RESOURCE ALLOCATION & “THE MARKET”

1. 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

2. 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)

3. 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)

4. DEMAND CURVE Price $ 2 1.50 D=MB No. Mars Bars 0 2 4

5. DETERMINANTS OF DEMAND • (Full ) price of the commodity • Prices of other commodities - compliments - substitutes • Consumer income/wealth • Consumer “tastes” (need?)

6. INCREASE IN DEMAND A  B caused by fall in price A  C caused by increase in income Price $ A C 2 B 1.50 D1 D No. Mars Bars 0 2 4

7. “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

8. PRICE ELASTICITY ILLUSTRATED P po P1 Dpe Dpi Q Qo` Qi Qe

9. 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)

10. SUPPLY CURVE Price $ S=MC 2 1.50 No. Mars Bars 0 2 4

11. DETERMINANTS OF SUPPLY • Price of the commodity • Prices of factors of production (cost) • State of technology • Other “goals” of firm

12. INCREASE IN SUPPLY A  B caused by increase in price A  C caused by improved technology Price $ S S1 B 2 A 1.50 C No. Mars Bars 0 2 4

13. 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

14. SUPPLY ELASTICITY ILLUSTRATED Si P Se P1 Po Q Qo` Qi Qe

15. MARKET EQUILIBRIUM Price $ S=MC 2 D=MB No. Mars Bars 0 2

16. EXCESS SUPPLY Price $ S A B 3 E 2 D No. Mars Bars 0 1 2 3

17. EXCESS DEMAND Price $ S E 2 A B 1 D No. Mars Bars 0 1 2 3

18. NECCESSARY CONDITIONS FOR COMPETITIVE MARKET • No barriers to entry or exit (large number of independent buyers and sellers) • Consumer bears costs and receives benefit • Consumer has perfect information on cost and benefits

19. WHY HEALTHCARE MARKETS “FAIL” 1. Uncertainty 2. Imperfect information and knowledge imbalance 3. Monopoly 4. Externalities 5. (Equity)

20. 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”.

21. IMPLICATION OF SID P S D2 D1 D Q

22. MONOPOLY MONOPOLY = one producer who determines price and quantity OLIGOPOLY = few producers who collude to set price. Engage in non - price competition

23. EXTERNALITIES Positive eg. Vaccination Negative e.g. Antibiotic Resistance

24. POSITIVE EXTERNALITY Price $ S=MC 4 2 MSB 1 D=MPB Quantity 0 2 4

25. 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

26. 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.

27. DEMAND FOR INSURANCE Degree of risk aversion Probability of requiring treatment Cost of treatment Premium “loading” Income

28. SOCIAL REASONS FOR “INSURANCE” 1. Systematic transfer from low to high risk, young to old. 2. Systematic transfer of income from rich to poor.

29. 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.

30. 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.

31. “SOLUTION” TO ADVERSE SELECTION • experience rating • exclusions and benefit ceilings • subsidisation of those “in need” • publicly financed health care systems

32. 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.

33. MORAL HAZARD $ per unit of HC D Welfare loss Po MC D Quantity of HC 0 Qo Q1

34. “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)

35. CO- PAYMENTS $ per unit of HC D Welfare loss Po MC P2 D Quantity of HC 0 Qo Q2 Q1

36. PUBLIC INTERVENTION Subsidisation and/or regulation of private insurers. Selective subsidies or provision of free services. Public provision and/or social insurance coverage.