Lecture 19: Externalities & Health

1. Lecture 19: Externalities & Health Richard Smith Reader in Health Economics School of Medicine, Health Policy & Practice

2. Overview of lecture • What are ‘externalities’? • Positive externalities and health • Negative externalities and health • ‘Global’ externalities and health • Externalities and public goods

3. What are ‘externalities’? • Costs and/or benefits of actions by one party which affect other parties • Externalities exist wherever a transaction affects an uncompensated party • Policy issue – design of appropriate institutions & legislation to align individual incentives & social welfare • Externalities (with public goods) are main reason for public health care systems worldwide

4. Positive externality • Positive externality – where social benefit of consumption of good exceeds private benefit • Private benefit – benefit to consumers who buy and consume good • Social benefit – benefit to all in society, including those who do not consume it  Equals private benefit of consumption plus benefit to others • Causes market failure (too little consumption)

5. Positive externalities & health • Caring for health of others (Good Samaritan) • interdependent utility functions • UA=U(hA, yA, hB); UB=U(hB, yB, hA), where h=health, y=income (other goods) • Private health increases national wealth • Knowledge & technology • Communicable disease surveillance & infectious disease control (Lecture 21) • Vaccination (herd immunity effect)

6. Positive Externality P S = MPC = MSC D = MPB Q

7. Positive Externality P S = MPC = MSC A Equilibrium Price PA D = MPB Q QA

8. Positive Externality P S = MPC = MSC A Equilibrium Price PA D = MPB Q QA Equilibrium Output

9. Positive Externality P S = MPC = MSC Consumer Surplus A Equilibrium Price PA Producer Surplus D = MPB Q QA Equilibrium Output

10. Positive Externality P S = MPC = MSC Consumer Surplus A Equilibrium Price PA Producer Surplus MSB D = MPB Q QA Equilibrium Output

11. Positive Externality P S = MPC = MSC B Consumer Surplus A Equilibrium Price PA Producer Surplus MSB D = MPB Q QA QB Equilibrium Output Herd immunity (eg 80% coverage)

12. Positive Externality P S = MPC = MSC B Consumer Surplus A Equilibrium Price PA Producer Surplus MSB D = MPB Q QA QB Equilibrium Output Economically Efficient Output

13. Positive Externality P S = MPC = MSC B Consumer Surplus A Equilibrium Price PA Producer Surplus MSB D = MPB Q QA QB Equilibrium Output Economically Efficient Output

14. Positive Externality P Total Gain to Other People S = MPC = MSC B Consumer Surplus A Equilibrium Price PA Producer Surplus MSB D = MPB Q QA QB Equilibrium Output Economically Efficient Output

15. Positive Externality P Total Gain to Other People S = MPC = MSC B Consumer Surplus A Equilibrium Price PA Producer Surplus MSB D = MPB Q QA QB Equilibrium Output Economically Efficient Output

16. Positive Externality P Deadweight Social Loss Total Gain to Other People S = MPC = MSC B Consumer Surplus A Equilibrium Price PA Producer Surplus MSB D = MPB Q QA QB Equilibrium Output Economically Efficient Output

17. Policy options • (Pigouvian) subsidies to ‘internalize’ external benefit • changing private benefits so they equal social benefits, such as providing ‘free’ vaccines • Direct provision of good, such as vaccine • Property rights to ‘correct’ market (e.g A ‘owns’ right not to be vaccinated, or B owns right to vaccinate) – UK vs USA schools

18. Negative externality • Negative externality – where social cost of consumption of good exceeds private cost • Private cost – cost to consumers who buy and consume good • Social cost – cost to all in society, including those who do not consume it  Equals private cost of consumption plus cost to others • Causes market failure (too much consumption)

19. Negative externalities & health • Infectious disease • Large part of reason behind public health movement in 19th Century (UK=PHLS/HPA; USA=PHS/CDC) • Lecture 21 – antibiotic resistance • Environmental degradation (vehicle emissions) • Child day care • individual vs social costs and benefits • Tobacco & passive smoking

20. Equilibrium with a Negative Externality Price/ Cost Quantity

21. Equilibrium with a Negative Externality Price/ Cost S (MPC) D (MPB/MSB) Quantity

22. Equilibrium with a Negative Externality Price/ Cost S (MPC) A Equilibrium Price PA D (MPB/MSB) QA Quantity

23. Equilibrium with a Negative Externality Price/ Cost MSC S (MPC) A Equilibrium Price PA D (MPB/MSB) QA Quantity

24. Equilibrium with a Negative Externality Price/ Cost MSC B S (MPC) A Equilibrium Price PA D (MPB/MSB) QB QA Quantity

25. Equilibrium with a Negative Externality Price/ Cost MSC B S (MPC) A Equilibrium Price PA D (MPB/MSB) QB QA Quantity Equilibrium Output

26. Equilibrium with a Negative Externality Price/ Cost MSC B S (MPC) A Equilibrium Price PA D (MPB/MSB) QB QA Quantity Economically Efficient Output Equilibrium Output

27. Deadweight Social Losses From Smoking P MSC MPC = S D Q

28. Deadweight Social Losses From Smoking P MSC MPC = S A PA = £3 D Q QA

29. Deadweight Social Losses From Smoking P MSC £10 MPC = S A PA = £3 D Q QA

30. Deadweight Social Losses From Smoking P MSC £10 MPC = S A PA = £3 D Q QA

31. Deadweight Social Losses From Smoking P MSC £10 Deadweight Social Loss MPC = S A PA = £3 D Q QA

32. Deadweight Social Losses From Smoking P MSC £10 Deadweight Social Loss B PB = £5 MPC = S A PA = £3 D Q QB QA

33. Deadweight Social Losses From Smoking • NOTE – the economically efficient level of production is not zero!  It would mean doing completely without goods yielding some benefit • Economically efficient level occurs when marginal benefit of reducing externality equals the marginal cost of reducing it • Policy issue is how to achieve this level

34. Policy options • (Pigouvian) taxation to ‘internalize’ external cost (e.g. cigarettes, petrol) • changing private costs so they equal social costs • Regulation of overall quantity produced (rationing e.g. cigarettes, petrol) • Property rights to ‘correct’ market (e.g. A ‘owns’ right to clean air, or B owns right to pollute air – determines flow of compensation, subsidy, tax etc)

35. Taxation P Old MPC A D Q

36. Taxation New MPC = MSC P Old MPC A D Q

37. Taxation New MPC = MSC P Old MPC B PB = £5 A D QB Q

38. Taxation New MPC = MSC P Old MPC B PB = £5 A PS = £2 D QB Q

39. Taxation New MPC = MSC P Old MPC B PB A Tax = £3 PS D QB Q

40. Problems with taxation • Taxation may not internalize all externalities (demand subject to other influences) • Taxation can internalize externalities only if transactions costs (implementing the taxation system) are sufficiently low • Coase theorem

41. Coase Theorem • Equilibrium is economically efficient regardless of who holds property rights – producer or consumer – when transactions costs are low • BUT: Equilibrium not economically efficient when transactions costs are high – depends on property rights, laws etc

42. Regulation • Direct government intervention to determine quantity of production/consumption (rather than indirectly through price) • Though incentives/quota’s (e.g. vaccine targets, incentive payments to GPs, congestion charge) • Through legislation (e.g. smoking in public places) • Through production/distribution (e.g. communicable disease surveillance)

43. Problems with Regulation • Costs may differ between firms and/or consumers which may not be accounted for • Uncertainty over MSB/MPB and MSC/MPC curves (required to set optimal equilibria) • Political costs • Transaction costs

44. ‘Global’ externalities & health • Communicable diseases • HIV/AIDS – global (geographic & demographic) • Tuberculosis - global (geographic & demographic) • Malaria - regional (geographic) • Acute Respiratory Infection, Diarrhoea – local (geographic & demographic) • Economic effects of ill-health • HIV/AIDS in Southern Africa – regional to global

45. SARS W135 E.coli O157 West Nile Fever Lyme Borreliosis ‘Global’ externality – (re)emerging infectious diseases 1996-2003 Legionnaire’s Disease Multidrug resistant Salmonella Cryptosporidiosis E.coli O157 E.coli non-O157 Typhoid SARS BSE Malaria nvCJD Diphtheria West Nile Virus Reston virus Echinococcosis Lassa fever Nipah Virus Yellow fever Cholera 0139 Reston Virus RVF/VHF Venezuelan Equine Encephalitis Buruli ulcer Dengue haemhorrhagic fever O’nyong-nyong fever Ebola haemorrhagic fever Human Monkeypox Dengue haemhorrhagic fever Cholera Cholera Equine morbillivirus Hendra virus

46. Cost of global health externalities

47. Externalities & public goods • Goods with significant positive externalities are often public goods • Goods with significant negative externalities are, conversely, public ‘bads’ • Public goods (bads) are under (over) consumed for additional reasons • Lecture 20!

48. Further references • McPake B, Kumaranayake L, Normand C (2002), Health Economics: an International Perspective. London: Routledge. Chapter 8. • Getzen T (2004). Health Economics: fundamentals and flow of funds. New York: Wiley. Chapter 15. • Smith RD, Coast J. Controlling antimicrobial resistance: a proposed transferable permit market. Health Policy, 1998; 43: 219-232. • Coast J, Smith RD, Millar MR. An economic perspective on policy to reduce antimicrobial resistance. Social Science & Medicine, 1998; 46: 29-38. • For future ref: • Smith, RD, Drager N. Cross-border risks and public health security. Oxford University Press. • Smith RD, Drager N, Hardimann M. The rapid assessment of the economic impact of public health emergencies of international concern. World Health Organization. • Yeung RYT, Smith RD. Can we use contingent valuation to assess the private demand for childhood immunization in developing countries? Applied Health Economics and Health Policy.