RESOURCE ALLOCATION & “THE MARKET”
• Demand, supply and the market
• Sources of “failure” in the market for health care
• The “insurance” system of funding health care
• Resource allocation in the absence of the “free” market - for discussion
DEMAND, SUPPLY AND THE MARKET
• 1. Concept of Demand (“buyers”)- demand curve
- influences on demand• 2. Concept of Supply (“sellers”)
- supply curve
- influences on supply• 3. Concept of the Market (“exchange”)
- interaction of d+s
- equilibrium (through price mechanism)
DEMAND• Consumers purchase those commodities
which, subject to their income constraint, maximise their utility
• “Demand” = willingness and ability to pay for a commodity at each
and every price, over a given period of time, subject
to all else being constant (ceterus paribus)
DEMAND CURVE
No. Mars Bars
Price$
1.50
2 40
2
D=MB
DETERMINANTS OF DEMAND
• (Full ) price of the commodity
• Prices of other commodities - compliments
- substitutes
• Consumer income/wealth
• Consumer “tastes” (need?)
INCREASE IN DEMAND
A B caused by fall in priceA C caused by increase in income
No. Mars Bars
Price$
1.50
2 40
2
D1
A
B
C
D
“ELASTICITY” OF DEMAND
• Price elasticity = % change in quantity demanded
% change in price• Shows responsiveness of demand to price• If : PE< 1 = inelastic
PE> 1 = elastic
PE = 1 = unitary elasticity
• Main determinant = availability of substitutes
PRICE ELASTICITY ILLUSTRATED
Q
P
P1
Qi
po
Qo` Qe
Dpe
Dpi
SUPPLY• Firms produce those commodities which,
subject to capacity, maximise their profit.• “Supply” = willingness and ability to
sell a commodity at each and every price, over a given period of time, subject to all else being constant (ceterus paribus)
SUPPLY CURVE
No. Mars Bars
Price$
1.50
2 40
2
S=MC
DETERMINANTS OF SUPPLY
• Price of the commodity
• Prices of factors of production (cost)
• State of technology
• Other “goals” of firm
INCREASE IN SUPPLY
A B caused by increase in priceA C caused by improved technology
No. Mars Bars
Price$
1.50
2 40
2
S
B
AC
S1
ELASTICITY OF SUPPLY
• Supply elasticity = % change in quantity supplied
% change in price
• Shows responsiveness of supply to price
• If: SE < 1 = inelastic
SE > 1 = elastic
SE = 1 = unitary elasticity
• Main determinant = flexibility in production
SUPPLY ELASTICITY ILLUSTRATED
Q
P
Po
Qi
P1
Qo` Qe
Si
Se
MARKET EQUILIBRIUM
No. Mars Bars
Price$
20
2
S=MC
D=MB
EXCESS SUPPLY
No. Mars Bars
Price$
2
20
3
1 3
A B
E
D
S
EXCESS DEMAND
No. Mars Bars
Price$
1
20
2
1 3
A B
E
D
S
NECCESSARY CONDITIONS FOR COMPETITIVE
MARKET
1 No barriers to entry or exit (large number of independent buyers and sellers)
2 Consumer bears costs and receives benefit
3 Consumer has perfect information on cost and benefits
WHY HEALTHCARE MARKETS “FAIL”
1. Uncertainty
2. Imperfect information and knowledge imbalance
3. Monopoly
4. Externalities
5. (Equity)
INFORMATION ASYMMETRY
Lack information on cost, effectiveness, benefits etc.
Not physically/mentally able to make
choice.
Leads to “agency relationship”.
Potential for “supplier-induced demand”.
IMPLICATION OF SID
Q
PS
D D1 D2
MONOPOLY
MONOPOLY = one producer who determines price and quantity
OLIGOPOLY = few producers who collude to set price. Engage in non -price competition
EXTERNALITIES
Positive eg. Vaccination
Negative e.g. Antibiotic Resistance
Quantity
Price$
20
2
S=MC
D=MPB
POSITIVE EXTERNALITY
4
4
MSB
1
EQUITY• The competitive market will yield a
distribution of commodities which is efficient.
• “Inequity” of distribution is NOT a “failure” of the market - it is not “designed” to achieve this.
• Equity is additional/alternative objective or a constraint
THE “INSURANCE” MARKET
Is a means by which a third party will pay for
care out of a central fund that individuals have
paid into; either by premium or taxation.
Is the “market” solution to uncertainty
concerning the timing and magnitude of
expenditure.
DEMAND FOR INSURANCE
Degree of risk aversion
Probability of requiring treatment
Cost of treatment
Premium “loading”
Income
SOCIAL REASONS FOR “INSURANCE”
1. Systematic transfer from low to high risk, young to old.
2. Systematic transfer of income from rich to poor.
ADVERSE SELECTION
Insurance may cover more high risk than low
risk individuals. If too many high risk cases are
covered, there will be excessive payouts, the
insurance company will lose money, premiums
will have to rise further, and the insurance
company will eventually close.
IMPORTANCE OF ADVERSE SELECTION IN “POOLING”
HEALTH RISK
1. Variation in individual cost extremely wide.
2. Significant proportion of variance in individual
cost is predictable.
3. High cost of insurers acquiring knowledge.
“SOLUTION” TO ADVERSE SELECTION
experience rating
exclusions and benefit ceilings
subsidisation of those “in need”
publicly financed health care systems
MORAL HAZARD
Once insured against “X”, “X” more likely to
occur.
Full insurance means money cost facing
consumer = zero.
Leads to “excess” demand - benefits from
resources used for providing health care
less that the benefits foregone from an
alternative use.
Quantity of HC
$ per unit of HC
Qo0
Po
D
Q1
Welfare loss
MC
D
MORAL HAZARD
“SOLUTION” TO MORAL HAZARD
use of co-payments or user charges
incentives to demand care from selected low-
cost providers (PPOs)
combining insurer with provider (HMOs)
use of primary care as “gateway” to services
non-price rationing (waiting lists)
Quantity of HC
$ per unit of HC
Qo0
Po
D
Q1
MC
D
Q2
P2
CO- PAYMENTS
Welfare loss
PUBLIC INTERVENTION
Subsidisation and/or regulation of private insurers.
Selective subsidies or provision of free services.
Public provision and/or social insurance coverage.