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Lecture 1

Introduction to Health Economics

Issa S. Ali

■ What is an economy?

The economy refers to all the economic activities and institutions

within a defined area (usually geographically, related to the
political borders of a nation state).

Economics The study of how individuals and societies choose

to use the scarce resources that nature and previous
generations have provided.

Economists study choices in a world of scarce resources.

What do we mean by resources?

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Resources or Factors of production: The inputs into the process

of production.
 inputs or resources: Anything provided by nature or
previous generations that can be used directly or indirectly
to satisfy human wants.

1) Labor is the work performed by employees. The value of their

work depends on their education, skills and desire to do a good
job. One of the goals of an owner is to train employees to become
more skilled to increase their productivity.
 The output of labor can be both physical and mental.

2) Capital: Things that are produced and then used in the

production of other goods and services.
 Buildings, tools and machines, desks, chairs, software,
roads, bridges, and highways are a part of the nation’s
capital stock.

3) Land implies all types of natural resources used to create

goods and services. In addition to land, it includes
commodities such as gold, timber, oil, copper and water.
Resources can also be renewable, such as forests, animals
and food.

4) Entrepreneurship is the driving force behind the creation of

a business. An entrepreneur finds ways to combine the other
factors of production – land, labor and capital – to produce a
product and make a profit.
 The most successful ones are the innovators who create new
products to bring to consumers.

Most resources are not, in themselves, useful as individuals

but they can be combined to make something that is useful.
This process is called production, and goods are the
result of combining resources in the production process.

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Production : the process that transforms scarce resources

into useful goods and services.

outputs Goods and services of value to households.

Goods are either products that you can hold or touch (e.g. a drug)
or else they are services that happen to you (e.g. a consultation).

Capital Goods and Consumer Goods

 Consumer goods: Goods produced for present consumption.
 Investment: The process of using resources to produce new
capital.

 In many societies, most of the production of goods and

services is done by private firms.
 Private airlines in the United States use land (runways),
labor (pilots and mechanics), and capital (airplanes) to
produce transportation services.

 But in all societies, some production is done by the

public sector, or government.
 Examples of government-produced or government
provided goods and services include national defense,
public education, police protection, and fire protection.

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What is health
 Health is a multifaceted concept and not easily
measurable.
 WHO definition:
 Health is a state of complete physical and mental well-
being and not merely the absence of disease or
infirmity (WHO, 1948)
 Refer to peoples’ health status (how healthy they are).

What is health

 Important part of human capital

 Human capital: value of learning, experience and
ability embodied in workers which increases
productivity and income.
 Asset: accumulates and depreciates
 Individual or households can improve their health
through use of health care, diet ..
 Production of health
 Health Production Functions
 Determinants of health

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What is health care?

Definition: The prevention, treatment, and management of
illness and the preservation of mental and physical well-
being through the services offered by the medical and
allied health professions.

 Important difference between health and health care

 Health care can be traded on the market but health
cannot.
 Demand health care to improve our health
 Demand for Health Care
 Health care markets differ from markets for other
commodities
 Role for Government

What is health economics?

 Health economics uses economic concepts and

methods to understand and explain how people
make decisions regarding their health behaviours
and use of health care.
 It also provides a framework for thinking about
how society should allocate its limited health
resources to meet people’s demand/need for
health care services, health promotion and
prevention.

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What is health economics?

1. Health economics is the study of how (scarce)

resources are allocated to and within the health
economy.
 Production of health care (doctors, specialists, or
nurses).
 How do we distribute health care across the
population?
 Based on who can pay or who needs it or some
combination.
 How much money should the government spend on
health care?

What is health economics?

2. Demonstrates the magnitude and importance of the
health sector
e.g. How fast it might be growing and why
3. What makes it different from other markets and how
our analysis may need to adjust
4. Models the determinants of health status and looks
and how government policy might improve health
status in short and long run

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There are three specific questions that are the primary

concern of economics:

Every society has some system or process that transforms its

scarce resources into useful goods and services. In doing so, it
must decide what gets produced, how it is produced, and to
whom it is distributed.

What goods are being produced and in what quantities?

(For example: what types of malaria prevention measures are
being implemented and how much of each type?.... protection
against mosquito bites. )
How are these goods produced? (What resources are required to
produce these malaria prevention measures?)

How is society’s output of goods divided among its members?

(Who has access to these measures?)

The Three Basic Questions

How efficient is society’s production and distribution? (Can

we get the same amount of protection from malaria using fewer
resources? Would an AIDS awareness campaign be a more
effective use of resources than malaria prevention?)

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What is a market?

 In economics, the term ‘market’ is used to describe any

situation where people who demand a good come together
with suppliers.
 For it to be a market the buyers and sellers do not have to
physically meet – for example, most obviously, trading on the
internet can involve networks of individuals in all parts of the
world who will never meet.

Figure 1, essentially, describes market that involve only firms

and individuals buying and selling goods.

 Figure 1 shows a simple model of the flow of commodities,

resources and money between households and fi rms.
 Households own resources Figure 1: the flow of money,
(labour, land, shares in resources and commodities.
capital) and supply them to
firms in return for money
(wages, rent, interest and
profit).
 Firms turn resources into
goods and supply them to
the households, again, in
return for money.
 Households that supply
more resources will receive
more money and therefore
will be able to consume
more commodities.

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 This simple market model involves only firms and

individuals buying and selling goods.
 In reality, most markets also have some kind of government
intervention. Such intervention in the market might involve
imposing taxes, fixing prices, licensing suppliers or
regulating quality.
 Alternatively, the government might decide to take control of
demand for a commodity and prohibit private demand, or it
might decide to take over supply entirely and prohibit
private supply.
 On the other hand, a government might make laws that are
intended to ‘free up’ market forces and make markets more
easily accessible.

Scarcity, Choice and opportunity cost

 Scarcity is considered the basic problem of economics.

Resources are scarce because we live in a world in which
humans’ wants are unlimited but the land, labor, and capital
required to satisfy those wants are limited.
 Because resources are scarce, choices are involved in
both production and consumption.
 If we use resources to produce hospitals then fewer
resources are available to produce other desirable goods
such as public health clinics.
 If we use more of our income through purchasing health
insurance then we have less income to purchase education.

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 The production and consumption processes then come together

to ensure that we produce the ‘right level’ of both hospitals and
clinics so that we do not produce an excess number of hospitals
and leave unmet wants for clinics.
 In other words, we want the quantity supplied to match the
quantity demanded.

Choices involve trade-offs. More hospitals means fewer

clinics. More holidays means fewer cars or clothes.

Opportunity cost The best alternative that we forgo, or give up,

when we make a choice or a decision.
Examples:
• The opportunity cost of going to a movie is the value of the other
things you could have done with the same money and time.
• Part of the cost of a college education is the income you could have
earned by working full-time instead of going to school.
• spending a day in the hospital waiting room may involve forgoing a
day at work (measured in wages lost).

 Economic analysis focuses on the process of decision

making
 Opportunity costs arise because resources are scarce. Scarce
simply means limited.
 Choices involve trading off the expected value of one
opportunity against the expected value of its best alternative.

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Marginalism
Marginalism: The process of analyzing the additional or incremental costs
or benefits arising from a choice or decision.

 Rational people often make decisions by comparing marginal

benefits and marginal costs.
 A rational decision maker takes an action if and only if the
marginal benefit of the action exceeds the marginal cost.

That is, if marginal benefit (the change in benefit) is greater than

marginal cost (the change in cost), we go ahead; if marginal benefit
is less than marginal cost, we do not.

Examples: Marginal utility, marginal product, Marginal cost, marginal

revenue

Efficiency and equity

Efficiency is a general term used to describe the relationship

between inputs and outputs; which in turn can be valued
respectively in terms of costs and benefits.

Efficiency is concerned with maximizing benefits with the

resources available, or minimizing costs for a given level of benefit.

In health care, benefits may be interpreted as health gains,

although health services produce a range of benefits including
less tangible things like information and reassurance ‫مثل المعلومات‬
.‫والطمأنينة‬

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Types of Efficiency
 Technical efficiency: where a given output is produced
with the least inputs (i.e. minimizing wastage). Also known
as operational efficiency;
 Economic efficiency: where a given output is produced at
least cost. Also known as productive efficiency;
 Allocative efficiency: where the pattern of output
matches the pattern of demand;
 Pareto efficiency: the point at which no one can gain
without someone else being made worse off.
Equity
Equity is about the distribution of benefits. It corresponds to the
issue of whether the distribution of goods and services to
individuals and the profits to firms are fair.

The Scope of Economics

Microeconomics and Macroeconomics

Microeconomics: The branch of economics that examines the

functioning of individual industries and the behavior of individual
decision-making units—that is, firms and households.

Macroeconomics: The branch of economics that examines the

economic behavior of aggregates—income, employment, output,
and so on—on a national scale.

 Microeconomics looks at the individual unit—the household,

the firm, the industry. It sees and examines the “trees.”
 Macroeconomics looks at the whole, the aggregate. It sees
and analyzes the “forest.”

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The Method of Economics

Economics asks and attempts to answer two kinds of questions: positive
and normative.

 positive economics An approach to economics that seeks to

understand behavior and the operation of systems without making
judgments. It describes what exists and how it works.
 For example: What determines the wage rate for unskilled workers?
What would happen if we abolished the corporate income tax?

 normative economics An approach to economics that analyzes

outcomes of economic behavior, evaluates them as good or bad, and
may prescribe courses of action. Also called policy economics.
 For example: Should the government subsidize or regulate the cost of
higher education? should we reduce or eliminate income taxes?

Of course, most normative questions involve positive questions. To know

whether the government should take a particular action, we must know first if
it can and second what its consequences are likely to be. (For example, if we
lower import fees, will there be more competition and lower prices?)

Theories and Models

 Economic theory: a particular idea or principle that aims to
describe how an economy works.
 Model: A formal statement of a theory, usually a mathematical
statement of a presumed relationship between two or more
variables.
 variable A measure that can change from time to time or from
observation to observation.

All Else Equal: Ceteris Paribus

 ceteris paribus, or all else equal: A device used to analyze the
relationship between two variables while the values of other
variables are held unchanged.
 Using the device of ceteris paribus is one part of the process of
abstraction.
 In formulating economic theory, the concept helps us simplify
reality to focus on the relationships that interest us.

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Expressing Models in Words, Graphs, and Equations

 We use both graphs and equations to capture the quantitative side of
our economic observations and predictions.

Testing Theories and Models: Empirical Economics

 In science, a theory is rejected when it fails to explain what is
observed or when another theory better explains what is
observed.

 empirical economics The collection and use of data to

test economic theories.

 Macroeconomists continuously monitoring and studying the

behavior of the national economy using thousands of items of
data, collected by both government agencies and private
companies, over the Internet.

Economic Policy
 Economic theory helps us understand how the world works, but the formulation
of economic policy requires a second step.
 We must have objectives. What do we want to change? Why? What is good and
what is bad about the way the system is operating? Can we make it better?

Four criteria in judging economic outcomes:

1. Efficiency: In economics, allocative efficiency ‫ كفاءة التوزيع‬. An efficient economy is
one that produces what people want at the least possible cost.

2. Equity: (fairness) fairness implies a more equal distribution of income and

wealth. Fairness may imply alleviating poverty.

3. Growth: economic growth: an increase in the total output of an economy.

4. Stability: A condition in which national output is growing steadily, with low

inflation and full employment of resources.

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How to Read and Understand Graphs

A graph is a two-dimensional representation of a set of

numbers, or data.

Time Series Graphs

A time series graph shows how a single measure or

variable changes over time.

Graphing One Variable

TABLE 1A.1 Total Disposable Personal Income  FIGURE 1A.1 Total Disposable Personal
in the United States, 1975–2012 (in billions of
dollars) Income in the United States: 1975–2012 (in
billions of dollars)
Total Total
Disposable Disposable
Personal Personal
Year Income Year Income
1975 1,187.3 1994 5,184.3
1976 1,302.3 1995 5,457.0
1977 1,435.0 1996 5,759.6
1978 1,607.3 1997 6,074.6
1979 1,790.8 1998 6,498.9
1980 2,002.7 1999 6,803.3
1981 2,237.1 2000 7,327.2
1982 2,412.7 2001 7,648.5
1983 2,599.8 2002 8,009.7
1984 2,891.5 2003 8,377.8
1985 3,079.3 2004 8,889.4
1986 3,258.8 2005 9,277.3
1987 3,435.3 2006 9,915.7
1988 3,726.3 2007 10,423.6
1989 3,991.4 2008 11,024.5
1990 4,254.0 2009 10,772.4
1991 4,444.9 2010 11,127.1
1992 4,736.7 2011 11,549.3
1993 4,921.6 2012 11,930.6

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Graphing Two Variables

X-axis The horizontal line against which a variable is plotted.

Y-axis The vertical line against which a variable is plotted.

origin The point at which the horizontal and vertical axes intersect.

Y-intercept The point at which a graph intersects the Y-axis.

X-intercept The point at which a graph intersects the X-axis.

Plotting Income and Consumption Data for Households

TABLE 1A.2 Consumption Expenditures

and Income, 2008

Average
Consumption
Average Income Expenditures
Before Taxes
Bottom fifth $ 10,263 $ 22,304
2nd fifth 27,442 31,751
3rd fifth 47,196 42,659
4th fifth 74,090 58,632
Top fifth 158,652 97,003

 FIGURE 1A.2 Household Consumption and Income

 A graph is a simple two-dimensional geometric representation of data.
 This graph displays the data from Table 1A.2.
 Along the horizontal scale (X-axis), we measure household income.
 Along the vertical scale (Y-axis), we measure household consumption.
 Note: At point A, consumption equals $22,304 and income equals $10,263.
 At point B, consumption equals $31,751 and income equals $27,442.

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positive relationship A relationship between two variables, X

and Y, in which a decrease in X is associated with a decrease
in Y, and an increase in X is associated with an increase in Y.

negative relationship A relationship between two variables,

X and Y, in which a decrease in X is associated with an
increase in Y and an increase in X is associated with a
decrease in Y.

Slope

slope A measurement that indicates whether the relationship

between variables is positive or negative and how much of a
response there is in Y (the variable on the vertical axis) when
X (the variable on the horizontal axis) changes.

Y Y Y
 2 1
X X 2  X 1

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 FIGURE 1A.3 A Curve with (a) Positive Slope and (b) Negative Slope

A positive slope indicates that A negative slope

increases in X are associated indicates the opposite—
with increases in Y and that when X increases, Y
decreases in X are associated decreases; and when X
with decreases in Y. decreases, Y increases.

 FIGURE 1A.4 Changing Slopes Along Curves

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