Basic Economic Principles

1. Basic Economic Principles N287E Spring 2006 Joanne Spetz 29 March 2006

2. Course web page and contact • My office is at Laurel Heights • Suite 410 • 2-4443 • Cell phone: 415-271-6496 • Nursing school office: N505 • Web page: www.saidin.com/joanne

3. Class time & assignments • Class time is divided • 11am-2pm, generally in classroom U506 • 15 minute break to get lunch • Readings • Finkler & Kovner book • Reading listed in syllabus, most are on line

4. Class time & assignments • Assignments • 2 problem sets • Final project • Be prepared to discuss readings in class • Grading • 30% each problem set • 10% proposal for final project • 30% final project • +up to 10 extra points for class participation

5. Final project • Business plan • Policy topics • Earthquake retrofit • Universal health insurance proposals • Health of academic medical centers • Workforce analysis • Solutions to the shortage • Mandatory overtime • Cost effectiveness analysis • Financial analysis • Financially troubled hospital or health care provider • Proposed hospital merger

6. What is “health economics”? • The study of health and health care from the economic perspective • Economics: • The study of the allocation of scarce resources

7. Principles of economics • Resources are limited • You must make choices • Substitutability • Resources can be dedicated to many uses • What is the value of alternate uses of a resource? • Heterogeneous preferences • One person’s pleasure is another’s poison

8. Trade occurs because… • People have different productivity • Specialized skills • Access to capital (land, equipment) • People have different preferences • Preferences vary with amount already consumed

9. Where did health economics start? • Kenneth Arrow, 1963 • “Uncertainty and the welfare economics of medical care” • American Economic Review • Some people focus on nursing economics • Donald Yett • Peter Buerhaus

10. Utility • Economic analysis begins with the concept of utility utility “diminishing marginal benefit” product

11. Indifference curves cheese better wine

12. How do we decide how much to consume? • Prices of trade determine consumption Cheese: $1/ounce Tangent point is optimal Wine: $3/glass Slope = -3

13. What if prices change? • New prices are wine=$2, cheese=$1 Cheese New optimal point Wine Slope = -2

14. Why marginal instead of average values? • The value of a tradeoff may vary based on the quantity of the unit • Average values does not reflect the actual change of a particular unit

15. Calculating Marginal Values

16. Volume discounts Cheese Optimal point Wine

17. From the indifference curves, we can derive a demand curve $ Demand for wine Wine

18. What about production? Cost Per pill MC=marginal cost Economy of scale = “diminishing marginal cost” # pills

19. How much do you choose to produce? • Marginal revenue = marginal cost $ MC P*=price Sum of individual demand curves MR=marginal revenue=demand Q*=quantity quantity

20. There is a logic to this • If you are a producer: • The marginal cost of making one more pill is $0.50 • The marginal revenue of that pill is $1.00  you will produce one more pill

21. Normally, there is a point where the margins balance • To sell more pills you have to drop the price • To increase production you might have to increase marginal cost of production • Build a new plant or pay overtime

22. Marginal costs can have many shapes $ $ MC MC quantity quantity

23. We also care about average costs MC $ “decreasing returns to scale” AC=average cost quantity

24. What do firms do? • Firms maximize profit • Profit = revenue – cost • Revenue = price * quantity • Cost = AC * quantity • Profit will maximize at MR=MC • If MR=$16 and MC=$12, producing one more unit increases profit $4

25. Equilibrium: where supply and demand intersect supply price Neither buyers nor sellers has any incentive to change the price they are bidding or asking. This is the price and quantity we will observe in the market. demand quantity

26. Changes in equilibrium • Shifting of the supply or demand curve can change the equilibrium market price and quantity • Understanding these changes are important because they reflect what we observe in the market place

27. How will this change the demand or supply for a drug? • cheaper generic medicines available in the market supply $ demand quantity

28. How will this change the demand or supply for a drug? • successful advertisement supply $ demand quantity

29. How will this change the demand or supply for a drug? • new technology and a more efficient production line supply $ demand quantity

30. How will this change the demand or supply for a drug? • rising costs of resources used to produce drug X supply $ demand quantity

31. In perfect competition… • Many buyers and sellers • Product is homogeneous • Can enter & exit market • Perfect information

32. In a perfect market… • Firms are “price-takers” S D There is zero “profit” in the long run – this means all firms earn the same economywide profit

33. Elasticity • Elasticity refers to the degree to which supply or demand changes with the price • “Inelastic” demand doesn’t change with prices (e.g., perfectly competitive market) • “Elastic” demand changes a lot with prices

34. A chart to explain elasticity $ Inelastic: price changes don’t affect quantity much Elastic: price changes affect quantity a lot Quantity

35. How do supply and demand lead to price changes? $ S Firms will bid up the price P1 D Q S1 D1 Excess demand

36. Economic theory applies to health care, to some extent • Production of health: • H = h(m,X) • m=medical care • X=other stuff (genetics, behavior, etc.)

37. We assume more medical care increases health • This is not always so… H= health Diminishing marginal returns m=medical care

38. Why can we have diminishing marginal returns to med care? • Nosocomial infections • Higher morbidity from some treatments • E.g., chemotherapy

39. What is “m”? • Medicare care is not a single, homogeneous thing • Some treatments don’t have decreasing returns • Some “treatments” have no effect on health • Improving “health” may not be the same as “curing” the patient

40. Smoking Fatty foods Motorcycling Exercise Veggies Volvos What about “X” Genetics Aging In most industrialized nations, X is more important than m

41. “Perfect competition” might not exist • No free entry/exit • Imperfect information • Uncertainty/risk • Non-homogeneous goods • People don’t see prices of products  Does this sound like health care?

42. Break Time!

43. Demand for nursing personnel wage Supply (perfect competition) Demand for nurses # nurses

44. Why do we see nursing shortages? • Limited number of employers • Delays in wage increases • Delays in producing new nurses • Licensing regulations • Minimum staffing requirements for hospitals, LTC facilities, other providers • Minimum wages

45. Limited number of employers • Supply slopes up Supply wage Shock to demand: D1 to D2 Wage responds slowly Temporary shortage D2 D1 # nurses

46. Slow production of new RNs S1 wage S2 Shock to demand: D1 to D2 S responds slowly Temporary shortage Can overshoot supply! w2 w1 D2 D1 # nurses

47. Monopsony from limited number of employers MC wage S w* D N* Nurses Reported shortage

48. Research on monopsony • Donald Yett • Survey • Data analysis • Urban vs. rural markets • Sullivan – monopsony • “inverse elasticity” • Hansen – no monopsony • Spetz et al. – some market power

49. Is This Shortage Different? • Severity of current shortage is greater than in the past • Demand won’t adjust even when wages rise • Focus on staffing due to recent research • Minimum nurse-to-patient ratios • Aging nursing workforce will lead to massive retirements • There cannot be enough new graduates to keep up

50. Delving more deeply into the nursing shortage… • Forecasts predict worsening shortage • Bureau of Health Professions report, 2002 • Buerhaus, Staiger, & Auerbach, 2000