Review of the Last Lecture
• Are discussing the production of health: section III of the course outline
• have discussed the aggregate production function HS=HS(HC) and
some of its properties
• discussed the output elasticity for health and looked at some estimates
of it => low => suggest “flat of the curve medicine”
• then began discussion of substitution in the production of health => two
types: 1) between healthcare and non-healthcare factors that affect HS, 2)
between different kinds of HC inputs
• ended the lecture by looking at the first kind of substitution in terms =>
HC vs highway safety
• discussed the isoquant map, the budget constraint, their slopes and the
efficient combination of inputs for a given HS (life expectancy)
317_L6_Jan 18, 2008
J. Schaafsma
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Efficiency Condition for Production
• recall that the slope of the isoquant is: - MPPHSG / MPPHCG
•Recall that the slope of the budget constraint is: - PHSG/ PHCG
• efficiency condition: budget constraint tangent to the isoquant, i.e,
MPPHSG / MPPHCG = PHSG/ PHCG
(2)
• equation (2) can be rewritten as:
MPPHSG / PHSG = MPPHCG / PHCG
(3)
• note: MPPHSG / PHSG = (output/unit)/($/unit) = output/$
• also true for MPPHCG / PHCG
• thus equation (3) states that efficiency requires that the last dollar
spent on each input creates the same addition to total output
317_L6_Jan 18, 2008
J. Schaafsma
2
Changes in the Budget Constraint
• Two changes: 1) parallel shifts 2) change in the slope
1) effect of a parallel upward shift (an increase in funding):
(i) result in increased spending on both healthcare and highway
safety
(ii) more output (longer life expectancy)
So what should the funding level for HC and highway safety be?????
=> Depends on how we value life expectancy at the margin
2) a change in relative input prices will change the factor input
combination (as the price of healthcare goods rises relative to the price
of highway safety goods => shift out of HCG into HSG (DIAGRAM)
two reasons: 1. relative price effect 2. possibly also a wealth effect
317_L6_Jan 18, 2008
J. Schaafsma
3
The Objective of Public Policy:
Social Welfare Maximization
• have shown that a combination of HCG and HSG can achieve a
given HS at a lower cost than using all the funds for HC only =>
strong argument for finding the optimal allocation of the funds
between HCG and HSG
• However, efficiency is not the ultimate objective of public policy
• social welfare maximization is the ultimate objective of public policy
• Social welfare depends on the utility (level of satisfaction or
enjoyment in life) experienced by individual members of society and
on the distribution of utility across the members.
• Individual utility depends on personal tastes and preferences, and on
income
317_L6_Jan 18, 2008
J. Schaafsma
4
Does an Efficiency Gain Necessarily
Result in a Social Welfare Gain?
• Might Argue (incorrectly):
• Shifting resources from HC to highway safety to lower the cost
of achieving the current aggregate life expectancy must increase
social welfare => HC and highway safety goods do not appear in
an individual’s consumption bundle, and aggregate life
expectancy which does, is unchanged
• Furthermore, the cost of achieving current aggregate life
expectancy has decreased => taxes can be cut, or more public
goods supplied => at least some people better off, no one worse
off => Social Welfare increases
• THERE IS A PROBLEM WITH THIS ARGUMENT!!!
317_L6_Jan 18, 2008
J. Schaafsma
5
Efficiency Gains May Have
distributional Effects
• assume that we are currently producing LE with an inefficient
combination of HC (too much) and Highway safety goods (too few)
(diagram)
• reducing healthcare inputs and increasing highway safety inputs
allows us to reduce total spending and achieve the same aggregate life
expectancy (on same isoquant)
• However, while aggregate life expectancy remains unchanged there
is a redistribution of life expectancy within society
• drivers (the non-poor) gain life expectancy from the safer roads
• non-drivers (the poor) don’t gain from safer roads, but lose out from
less HC spending => life expectancy down isoquant)
317_L6_Jan 18, 2008
J. Schaafsma
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Redistribution and Social Welfare
• The impact on social welfare from a move from an inefficient
combination of HCG and HSG (for attaining a given aggregate
Life Expectancy) to the efficient combination depends not only
on the redistribution of life expectancies within society (poor to
non-poor) in our example)
• it also depends on how the cost savings from moving to the
efficient combination are used
• if the cost savings are used to cut personal income taxes, the
poor don’t benefit and are worse off than before (lower life
expectancy) and the non-poor are better off (lower taxes and
longer life expectancy) => Social Welfare could decline =>
occurs if adverse redistribution of utility from poor to non-poor
more
than offsets the utility gain from improved efficiency!
317_L6_Jan 18, 2008
7
J. Schaafsma
If Cost Savings are used for Low
Income Housing
• social welfare will likely increase if the cost savings are used for
programs to help the poor, e.g. low income housing, food vouchers,
income assistance, retraining programs
• Such programs yield utility directly to the poor and also improve life
expectancy
• BOTTOM LINE: whether a move to greater efficiency improves
social welfare depends on who gains and who loses from the direct
effects of the move to efficiency and on how the cost savings from the
efficiency gain are distributed across the population
317_L6_Jan 18, 2008
J. Schaafsma
8
Lifestyle and HC as determinants of
HS
• a healthier lifestyle leads to a better HS
• more HCG also lead to a better health status (up to a point:
iatrogenic effects)
• isoquant diagram applies here using units of healthy life style
promotion by government and HCG as inputs (DIAGRAM)
• get the same efficiency conditions => last dollar spent on
healthcare should have the same impact on life expectancy as the last
dollar spent on healthy lifestyle promotion
• Should government engage in healthy life style promotion if there
are efficiency gains to be had? (same aggregate life expectancy at
lower cost)
317_L6_Jan 18, 2008
J. Schaafsma
9
The Key Question with Healthy
Lifestyle promotion
• When healthy lifestyle promotion causes people to adopt healthier
lifestyles are they better off? Depends!!!!
• Consider each of the following: tobacco consumption, sugar
consumption, skiing
• Tobacco consumption is bad for health. Should we campaign to
eliminate its consumption?
• Sugar consumption is bad for health. Should we campaign to
eliminate sugar consumption?
• skiing is a high injury sport. Should we campaign to eliminate
skiing as a sport and persuade people to take up some safer sport with
the same health benefits?
317_L6_Jan 18, 2008
J. Schaafsma
10
Substitution between Healthcare
Goods
• Now consider that HC is not a homogeneous good => consists of
many components: doctors, nurses, hospital beds etc.
• Question is: is there substitutability in production across these
HC inputs? e.g., can nurses substitute for doctors, or can
equipment substitute for labour input, etc.?
• Can draw the isoquant diagram using doctors and nurses time as
inputs: fixed factor proportions or substitutability at the margin?
• Expect some substitutability => US studies suggest that properly
trained nurses could substitute for 25 – 50 % of doctor’s services
without loss of quality.
317_L6_Jan 18, 2008
J. Schaafsma
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Can we be Confident that the
Combination of HC goods is
Efficient?
• can we be confident that the combination of nurses and
doctors time is efficient, i.e., that at the current combination the
budget constraint is tangent to the isoquant
• if yes => we are getting the maximum HS for our expenditure
on doctors and nurses
• if no => we can in principle reallocate the funds to achieve the
same HS at a lower cost
317_L6_Jan 18, 2008
J. Schaafsma
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Empirical Evidence: the ratio of
Doctors to Nurses is too High
• empirical evidence suggests that the current combination of
doctor/nurses inputs is inefficient
• could substitute lower cost nurses’ time for some doctors’ time
without lowering HS outcomes (DIAGRAM)
• why does this inefficiency exist?
• likely reason => tradition and physician preferences, not relative
factor prices, determine factor input combinations (we’ll return to
this later in the context of modeling the practitioner firm)
317_L6_Jan 18, 2008
J. Schaafsma
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