Teaching programmes:
Master of Public Health, University of Tromsø, Norway
HEL-3007 Health Economics and Policy
Master of Public Health, Monash University, Australia
ECC-5979 Health Economics
Master of Health Administration, Monash University
ECC-5970 Introduction to Health Economics
Main text:
Olsen JA (2009): Principles in Health Economics and Policy,
Oxford University Press, Oxford
Lecture 3:
Market failures in health care
Jan Abel Olsen
University of Tromsø, Norway
www.janabelolsen.org
1: The perfect market model
A ‘perfect market’ is perfect because:
1) Sovereign consumers get what they want
– if they are willing and able to pay
2) Producers cannot exploit consumers, because
– profits are evaporated in the ‘price war’
3) Producers’ cost of the last unit produced =
Consumers’ valuation of the last unit consumed
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Key assumptions behind the perfect market model
Assumption
Implication
1.
Full information
Buyers know how much and when they wish to consume,
as well as the quality of the goods.
2.
Impersonal transactions
Buyers and sellers act independently and operate at
arm’s length.
3.
Private goods
Only the person consuming the good is affected by it; she
pays all the social costs and gains all the social benefits.
4.
Selfish motivation
Buyers are ‘only in it for getting satisfaction’, and sellers are
‘only in it for the profit’.
5.
Many buyers and sellers
No single buyer or seller can influence the market price,
neither alone nor through co-ordinated action.
6.
Free entry (and exit)
Anyone who would like to sell the products may start to do
so, and anyone may leave the market whenever they want.
7.
Homogenous products
Buyers cannot distinguish between the products of the
different producers.
Assumption
The real world imperfect market for health care
1.
Full information
Uncertainty as to if one will consume health care
Asymmetric information as to its quality
2.
Impersonal transactions
Personal transactions based on trust.
3.
Private goods
Some health care are public goods (‘public health programs’)
Some health care involve externalities
4.
Selfish motivation
Suppliers are restricted by professional codes of ethics.
5.
Many buyers and sellers
Depends on the population size, but in general few hospitals
and specialists within a given relevant region.
6.
Free entry (and exit)
Restrictions on who can practice (law against quackery).
Financial regulations in terms of public reimbursements.
7.
Homogenous products
Product differentiation; different brand names on the same
substance, higher quality signalled through more amenities.
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Three intrinsic characteristics of the market for health care*
Market or policy
solutions:
(1)
An individual does not know if she will need
Uncertainty: health care, nor its eventual financial implications
Insurance
(2)
Suppliers know more about the impact of health
Asymmetric care on the consumers’ health than consumers
information: know
Regulation
(3)
Contagion: A’s health impact upon B’s health
Externalities: Caring:
A’s health impact upon B’s utility
Subsidisation
*Evans RG (1984) Strained Mercy: The Economics of Canadian Health Care.
See chapters 2-4, available at:
http://www.scribd.com/doc/45773592/Economics-of-Canadian-Health-Care
Two different reasons for interventions in
the market for health care
• Efficiency reasons:
– Inherent failures/imperfections in the market for
health care
• Equity reasons:
– People prefer a more equal distribution of health
care than what results from an unregulated market
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2: Asymmetric information
and the agency relationship
• Asymmetric information exists when one party
possesses more information than the other, and
where this information is of a kind that is considered
important to the latter
• Doctors possess two types of information that are
important to patients:
– Diagnostic information: What is wrong with the patient?
– Treatment information: What can be done for the patient?
Who holds which type of information?
The patient holds information on the illness, which is
required for the doctor to set a diagnosis.
The doctor holds information on the production
function: H = f(HC), i.e. the expected effect of health
care on health
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The agency relationship
(based on Alan Williams, 1988)
“The doctor is there to
give the patient all the
information the patient
needs in order that the
patient can make a
decision, and the doctor
should then implement
that decision once the
patient has made it.”
“The patient is there to
give the doctor all the
information the doctor
needs in order that the
doctor can make a
decision, and the patient
should then implement
that decision once the
doctor has made it.”
The doctor’s dilemma: Dual agency
• Perfect agent for the patient
and/or
• Perfect agent for the third party payer
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3: Externalities
The impact of one person’s behaviour (or one
institution’s actions) on another person’s utility
(or another institution’s costs or revenues)
that are not signalled through the market, i.e.
the costs and values of these effects are not
revealed in the market.
Externalities in health
• Selfish externalities
– Your health may affect my health
– Your health may affect my consumption/utility
• Unselfish externalities
– I care about your health (‘caring externality’)
– I care about your utility
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Extending the utility function
UA = u(CA, HA), the simplest utility function
UA = u[CA, HA(HCA, HB), SRA, G(HA, HB), HB, UB]
A, B
= individuals
U
C
H
HC
SR
G
= utility
= consumption
= health
= health care
= social relations
= government spending (public goods)
The instrumental nature of health care
– and of health
HC = health care
H = health
W = wealth
SR = social relations
U = utility
HC
W
H
U
SR
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The interpersonal relationships in health
SRA
HC = health care
SR = social relations
H = health
C = consumption
T = tax
G = government spending (public goods)
U = utility
HCA
HA
UA
CA
TA + TB = G
CB
HCB
A and B are anonymous to each other
- no social relations with one another
UB
HB
SRB
Selfish reasons why A care for B’s health
SRA
- Contagion:
HB  HAUA
HCA
HA
UA
CA
- Economic contributions:
HB  TB  G UA
TA + TB = G
CB
HCB
HB
UB
SRB
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Private Benefits + External Benefits
= Social benefits
• Private benefits are reflected in the individual demand
curve
• External benefits = Additional value to other members of
society
• Social benefits = Total value to all members of society
• Optimal X*: Marginal social benefits = Marginal costs
Positive externalities I
co-payment: p > 0
P
DS
DP
P = MC
MC
s
P>0
XP
X*
X
Figure 4.2
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Positive externalities II
’negative prices’: p < 0
P
DS
DP
P = MC
MC
s
X
XP
P<0
X*
Positive externalities III
free health care (special case): p = 0
P
DS
DP
P = MC
MC
s
P=0
XP
X*
X
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4: Policy solutions to positive externalities
• Direct regulations
– Contagion: mandatory vaccination
– Productivity: prioritise patients who return to work
• Indirect regulations (price mechanism)
– Contagion: subsidised vaccination
– Productivity: workplace health programmes
Policy lessons from market failures
• Uncertainty
 Insurance
• Asymmetric information  Regulation
• Positive externalities
 Subsidies
– Positive externalities don’t necessarily imply free health care
– Externality-justified interventions don’t necessarily correspond
with equity objectives
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