
supply of health insurance
hospitals and physicians
pharmaceutical industry
We would like the health care market
to be in a state of allocative efficiency, or Pareto optimality.
• Pareto improvement
Given a set of alternative allocations and a set of individuals,
a movement from one allocation to another
that can make at least one individual better off
without making any other individual worse off
is called a Pareto improvement.
• Pareto efficient or Pareto optimal
An allocation of resources is Pareto efficient or Pareto optimal
when no further Pareto improvements can be made.
If an economic system is not Pareto efficient,
then it is the case that some individual can be made better off
without anyone being made worse off.
Fundamental Theorems
of Welfare Economics
• 1st welfare theorem:
Under certain regulatory conditions
(many buyers and sellers, full information,
costless transactions, free entry and exit, etc.,)
every competitive equilibrium is a Pareto Optimal allocation.
• 2nd welfare theorem:
With the correct redistribution of income
(or reallocation of resources)
any Pareto optimal point can be achieved
by a competitive equilibrium.
• Conditions that disrupt the 1st and 2nd welfare theorems:
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Market is non-competitive
Access to information is restricted or prohibitively costly
Good or service is not marketable or no market exists
Increasing returns or externalities, public goods
• How is the medical care market different from most
markets we study as economists?
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Unpredictable and irregular demand
Supplier is advisor
Product uncertainty
Different supply conditions
Unusual pricing practices
Barriers to information
Object of social concern
1. Unpredictable and irregular demand
• Medical care is not something you can
choose not to purchase.
• Medical care services are demanded when there is a
departure from the normal state (i.e., illness, or in an
emotional state).
• People would like to avoid illness (and hence, participation
in the medical care market).
• But, this is not the case for all medical services. We must
consider the type of treatment.
2. Supplier is advisor
• The seller of the good or service is the
one recommending that good or service.
“Say ahhh!”
• We must trust the physician about whether to consume
his good or not.
• Doctor is giving advice about use or continued use, but
it should be in the patient's best interest.
3. Product Uncertainty
• Uncertainty as to the quality of the product.
• Uncertainty due to inexperience
(especially with severe illnesses).
• Uncertainty due to lack of knowledge as to the
consequences of purchase.
• But, what is the standard of quality?
4. Different supply conditions
• Restrictions to the profession by licensing.
• High costs and limited entry to medical school.
• Advertising affects supply of services, drugs.
• But, should the government be involved in supply of
medical care?
5. Unusual Pricing Practices
• Extensive price discrimination by income.
• Barriers to advertising.
• How should we model physician’s pricing behavior?
6. Barriers to information
• About costs of treatment
Solutions?
• Insurance against medical care costs. (Problems?)
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moral hazard
adverse selection
administrative costs
pooling of unequal risks
• Barring some types of care.
• Ask friends or colleagues.
• About effects of treatment
7. Object of social concern
• Some believe medical care is a right.
• Some believe we need programs to take care of
those who can't take care of themselves.
• Some are concerned about communicable diseases.
• Some believe individuals may not be the best judge
of what is good for them.