Chapter 1Introduction(c) 2012 Cengage Learning. All Ri.docx

Chapter 1
Introduction
(c) 2012 Cengage Learning. All Rights Reserved. May not be
copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product
or service or otherwise on a password-protected website for
classroom use.
classroom use.
What is Health Economics?Study of health
economicsApplication of various microeconomics tools to
health issues and problemsGoal of health economicsPromote a
better understanding of the economic aspects of health care
problemsSo that corrective health policies can be designed and
proposed
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What is Health Economics?Health economicsBroad range of

concepts, theories, and topics. . . studies the supply and demand
of health care resources and the impact of health care resources
on a population.The Mosby Medical Encyclopedia (1992, p.
361)Is defined in terms of determination and allocation of
health care resources
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Health Care ResourcesMedical suppliesPharmaceutical goods,
latex rubber gloves, bed linensPersonnelPhysicians, lab
assistantsCapital inputsNursing home and hospital
facilitiesDiagnostic and therapeutic equipmentOther items that
provide medical care services
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Health Care ResourcesTrade-offs are inevitableResources are

limited or scarce at a given point in timeWants are
limitlessSociety must make a number of fundamental but crucial
choicesScarcityEach society must make important decisions
regarding the consumption, production, and distribution of
goods and services
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The Four Basic Questions
What mix of nonmedical and medical goods and services should
be produced in the macroeconomy?
What mix of medical goods and services should be produced in
the health economy?
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The Four Basic Questions
What specific health care resources should be used to produce
the chosen medical goods and services?
Who should receive the medical goods and services that are
produced?

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The Four Basic QuestionsAllocative efficiency answers the first
2 Choose the best way to allocate resources to different
consumption usesProduction efficiency answers the 3rdChoose
the best mix of inputs to produce the maximum output
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Production & Allocative EfficiencyProduction possibilities
curve (PPC)Illustrates production and allocative efficiencyAn
economic model that depicts the various combinations of any
two goods or services that can be produced efficiently
given:Stock of resourcesTechnologyVarious institutional
arrangements
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A point outside the PPC, such as G, is not yet attainable but can
be reached with an increase in resources or through institutional
or technological changes that improve productivity.
The PPC shows the trade-off between any two goods given a
fixed stock of resources and technology.
Any point on the PPC, such as points A through E, reflects
efficiency because units of one good must be given up to

receive more of the other.
A point in the interior, such as F, reflects inefficiency because
more of one good can be attained without necessarily reducing
the other.
Figure 1.1 - Production Possibilities Curve for Maternity and
Nursing Home Services
Quantity of
maternity
services
(M)
Quantity of nursing home services (N)
B
E
G
A
MF
MC
MD
NF
NC
ND
F

C
D
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Production Possibilities CurvePoint CMedical resources are
fully utilized MC units of maternity care servicesNC units of
nursing home servicesPoint DMedical resources are fully
utilized MD units of maternity care servicesND units of nursing
home services
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Production Possibilities CurveMovement from point C to point
DOne more unit of nursing home services ND–NC (MC –
MD)units of maternity care services are given up to receive the
additional unit of nursing home servicesMedical inputs must be
reallocated from the maternity care services market to the
nursing home services marketOpportunity cost of producing an
additional unit of nursing home servicesForgone units of
maternity care services, MC – MD

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Production Possibilities CurveOpportunity costValue of the next
best alternative that is given upLaw of increasing opportunity
costExplains the bowed-out shape of the PPCOpportunity cost
increases with a movement along the curveBecause of imperfect
substitutability of resources
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Production Possibilities CurvePoint F - Underutilization of
resourcesInefficient In the interior of the PPC More units of one
medical service can be produced without decreasing the amount
of the other medical servicePoint B on the PPC
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Production Possibilities CurvePoint GOutside the current
PPCAttainable in the future if:Stock of health care resources
increasesA new, productivity-enhancing technology is
discoveredVarious economic, political, or legal arrangements
change and improve productive relationshipsPPC shifts out and
passes through a point like G

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Production Possibilities CurveProduction efficiencyAttained
when the health economy operates at any point on the
PPCAllocative efficiencyAttained when society chooses the best
or most preferred point on the PPC
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The Distribution Question The fourth questionDeals with
distributive justice or equityIs the distribution of services
equitable, or fair, to everyone involved?Two ways of
distributing output: Pure market systemPerfect egalitarian
system

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Pure Market SystemGoods and services - distributed based on
each person’s willingness and ability to pay because:People
face an incentive to earn incomeTo better afford goods and
servicesTend to work hard and save for present and future
consumptionEfficient allocation of resourcesEconomy operates
on the PPC
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Pure Market SystemPriceRationing mechanismDifferences in
ability to paySome have consciously chosen to work harder and
save more than othersSome people have less income because of
unfortunate life circumstancesPeople without sufficient
incomesFace a financial barrier to obtaining goods and services
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Pure Market SystemGiven income disparitiesSome people may
be denied access to needed goods and servicesPure market
systemViewed as inherently unfair by manyIn terms of
distribution of important goods and services such as health care

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Perfect Egalitarian SystemA central committeeEnsures everyone
receives an equal share of goods and servicesEveryone has
access to the same goods and services without regard to income
status or willingness to payAn incentive may exist for people to
choose to work and save less Inefficient allocation of
resourcesEconomy may operate inside the PPC
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Mixed SystemsMost countriesRely on central versus market
distribution varying by degree across countriesIn the United
StatesMany goods and services are distributed
by:MarketGovernmentSupplemental Nutrition Assistance
Program, Temporary Assistance for Needy Families, Medicaid
programs
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Implications of the Four QuestionsScarcity of economic
resourcesResults in each society making hard choices
concerning consumption and production activitiesGenerally,
societies wish to produce the best combination of goods and
servicesBy employing least-cost methods of production
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Implications of the Four QuestionsTrade-offs are
inevitableSome amount of one good or service must be given up
for the production and consumption of another good or service
to increaseSocieties’ choices may involve sensitive trade-
offsYoung vs. oldPrevention vs. treatmentMen (prostate cancer)
vs. women (breast cancer)
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Implications of the Four QuestionsAchieving equityDesirable
goalSociety seeks redistribution of incomeRedistribution of
income – TaxationCreates a disincentive for
efficiencyProduction inside the PPCTrade-off between equity
and efficiency often exists

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Pulse of the Health EconomyHealth economy involves activities
related to population health:Production and consumption of
goods and servicesDistribution of those goods to
consumersPerformance indicators of medical
careCostsAccessQuality
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Medical Care CostsRepresent the total opportunity costs when
using various societal resources to produce medical careCenters
for Medicare and Medicaid Services (CMS), United
StatesCollects and reports data on the uses, sources, and costs
of medical careData yield important insights on the utilization
of health care funds, their source, and the actual amount spent
on medical care
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Figure 1.2 - Uses of Health Care Funds in the United States,
2010

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Sources of Medical FundsFunds spent on national healthFrom
the private sector53% in 201076% in 1960Mid-1960s saw the
introduction of: Public health insurance programsMedicare and
Medicaid
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Private insuranceHas expanded its role as a source of
fundsSubstituted greatly for out-of-pocket paymentsReflects a
greater number of individuals and more types of medical care
covered Government fundsSpent by Medicare and
MedicaidAmount to less than half of all health care spending in
the U.S.
Sources of Medical Funds
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Figure 1.3 - Sources of Health Care Funds in the United States,
2010

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Sources of Medical FundsWoolhandler and Himmelstein
explain:CMS includes only direct purchasing of medical care
(Medicare, Medicaid, and government-owned hospitals)CMS
excludes public employee benefitsFederal Employees Health
Benefits ProgramVarious state employee health insurance
programsEmployer-sponsored health insurance premiums are
exempted from various federal, state, and city taxes
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Sources of Medical FundsWoolhandler and Himmelstein
explain:Government - responsible for financing nearly 60
percent of all health care costsDirect spending of government =
45%Public employee benefits = 5 to 6%Tax subsidy for health
insurance premiums = 9% or more
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Amount of Medical Care SpendingCosts of health care are high
and continually rising U. S. spent $2.6 trillion or $8,400 per

person in 2010Compared to $26.9 billion and $141,
respectively, in 1960Trade-offs may be involvedHigh health
care costs = Lower amounts of other goods produced and
consumed
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Amount of Medical Care SpendingGreater productive capacity,
over timeProductivity-improving technologiesMore labor and
capital resourcesPPC has likely shifted outMore of one good or
service can be produced without sacrificing the othersTo control
differences in the productive capacityDivide amount of health
care spending by GDP
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Figure 1.4 - National Health Care Costs as a Percentage of GDP
from 1960 to 2010
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Medical Care AccessDoes everyone have reasonable access to
medical care on a timely basis?Timely access is often measured
by percentage of individuals with health insuranceInsurance
provides access to high-cost, life-saving interventions, for a
small premiumCost of catastrophic care – very high
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Medical Care AccessThe health insurance productBefore the
1970s most people purchased only hospital insuranceToday
people purchase health insurance for other types of medical
careAmount of medical care expenditures covered by insurance
has increased over the years
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Figure 1.5 - Percentage of the U.S. Population without Health
Insurance from 1940 to 2010
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Medical Care QualityMeasure of medical care qualityInfant
mortality rate (IMR)Number of children below one year of age
that died as a percentage of all live births in that same yearIMR
has improved significantly over time
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Figure 1.6 - Infant Mortality Rates in United States, 1960 to
2009
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System Structure & PerformanceSystem structureWays in which
various organizations are designed in terms of their size and
scopeMix of market activities and government
involvementFinancing and reimbursement mechanismsHelps to
establish the prevailing incentives in a health
economyInfluences how people, organizations, and government
itself behave
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Structural Remedy
Conduct Remedy
Figure 1.7 - Structure, Performance, and Policy
StructureOrganizationsMarketsGovernment (Laws, Regs)
Behavior of peopleWorkConsumptionSavings
Behavior of Organizations and
MarketsPricingProductionInvestment
Behavior of government Pursue public or special interests
PerformanceEfficiencyEquity
Public PolicyAntitrustRegulation
(Social and Industrial)Taxes
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The PPACA contains many provisions that should
monumentally alter the financing, reimbursement, and delivery
of health care in the U.S.At this time, it is unclear if the U.S.
Supreme Court will uphold or invalidate this new health care
reform legislation
Patient Protection and Affordable Care Act of 2010
The book is Management principles For Health Professionals
Seventh Edition by Joan Liebler and Charles R. McConnell
Reading Study Chapters 1 and 2 of the text. Review the
PowerPoint lessons for Chapters 1 and 2 Assignments The

following Assignments should be completed and submitted to
the course faculty via the learning platform for evaluation and
grading. Submit your responses to these questions in one
WORD document. List the question first, and then your
response. Be sure to properly site your sources, both in-text and
with a reference list at the conclusion. If you use an online
source to support your answers, you must provide a properly
formatted link to the source. You should use APA citation
format and make sure your sources are credible. In most cases,
your responses should be no more than 400 words.
Note: The simple graphs called for in some of the assignments
can be created in WORD or you can draw them separately but
just include your interpretation in the assignment.
1. Draw a bowed-out PPC with an aggregate measure of medical
services, Q, on the horizontal axis and an aggregate measure of
all other goods (and services), Z, on the vertical axis. Discuss
the implications of the following changes on the quantities of
medical services and all other goods. Short Answer Questions:
a. A movement down along the curve.
b. A movement from the interior of the curve to a northeasterly
point on the curve.
c. An increase in the quantity of labor in the economy
d. A technological discovery that increases the production of Z.
e. If it were your choice, where would you choose to produce on
the PPC? Why?
2. Identify the three legs of the medical stool. Explain how
trade-offs might take place among the three legs. If you had to
choose one of the three to improve upon at the neglect of the
others, which would you choose? Why?
3. Does the U.S. health care system possess a privately or
publicly financed health care system? Explain. 4. What are two
major uses of medical funds? How do the two major uses relate
to the four basic questions?
5. In your own words, explain the general link between system

structure, performance, and policy.
6. Describe the factors that make it difficult to measure output
in medical care markets.
7. As mentioned at the beginning of the chapter, the life
expectancy rate in Russia fell significantly from 1989 through
1994. Use health production theory to explain what would
happen to the relationship between good health and medical
care in Russia if alcohol consumption diminished and the
market economy strengthened. Provide a graph to illustrate your
explanation.
8. Use health production theory to explain the role gender plays
in the production of health during pregnancy. Provide a graph to
illustrate your answer.
9. Use production theory to graphically illustrate the case in
which a medical innovation improves health without any change
in the consumption of medical care.
10. In your own words, use utility analysis to explain why
people demand health. How does the law of diminishing
marginal utility fit into the analysis?

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Chapter 1Introduction(c) 2012 Cengage Learning. All Ri.docx