Handbook of health economics volume 1 part 2

There are other market structures that lead to sub-optimal resource allocation because some agents have enough power to set prices by shifting demand or supply. For example, if there are only a few large sellers in the market oligopoly the sellers have enough market power to set prices and the market fails to allocate resources efficiently. A good example of oligopolies is in the US health insurance industry which is dominated by a few large companies.

In some local areas, there might be only one company which essentially means that they are monopolies. Thus the condition that everyone in the market is a price taker is contravened in health care and that does lead to market failures.

Health care as a product or service is not consumed because it provides a consumer with satisfaction it might even be unpleasant or painful , but because the individual wants to retain good health. The qualities of the product health make it difficult for markets to meet the ideal market conditions.

Health is not a marketable product, that is, it cannot be exchanged between consumers. Since demand for health care is derived from the demand for health, the non-marketability of health reduces the power of market forces demand and supply to determine prices and quantities.

Consequently the ability of the market to determine resource allocation is greatly reduced. There are several information asymmetries in health care, but we will examine two: between the doctor and the patient, and between the consumer and the health insurance company.

Doctors suppliers know more about illness and treatments than their patients. Patients depend on the doctor to act in their best interest, but there is a conflict of interest because the doctor is selling a service to the patient.

In this case demand and supply are jointly determined by the same individual at the same time which can result in market failure. For example, if the doctor is driven by the profit motive, or is seeking higher income, the doctor might order more services than necessary e. There are several studies that indicate evidence of supplier-induced demand in health care. In a Japanese study, Izumida, Urushi and Nakinishi found that increases in the number of physicians per capita significantly increased use of inpatient services and outpatient services.

This finding is supported by findings of an American study that found similar market failure in large metropolitan areas. Information asymmetry between individuals purchasing health insurance and the insurance company results in two market failures termed adverse selection and moral hazard. Individuals in poor health have a greater incentive to purchase health insurance than those in good health. Individuals in poor health make greater utilisation of health care than the healthy, leading to higher payouts by the insurance company.

To avoid incurring losses, insurance companies might raise premiums. Higher premiums will further discourage healthy individuals from purchasing health insurance so that only the very ill buy insurance leading to losses by insurance companies and eventually this might mean the demise of a market.

The other solution is screening and experience rating that allows insurance companies to change different premiums according to risk levels. Individuals covered by insurance tend to use more health care and they might not take necessary precautions to stay healthy because they know they have insurance coverage. This leads to inefficient use of resources. Insurance companies try to correct this by employing gate-keepers who monitor and restrict health care access and by charging co-payments and deductibles.

Unfortunately, these are applied to everyone including those not overusing services, which make these solutions inefficient. An increase in demand for health care e. The increase in prices might result in the physician supplying less hours of work. If the price for services goes up, he might be able to earn that income by seeing only 80 patients a week.

Thus supply and demand in health care are not determined independently leading to market failures. Consumers seeking care are not always in a position to make the best judgment about their welfare even if they have the ability and freedom to do so.

For one, they lack necessary information about their illness or the effective treatment. Moreover, there are some situations of extreme stress making it impossible for the individual consumer to make the judgment e. Furthermore, consumers cannot accurately predict the results of consuming health care.

When visiting a doctor for a particular condition, the consumer is not able to predict accurately what the results of the visit will be, even if they have been through similar circumstances before. A treatment regimen that worked previously might not work the same way. Economists consider an individual to be rational if they made consistent and transitive decisions.

For example, an individual is offered three choices A, B, and C. However there are numerous findings of consumers acting irrationally. Thus there is evidence that consumers do not always act rationally thus the condition is not met in health care. Externalities are spill-over effects of consumption or production. Positive externalities occur when the actions of one individual result in a spill-over that improves the well being of another individual and negative externalities impose a cost on another individual.

An example of a positive externality is immunisation. Their immunisation provides a benefit to others—a positive externality. With the presence of externalities, individual production or consumption decisions are not optimal because they are made without consideration of all costs or benefits. Often, spill-over effects are not included in decision-making because they are not visible to the producer or consumer. In the case of a negative externality, the external spill-over costs are not included and in the case of positive externality, the spill-over benefits are excluded.

Therefore, the consumption or production level selected is not optimal or efficient. In cases of positive externality, the production or consumption level is below the optimal while with negative externalities the level is higher than optimal. Therefore externalities lead to inefficiency and so to market failures. The market is usually not able to correct inefficiencies arising from externalities.

To correct failure due to externalities, the consumer or producer has to consider both the private and the external spill-over costs or benefits. Such considerations in the decision-making process would result in production or consumption at optimal levels. One method of making the producer or consumer consider total benefits or costs in production is to provide subsidies in case of positive externalities, or taxes in the situation of negative externality.

The tax serves to make the producer aware of the extra costs that they impose on society so that they can arrive at optimal quantities in their decision-making.

Thus taxes or subsidies might eliminate the effects of externalities and lead to efficient allocation of resources. However, these usually require government action. The way taxes are used allocated and distributed has an effect on societal welfare. Furthermore, there are issues of measurement and arriving at the correct amount of tax or subsidy that will lead to efficiency.

Another implied condition is that consumer tastes are already determined at the time the consumer enters the market. This condition is not met in health care and consumer tastes are malleable. For example, consumers in the USA might demand newer, more expensive technologies rather than older ones that are equally effective, but less expensive. Such demands lead to unnecessary increases in health care costs—an inefficient use of resources market failure.

Increasing returns to scale refer to production situations with large fixed costs so that as the scale of production increases the average per unit cost of production decreases. This is true in industries that require expensive machinery to operate and, once the machinery is in place, the extra costs of production are not as high as the initial costs of setting up such machinery. In health care, there are increasing returns to scale. For example a hospital or imaging centre might cost a lot to build and equip, but once it is in operation the more services it provides the smaller the per unit costs of providing each unit of service.

The existence of economies of scale leads to market power because large firms have lower average costs and are able to survive in the market and to make profits. This also means that the large firms are more efficient than the smaller ones. If there are economies of scale, it would make sense to ensure that the industry has a few larger firms producing at low per unit costs rather than many little ones producing at higher per unit costs. This might happen naturally survival of the most efficient because larger producers experience lower average costs and are less likely to make a loss than small firms producing at high average costs.

If there are infinite economies of scale, the most efficient production might need only one firm—a situation termed natural monopoly. This situation gives the one or few firms a great deal of market power which can be used to set prices at very high levels reducing consumer purchasing power and welfare , produce poor quality services, or practice price discrimination segmenting the market and charging consumers different prices for the same good or service.

This situation can lead to a transfer of income from consumers to the powerful producer, and therefore, a decrease in consumer welfare. The bottom line then is that this condition no economies of scale is contravened in health care leading to non-competitive market structures and to monopoly pricing and lower consumer welfare—market failures. According to economic theory, the objective of a producer is to make as much profit as possible profit maximisation.

Producers who seek to maximise profits are forced to be efficient because they need to reduce production costs so as to increase their profits. Under perfect competition, they are driven to be efficient, not only by the profit motive, but also by the need to stay in business.

In doing so they use resources efficiently thus improving social welfare; however, in health care not all firms are profit driven. For example, in the USA and in other countries, there are hospitals that are not for profit, but provide a necessary service. In fact, of the 5, hospitals in the USA in , only 1, were for profit This implies that the majority of the hospitals are driven by other goals than profit. They might also be motivated by the satisfaction they get from seeing their patients recover.

Thus the profit motive is not always the dominating factor in health care. This implies that health care firms are not necessarily driven to be efficient in production as other firms aiming to make a profit under stiff competition.

In the USA, a large number of nursing homes are for profit and so is the health care product market pharmaceuticals and equipment. Therefore the US health care industry is not all profit driven but has for-profit enclaves. This would imply that the profit motive condition is also contravened in health care. Firms do not always strive for efficiency.

In the USA, there are disparities in health status and access to care. Minority populations African Americans, American Indians, Hispanics and others experience poor health status and poorer effective access to health care than the majority white population. There are also gender disparities with women experiencing worse health care access than men although they have longer life expectancies. There is therefore an unequal distribution of health and health care that is not approved by society.

Some of the reasons for the unequal distribution are economic while others might be historical. The minority health disparities seem to be experienced by other countries as well such as the UK, 19 India, Australia and others. Disparities might not be corrected by the market. Consistent with economic theory, markets respond to failures by developing structures that fill the gaps resulting from such failures. Market structures are not always successful in closing such gaps.

They might even create other inefficiencies as is the case of health insurance adverse selection, moral hazard and stinting. Governments can and do intervene in markets to correct market failure.

The intervention might come in the form of taxes, subsidies, regulations and providing services directly. In US health care there are subsidies for older people, or people with disabilities and for children. Support for direct supply of services is that governments can provide more of the merit goods or services with positive externalities that markets tend to under-produce; they can provide services in industries with economies of scale and ensure that minimum standards are met and there is greater equality in distribution of goods or services.

However, government intervention is not always successful in correcting market failure. There are government failures due to reasons such as: poor information about the type and size of services needed to correct the failure; political exigency focusing on short term effects e.

Obviously, health care markets do not function like the ideal economic market. These markets do not meet all necessary or sufficient conditions for the ideal economic market. Therefore, there are numerous market failures and inefficiencies due to such failures.

Moreover, the distribution of health and health care is not at a desired level. As a consequence, there have to be interventions in these markets to close gaps and improve efficiency.

However, issues of economic efficiency, market structure, and whether the government has any role in the health care of its citizens can be a cause of bitter and divisive political debates e. Such debates tend to use economic theory without full disclosure of the assumptions made about the market. This is particularly true of arguments that support the market economy blindly without due consideration for market failures and their impact on economic efficiency and social welfare.

The result is statements that sound true to a non-economist, but are totally false given that the wrong assumption has been made.

There is evidence that government control in health care can have desirable results in the form of better and equitable access to care and good health outcomes. Some of the more successful health care systems are government controlled with little influence from the market and others are very tightly regulated.

A good example of a government controlled health care system is the Cuban system. It is built on a strong primary care foundation. It provides comprehensive health care to all its residents with nobody falling between the cracks. For example, Cuba enjoys higher vaccination rates It exports medical products such as vaccines. Consequently, Cuba attracts about 20, health tourists annually. One fundamental difference between the Cuban system and market-based systems is the philosophy on which the system is built.

Based on this belief, the system is set up to make sure that health care is accessible to all Cubans. The fundamental philosophy governing the health care system in any country is reflected in the kind of system that is in place to provide care. If a country treats health and access to care as a basic human right for its citizens, then the question of profit maximisation would be a non-issue.

The health care system would have a different objective function with a slightly different focus. Efficiency in health care markets would be judged by a different standard because then the objective function of the health care system would be different from a typical economics objective function.

Efficiency in health care does not always lend itself to market forces because health care takes on properties of merit goods. Consumption of such goods is desirable because the social benefits exceed the private benefits, i. Like education, health can be viewed as capital stock or human capital. According to Grossman, each individual is endowed with a stock of health which depreciates over time, but the individual has the ability to increase this stock through healthy behaviour such as good diet, accessing health care and preventive measures.

This is also true of education and that is why the governments play a big role in it. If merit goods are left to the private sector—or the market, there is under-consumption e. Moreover, other desirable features in a country might not be attainable through market forces alone. For example, if health and health care equity are desirable features, there might be need for government intervention because these qualities are not easily attained through the market.

Government involvement in health care is often necessary because there are many market failures in health care and the market is not always able to correct such failures. It is even more important for smaller countries to determine and explicitly state the philosophical foundations of their health care systems. Furthermore, their citizens might be dependent on accessing care from other countries, or at the very least they might depend on getting health care manpower from other economies.

For example in Oman, the health care system might use care providers from outside the nation. This might make their system more vulnerable to inefficiencies from outside Oman.

However, the example of Cuba indicates that a small economy can avoid the inefficiencies of other economies by being clear about what the fundamental purpose of their health care system is and then building it to attain the stated purpose. Another example is Thailand that reformed its health care system in with a clear purpose of attaining universal health care.

With this aim, the country built a health care system supported by an insurance system and an electronic data storage and access system that improved efficiency and increased access for the poor. National Center for Biotechnology Information , U.

If you wish to place a tax exempt order please contact us. Graduate students and professors worldwide working in all subdisciplines of economics and finance. Add to cart. Sales tax will be calculated at check-out. Free Global Shipping. Description What new theories, evidence, and policies have shaped health economics in the 21st century?

In 16 chapters they cover recent developments in health economics, from medical spending growth to the demand for health care, the markets for pharmaceutical products, the medical workforce, and equity in health and health care.

Its global perspective, including an emphasis on low and middle-income countries, will result in the same high citations that made Volume 1 a foundational text. Presents coherent summaries of major subjects and methodologies, marking important advances and revisions.

Serves as a frequently used non-journal reference. Introduces non-economists to the best research in health economics.