This document provides an outline of microeconomic tools that are useful for health economics. It discusses concepts like scarcity, opportunity cost, efficiency, demand, supply, market equilibrium, elasticity, consumer theory including indifference curves and budget constraints, and production possibility frontiers. Key points covered include the law of demand and supply, how demand and supply curves are derived, factors that shift curves like income, prices of substitutes and complements. It also discusses technical efficiency, cost-effective efficiency and allocative efficiency.

1. Micro-economic Tools for
Health Economics
Abdur Razzaque Sarker
MHE (Health Economics), MSS (Economics)
Health Economics and Financing Research Group
ICDDR,B
and
PhD Fellow in Strathclyde University, UK
Email: razzaque.sarker@gmail.com
1

2. Outline:
• Scarcity and opportunity cost
• Efficiency
• Demand
• Supply
• Market Equilibrium
• Elasticity
• Consumer Theory: Indifference Curve ,Utility and
Budget Constraint
• Production Possibility Frontier
• Supplier Induced demand
2

3. Scarcity and Opportunity Costs
 Scarcity means that there are not, and can never
be, enough resources to satisfy all human wants
and needs.
3

4. Opportunity Cost: The cost of the foregone opportunity
 Real cost of an activity (for example, provision of hospital
services) as the other outputs that must be given up (for example,
other health services such as immunizations, or non-health services
or commodities such as defense or vehicles) because productive
resources are committed to it.
Scarcity and Opportunity Costs
4

5.  Efficiency is an instrumental concept, it is always necessary
to specify clearly the outcome being sought or the ‘output’
being produced.
Efficiency
5

6. Efficiency……!!!!!!!!!
6

7. Elements of Efficiency
Do not waste
resources
Produce each
output at least cost
Produce the types and
amounts of output that people
value most
 These are the three main elements of efficiency
7

8. Elements of Efficiency
Do not waste
resources
Produce each
output at least cost
Produce the types and
amounts of output that people
value most
Production
Efficient Resource Allocation
Consumption
8

9. Elements of Efficiency
Do not waste
resources
Produce each
output at least cost
Produce the types and
amounts of output that people
value most
Production
Efficient Resource Allocation
Consumption
Supply and Demand
9

10. Elements of Efficiency
Do not waste
resources
Produce each
output at least cost
Produce the types and
amounts of output that people
value most
Technical Efficiency Cost-effective
efficiency Allocative Efficiency
 Technical efficiency requires that for any given amount of output, the amount of inputs
used to produce it is minimized (e.g. hospital…??)
 It requires that, in addition to technical efficiency being attained, inputs be combined
so as to minimize the cost of any given output
 Resources be used to produce the types and amounts of outputs which best satisfy
people
10

11. Allocative Efficiency
Example…!!
 If mothers of young children want counseling services
for behavioral problems instead of frequent well-child
check-ups, then allocative efficiency might be improved by
changing the mix of primary care services even if the well
child examinations were being provided cost effectively
 If producers are supplying too much or too little of any
good or service relative to consumers' wishes it leads to
allocative inefficieny
11

12. Doing the right
thingsDoing things right
Elements of Efficiency
Do not waste
resources
Produce each
output at least cost
Produce the types and
amounts of output that people
value most
Technical Efficiency Cost-effective
efficiency Allocative Efficiency
 Efficiency means both 'doing things right' (technical efficiency
and cost-effectiveness), and 'doing the right things' (allocative
efficiency)
 Pareto Efficiency..?????
12

13. Demand
13
Demand :How much of a good a consumer is ready to buy at a
certain price, holding other things constant.
Factors affecting demand of a good:
 Good’s own price
 Income of the consumer
 Price of related goods
 Tastes/preferences
 Various sociological factors
 Factors outside human control, such as the weather

14. Law of demand
• The law of demand states that; the higher the
price of a good the lower the quantity
demanded
• If Price increases then Quantity demanded
decrease
14

15. Demand Schedule
Price Quantity demanded
30 TK/KG 6 KG
40 TK/KG 4 KG
50 TK/KG 3 KG
60 TK/KG 2 KG
15

16. Deriving a Demand Curve
16
 Downward sloping demand
curve
Price
43 62
60
50
40
30
Quantity demanded
 Demand Curve shows the relationship between the
price of a good and quantity demanded of the good

17. Movement Vs Shift of Demand Curve
• We move along the demand curve only when
the price of the good changes
Demand curve shifts because of:
• Change in income
• Change in price of a substitute
• Change in price of a complement
• Change in tastes and preference
17

18. Other Economic Factors Affecting
Demand
• If income increases, then at any given price, consumer
is willing and able to purchase more q
18q0 q1
Price
P0
DO D1
Physician Visits

19. Other Economic Factors Affecting Demand
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Substitutes - Goods which satisfy the same needs of the
consumer and therefore can replace each other in use
 e.g. Coke and Pepsi
 e.g. Butter and Jam
 e.g. CNG gas and Petrol

20. Other Economic Factors Affecting
Demand
• e.g. Coke and Pepsi
• If price of Coke increases, D for Pepsi___
20
P
D0
D1
Demand for Pepsi
Demand for Pepsi----

21. Other Economic Factors Affecting Demand
Complements -
• Two goods are complementary if using more of good A
requires use of more good B.
• When two goods are consumed together
 e.g. left shoe and right shoe
 e.g. DVD players and DVDs
 e.g. Tea and Sugar
 e.g. Car and Petrol
21

22. Other Economic Factors Affecting
Demand
• If Price of petrol become cheaper, consumption or
demand for car increases___
22
2. Complements
P petrol
D0
D1
Quantitiy of petrol demanded
Price of car falls
(Price of petrol unchanged)

23. Supply:
 The amount of a good, a producer/seller is ready to
sell at a given price, holding other things constant.
Factors affecting supply of a good:
• The price of the good
• Technology
• Price of input
• Gov’t policies and regulations
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Supply

24. Law of Supply
• All other factors remaining unchanged; as the
price of a good increases, the quantity of the
good offered by a supplier increases and vice
versa.
• Price increases quantity supplied increases
24

25. Supply Schedule
Price Quantity Supplied
30 TK/KG 2 KG
40 TK/ KG 4 KG
50 TK/ KG 6 KG
60 TK/KG 8 KG
25

26. Deriving a Supply Curve
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 Supply curve shows the relationship between price
and quantity supplied of a good; ceteris paribus
Price
P1
P0
q0 q1
 Supply curve is upward sloping

27. Other Economic Factors Affecting Supply
• If price of factors of production (land, labor, capital)
increases i.e. cost of production increases, then at any
given quantity, producer charge more prices.
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1. Cost of production
q0
Price
P0
SOS1
Physician Visits
P1

28. Other Economic Factors Affecting Supply
• If technology improves, then at any given price,
producer will be willing to sell more
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2. Technological Improvement
q0
Price
S0
Physician Visits
P0
q1
S1

29. The market
29
Quantity per time
period
Price
D
S
PE
QE
Equilibrium

30. P1> PE [excess supply]
30
Quantity per time
period
Price
D
S
PE
QE QSQD
P1
If there is Excess Supply in the market then there will be an downward
pressure in price and price will decrease until it reaches the equilibrium

31. P1< PE [Excess demand]
31
Quantity per time
period
Price
D
S
PE
QEQS QD
P1
If there is ED in the market then there will be an upward pressure in
price and price will increase until it reaches the equilibrium

32. Elasticity – the concept
 If price rises by 10% - what happens to demand?
 We know demand will fall
HOW MUCH?
3 Possibilities-
1. By more than 10%?
2. By less than 10%
3. Not more or not less than 10%
That means in the first cases the responsiveness is
more. And........
 Elasticity measures the extent to which demand
will change
32

33. 33

34.  If demand changes a lot when the price changes, we
say that demand is relatively elastic
 If demand changes only slightly when price increases,
we say it is relatively inelastic.
Elasticity of Demand
34

35. Elasticity
Price (£)
Quantity Demanded
10
D
5
5
6
Govt decides to lower price
to attract utilization
Not a good move!
35

36. Elasticity
Price (£)
Quantity Demanded
D
10
5 20
Govt. decides to reduce price to increase usages
7
Good Move!
36

37. Elasticity
 When we see an elasticity larger than -1 it is elastic
demand, meaning a change in price has a relatively large
impact on demand
 If the elasticity is between 0 to -1, it is inelastic demand –
the percentage change in demand is smaller than the
percentage change in price
37

38. Consumer theory
• The consumer will choose the best bundle he
can afford
• The theory has two parts:
– What do we mean by best bundle
– What a consumer can afford
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39. Consumer Preference
• Three assumptions:
– Completeness: Consumer can clearly describe his
preferences over different bundles . He is able to
clearly say whether he is indifferent between two
bundles A and B or whether he prefers one over
another .
– Transitivity: If A is preferred to B and B is preferred
to C, then A must be preferred to C.
– Non-satiation : More is always better.
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40. Preference Map
• Preference Map: If a consumer’s preferences/
behavior satisfies this three assumptions then
we can put his preferences into a graph.
Preference map is a graphical representation
of a consumer’s preference. It is the collection
of all indifference curves.
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41. Indifference Curve
• Indifference curve is the combination of all
consumption bundles among which the
consumer is indifferent.
2
1
1 2
IC1
Movie
pizza
A
B
C
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42. Properties of Indifference Curve
• Consumer always prefers higher indifference
curve (further from the origin).
• Indifference curves are downward sloping
• Any two indifference curves can not cross
each other.
42

43. Marginal Rate of Substitution
• The MRS measures the amount of one product a
consumer must be given to compensate for giving
up one unit of the other.
• The slope of the Indifference curve is MRS= -
• MRS is not constant, it varies over the
indifference curve
• As we move down along the IC, MRS falls.
2
1
43

44. Budget Constraint
• The budget constraint
indicates the set of bundles
the consumer can afford
with a given income
• Slope of the budget
constraint to the right is
Pc/Pb, and measures how
much beef must be
sacrificed to get one more
pound of chicken
44

45. Consumer Equilibrium
• To maximize satisfaction given a
budget constraint, the consumer
will seek the highest attainable
indifference curve
• Consumer will choose the point at
which indifference curve is tangent
to the budget line.
• In the diagram to the right, point A
on indifference curve U2 represents
the best the consumer can do
45

46. Production Possibility Frontier
• A curve that shows which alternative
combinations of commodities can just be
attained if all resources are used; it is thus the
boundary between attainable and
unattainable commodity combinations.
46

47. Production Possibility Frontier
47

48. Externalities
• Externality—Actions of one party make another worse/better
off, yet the first party does not bear these costs or receive
these benefits
• Negative Externality – Second hand smoking, spread of a
contagious disease by a person who rides a public bus, driving
while intoxicated and injuring another
• Positive Externality –using a condom, deworming
48

49. The Agency Relationship
 A doctor-patient relationship is most frequently
seen as one of agency
 The patients (principals) are less informed than
doctors (agents) about the relationship between
healthcare and health.
The perfect agent physician chooses the health
services as the patient himself would choose if
only the patient possessed the information that
the physician does.
49

50. Imperfect Agency and Supplier-
Induced Demand (SID)
 Supplier-induced demand (SID) refers to the
phenomenon of physicians deviating from their
agency responsibilities to provide care for their self-
interests rather than their patient interests
 SID represents one of the major intellectual and
policy controversies in health economics.
50

51. 51
Reinhardt Fee Test of Inducement
Q1 Q2 Q3 Q4
P4
P1
P3
P2
Utilization of
Healthcare
Price of
Healthcare
D1
D2
D3
S1
S2

52. References:
• Philip Jacobs (1991), The Economics of Health
and Medical Care. Third Edition, Aspen
Publishers Inc.
• S. Folland, A.C. Goodman and M. Stano
(2000), The Economics of health and health
Care, Macmillan, 3rd edn.

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