Health Care Markets and efficiency chap8

Question 1

Asymmetry of information

Answer 1

A market situation where all participants do not have access to the same level of information.

Question 2

Deadweight loss

Answer 2

The loss in allocative effi ciency occurring when the loss of consumer surplus outweighs the gain in producer surplus.

Question 3

Externality

Answer 3

The cost or benefi t arising from an individual’s production or consumption decision which indirectly affects the well-being of others.

Question 4

Market failure

Answer 4

A situation in which the market does not result in an effi cient allocation of resources.

Question 5

Monopoly power

Answer 5

The ability of a monopoly to raise price by restricting output.

Question 6

Moral hazard

Answer 6

A situation in which one of the parties to an agreement has an incentive, after the agreement is made, to act in a manner that brings additional benefi ts to themselves at the expense of the other party.

Question 7

Natural monopoly

Answer 7

A situation where one fi rm can meet market demand at a lower average cost than two or more fi rms could meet that demand.

Question 8

Public good

Answer 8

A good or service that can be consumed simultaneously by everyone and from which no one can be excluded.

Question 9

Social cost

Answer 9

The total costs associated with an activity including both private costs and those incurred by society as a whole.

Question 10

Supplier-induced demand

Answer 10

The demand that exists beyond what would have been asked by consumers if they had been perfectly informed about their health problems and the various treatments available.

Question 11

Transaction cost

Answer 11

Costs of engaging in trade – i.e. the costs arising from fi nding someone with whom to do business, of reaching an agreement and of ensuring the terms of the agreement are fulfi lled.

Question 12

What can constitute a monopoly?

Answer 12

Monopoly is characterized by a single supplier in the market. A natural monopoly is a situation where one fi rm can meet market demand at a lower average cost than two or more fi rms could meet that demand. However, monopoly can occur as a result of other conditions: • there are barriers to entry; • there are few providers; • there are few close substitutes.

Question 13

Adverse selection

Answer 13

When a party enters into an agreement in which they can use their own private information to the disadvantage of another party.

Question 14

Price discrimination

Answer 14

Price discrimination means offering the same product at different prices to different people. For example, railways and airlines often charge lower prices to students, young people and elderly people.

Question 15

Many health services are delivered by hospitals or other central institutions that hold monopoly power. Drawing on your own knowledge and understanding of health care, can you think of any features of health care provision that are characteristic of a monopoly?

Answer 15

In some cases there are close substitutes to health care. For example, if someone has infl uenza then they could take drugs for symptomatic relief. They could alternatively just spend some time in bed until the symptoms stop. In this case, rest is a substitute for medication. However, in most cases there are probably no substitutes: with a disease like appendicitis there is no real substitute for surgical treatment. Health care professionals require a licence to practise. This licence is an example of a barrier to entry in the health care market. Patents are also barriers to entry because they prevent other manufacturers from producing a particular good. Patents are very common in the pharmaceutical industry. Health care providers are not usually considered to be natural monopolies. It was noted in Chapter 6 that economies of scale exist only for small hospitals. It is unlikely, therefore, that a single provider can operate at a lower cost than would be achievable by several competing providers. However, in rural areas travel to other providers may be prohibitively expensive such that the local hospital is in effect a monopoly supplier for the local population.

Question 16

Externalities

Answer 16

They are a for, of market failure.

An externality is a cost or a benefi t arising from an economic transaction that falls on people who do not participate in the transaction. The normal interactions in the market take personal benefi ts into account, since private demand functions refl ect self-assessed benefi ts to individuals. When there are external costs and benefi ts, the parties involved in the transaction do not take these costs and benefi ts into account. This failure to place a value on all costs and benefi ts can lead the market to under-provide or over-provide a good.

Question 17

1 How is smoking a negative externality?

2 What might governments do to limit this externality?

Answer 17

1 When people smoke there is a cost to themselves in terms of poorer health outcomes. However, there is also a cost to other individuals from second-hand smoke. When people are weighing up the costs and benefi ts of smoking, they focus on the impact on them. The market also doesn’t consider the cost to others, and therefore the market over-supplies the good. Another example of negative externality is pollution produced by a manufacturing company. The pollution affects the neighbourhood around the company, but the company does not bear any direct costs from the pollution. So the company does not consider this a cost when it is deciding how much of the good to produce. In these cases, the private cost is less than the social impact, which causes individuals to underestimate costs and so over-supply.

2 Governments need to raise the price of smoking to refl ect the cost to society. This can be achieved through a specifi c form of taxation called a Pigouvian tax. Pigouvian taxes aim to internalize the cost of negative externalities. Taxes work by increasing the cost of the consumed goods, which will lead to a lower equilibrium quantity. In the case of smoking, duties on cigarettes would be charged. Other examples might be duties on alcohol and the more recent suggestion in the USA to tax junk food. In the case of pollution, governments could introduce emission charges.

Question 18

What is a public good?

Answer 18

a good or service that can be consumed simultaneously by everyone (it is non-rival) and from which no individuals can be excluded (non-excludable). If the provider of a public good tries to ask people how much they are willing to pay to receive it, consumers say they don’t want it. Why? Because the consumers know that once the good is provided they can consume it even if they don’t pay for it. This is called the free-rider problem.

Question 19

Example of a public good

Answer 19

A classic example of a public good is street lighting: all individuals on the street use the lighting at the same time and no person can be excluded from using it. In addition, if someone walks down the street this does not limit the lighting available to others on the street. Such programmes will be under-provided by the market because people hope to benefi t without having to contribute to the cost. In other words, there are incentives for free-riding.

Question 20

Is healthcare a public good?

Answer 20

No, it isn’t. For one thing, it is rival. If one person consumes a drug (or a consultation, or a vaccination) then there is one drug (consultation, vaccination) less available for others to consume. Health care is also excludable – providers can easily prevent individuals from consuming it. However, there are aspects of health that are public goods, one of which is infection control such as malarial management through environmental measures (Mills and Gilson 1988). Everyone in the community can benefi t from having a malaria-free water supply without stopping anyone else from benefi ting – it is non-rival. Furthermore, no one can be excluded from this benefi t. Information, something that is an integral part of many public health programmes, can also be considered a public good. However, this is only non-excludable if individuals possess the access goods which enable them to receive that information.

Non-excludability leads to free-riding so that individuals consume more than their fair share of the good. Non-rivalry leads to lower than socially optimal consumption. As a result, perfectly competitive markets under-supply public goods so that direct delivery or fi nancing by government is required to reach a socially optimal level of output.

Question 21

Asymmetry of information

Answer 21

Asymmetry of information exists when one person in an economic transaction has more relevant information than the other person

Question 22

consumer moral hazard

Answer 22

Another form of market failure observed in both health care provision and health insurance markets is moral hazard. This occurs if the informed person, after the transaction has been agreed, uses their information to the disadvantage of the uninformed person

someone who is insured may have an incentive to act recklessly (consumer moral hazard). This can manifest itself in less effort being made to avoid the need for health care – just like when individuals might take less care over locking up a bicycle when it is insured, people might not take exercise, might drink excessive alcohol or smoke.

Insurers suffer fi nancially from consumer moral hazard. To address this, the insurer could build a clause into the contract that disallows such behaviour but the transaction costs of monitoring whether the insured are adhering or not would be too high.