Introduction to Health Economics

Dr. Katie Sauer University of Southern Indiana

Outline: I. What is Health Economics? II. Is health care so different that it needs its own branch of economics? III. Why is Health Economics important? IV. How do we go about ³producing´ health? V. The Demand for health care VI. Employer-Provided health insurance

I. What is Health Economics?
Health economics is the study of how (scarce) resources are allocated to and within the health economy.

II. Is health care so different that it needs its own branch of economics?
7 distinctive features of the health sector: 1. presence and extent of uncertainty - you can¶t predict your health - your health care costs could be hundred of thousands of dollars 2. prominence of insurance - for the majority of goods/services that people purchase, insurance is not involved - in health care, people who can afford insurance, often choose to buy it

3. information asymmetry - you may have more information than your doctor - your doctor is better informed on treatment - you know more about your health than your insurance company 4. role of nonprofit firms - health care industry has a mix of for-profit and non-profit firms 5. restrictions on competition - board certification / medical license - standards

6. role of equity and need - no one needs a pair of Nike shoes, but you might need to see a doctor - what constitutes need? - should access to health care be equitable? 7. government subsidies and public provision - immunizations - US: Medicare/Medicaid

III. Why is Health Economics important? 1 magnitude of health sector in the economy 2 national policy concerns 3 many health issues have an economic component

1. Magnitude of Health Sector in the US economy

Health Spending in the US
National Health Expenditures (NHE)

Source: Centers for Medicare and Medicaid Services , Offices of the Actuary: Data from the National Health Statistics Group

Health Care Spending as a share of GDP

Source: OECD Health Data 2008

Health Care and the US Labor Force (2007)


2 National Policy Issues
-substantial government resources are devoted to health care - research funding - Medicare / Medicaid - growing costs are an issue - ensuring quality

- production / costs - insurance - economic reasons behind people¶s health choices - extent of government intervention

IV. How do we go about ³producing´ health? Health is influenced by many factors: - professional health care - human biology - lifestyle - environment - education Let¶s focus on the professional health care factor. - more health care generally leads to higher levels of health - the returns to health care are decreasing

The production function for health:
measure of health (ex: life expectancy)

Health 96 95 92 85

As more health care is used, health increases. As health care is increased, health increases by a smaller and smaller amount.







Health Care Inputs

It is possible to get ³too much´ health care.
measure of health


Too much health care can actually reduce health. - iatrogenic disease (provider caused) ex: drug interactions, surgery risks, hospital infections - ³medicalization´ takes away ability face natural hardships

Health Care Inputs

In health care, ³more´ is not always better.

V. The Demand for health care The amount of health care a person is willing and able to purchase is inversely related to its price. - Do people really consider ³price´ when it comes to their health? Generally yes!
P P 500 50 25 D 2 4 Q 5 40 Q D

The demand curve will be flatter, the more optional a procedure is.

Insurance and the demand for health care If the price of an office visit is $50, how many visits will you make?

If the price of an office visit is $50, how much money will you spend on health care? Suppose you purchase an insurance policy which pays for all of your health care. Now the cost of an office visit to you is $0. How many visits will you make?

Health insurance causes people to seek more health care than they would if they had to pay all of their expenses themselves.

VI. Employer-Provided health insurance Many people receive health insurance through their employer. Labor Market
wage Supply of workers


Demand for workers Q* number of workers




Suppose that an employer provides a health insurance benefit to its workers. It costs $1 per worker per hour to provide. It is worth $1 to the workers.

D Q1 number of workers

wage $1

S S2


Workers would be willing to earn $1 less per hour, because they would be getting $1 worth of insurance. This would shift the supply of workers curve down by $1.

D Q1 number of workers


S S2


Since the employer now has to pay $1 per hour for insurance for each worker, it is more expensive to hire workers. The demand for workers curve would shift down by $1.

$1 D2 Q1 D

number of workers


S S2

The new equilibrium wage is lower. The same number of workers are hired.

w1 w2

D2 Q


number of workers

What do you suppose would happen if the benefit was worth $2 to workers and cost $1 to provide?

What happens when employers are required by the government to provide a certain level of insurance benefits? total compensation = wages + insurance benefit If the employer is required to raise the insurance benefit that they provide, - they may choose to lower the wages they pay, and keep total compensation the same - they may choose to keep wages the same and raise total compensation

example: Suppose a firm pays its workers $50,000 each in total compensation. $45,000 is monetary wages $5,000 is an insurance benefit Suppose the government requires each firm to provide a minimum level of insurance benefits. For this firm to reach the minimum, it will cost an additional $1,000 per worker.

The firm would have a couple of options: - Choose to keep monetary wages at $45,000 and pay the $6,000 worth of insurance. total compensation = 45,000 + 6,000 = 51,000 - Choose to lower monetary wages by $1,000 to offset the cost of the required insurance. total compensation = 44,000 + 6,000 = 50,000

What do you think the firm would choose to do?


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