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Chapter: Medicine Study Notes : Public Health

Health Economics

The study of how individuals and societies, experiencing virtually limitless wants, choose to allocate scare resources to best satisfy their wants

Health Economics


·        = The study of how individuals and societies, experiencing virtually limitless wants, choose to allocate scare resources to best satisfy their wants

·        Scarcity:

o   Resources (main factors of production – natural resources, capital, labour) are scare 

o   ® Goods and services produced from them are scarce

o   Can‟t have as much as we would want if they are free

o   Will always be medical interventions that cannot be funded

·        Choice: Because of scarcity, we must make choices

·        Opportunity cost: 

o   The loss of the next best opportunity we could have chosen (ie if we use time/money on one thing, it‟s not available for something else) 

o   When doing an evaluation: deduct GST (it‟s a transfer), use real price (eg not subsidised cost of a drug), include indirect costs (eg patient travel) 

o   Can be calculated from different perspectives: eg provider, funder, society

·        Marginal analysis:

o   = Incremental benefit (ie marginal benefit) from incremental cost (ie marginal cost)

o   Decisions are usually about whether to expand or contract – not stop or start

o   Marginal cost is NOT the same as average cost

·        Efficiency:

o   = Maximising benefits from certain cost of inputs

o   Not the same as cost-cutting: if you cut costs and output falls then haven‟t improved efficiency

o   Effectiveness: are patients better off (eg have better health) with intervention than without

o   Technical efficiency: providing effective services at least cost – doing things right 

o   Allocative efficiency: concentrating resources on effective services that offer the biggest payoff in terms of health – doing the right things

o   Inefficiency is unethical (if budget is constrained)

·        Equity:

o   = Fairness: usually of distribution or payment

o   Equal access for equal need (what is need – ill health or capacity to benefit) 

o   Equal resources for equal need (same amount of money for equal needs – basis of the DHB funding formula)

o   Equal outcomes: allocate resources to achieve same health status of different populations

·        Markets:

o   Means of allocating scarce resources

o   Result from the interaction of demand and supply, mediated by price 

o   Consumers can signal demands, maximise their „well-being‟ or utility, producers can shift resources accordingly

o   If there is perfect competition, theoretically you get allocative efficiency

o   For this to work, requires:

§  Perfect information (eg about quality, costs, etc)

§  No externalities (someone else bears a cost or benefit) 

§  Goods and services must be rival in consumption (ie if I buy it no one else can have it) and excludable (you can‟t have it if you can‟t pay)

§  Freedom of entry and exit

§  Perfect competition – no monopolies

§  No supplier-induced demand 

§  Equity is not an issue (ie no merit goods – goods that society believes should be more widely available than would occur through markets alone)

o   Market failure in health care:

§  Externalities eg immunisation

§  Monopolies eg secondary services, labour markets

§  Asymmetric information eg health professionals

§  Supplier induced demand (especially if fee-for-service)

§  Highly inelastic demand

o   Health Insurance Markets

§  Uncertainty about future health needs + high costs ® demand for insurance 

§  Moral Hazard: will now consume more health care than they otherwise would as someone else is paying (can control with co-payments) 

§  Adverse selection: patients who know they will need it are more likely to purchase it. Insurers won‟t know so premiums won‟t reflect risk 

o  Want to getting advantages of market efficiency and overcoming market failure ® ?government failure, purchaser provider splits, quasi markets (health care plans)


·        International Comparisons:  Health Expenditure per capita and GDP.  NZ is on the line

·        Economic Evaluations :

o  = Comparative analysis of alternative courses of action in terms of their costs and consequences

o  Informs choices about the allocation of scarce resources

o  Needed to determine efficacy (in lab conditions), effectiveness (more good than harm in practice)

o  Can be prospective or retrospective

o  Types of evaluation:

§  Cost minimisation: compare inputs, assume outputs are equal 

§  Cost benefit: compares different outcomes (eg flu jabs and hypertension screening). Convert to common unit ($) to compare – but can human life be valued? 

§  Cost effectiveness: relates cost to a clinical measure (eg ¯blood pressure, morbidity, life years gained). Has superseded cost-benefit analysis due to problems allocating monetary values to all outputs 

§  Cost utility: cost per QALY gained.  Can compared across a whole range of interventions ut methodological problems. Example: Impact on QALYs of dialysis verses kidney transplant.


·        Common approaches to valuing human life:

o  Human capital: future earnings (but elderly have none)

o  Implied valuations: value implicit in past policies

o  Insurance values: but this is paid to survivors 

o  Willingness to pay to reduce low probability of death: survey or observe (eg how much do people spend on safety)

·        Theory X and Y:  Summarising different approaches to health care in health economics


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