Introduction To Health Economics (Understanding Public Health)

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Other models are somewhere in between. The behaviour of some health care organisations, such as pharmaceutical companies, providers of services like dentistry, ophthalmic services and pharmaceutical dispensing and for-profit insurance companies can relatively easily be analysed using these models. It may be more difficult for other organisations. However, they may provide relevant insights, for example regulation of the UK provider sector is increasingly guided by the use of market forces involving contestability to provide some competitive pressures for efficiency.

Economics analyses many economic activities by according to marginal principles, which is a special case of what is called incremental analysis.

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Incremental analysis means that the effects of changes in the use of resources are examined according to how they differ from current use. Analysis is focussed on, for example, how much costs and benefits are increased or decreased due to a change in resource use, rather than the absolute levels of costs and benefits that exist after the change. It does not mean an unimportant change — the costs and benefits involved even in a small change in resource use could be very large. There are two reasons for analysing incremental and marginal changes.

First, looking at incremental values of economic variables often gives a better view of the issues faced in decision making.

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Secondly, an influential economic theory suggests that people do, at least implicitly, make decisions using marginal principles. For example, the marginal cost of a good or service is defined as the extra cost that is incurred by producing one more unit of it. That cost could be large, even though the change in the amount of the good or service is small.

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As an extreme example, suppose that the service is a particular surgical operation and the surgical unit performing it has reached full capacity for its operating theatre. Performing one extra operation would require a new theatre to be built, so its marginal cost would be very high. However, the marginal cost of the last operation performed within the existing capacity may have been quite small, simply the cost of theatre staff, disposables and subsequent care. As this demonstrates, marginal cost may vary considerably with respect to the same size of change in the other variable, in this case one operation, depending on the absolute level of that other variable, in this case the number of operations already being performed.

A well-known example of the importance of looking at incremental costs is in assessing the impact of early discharge schemes that aim to lower hospital inpatient surgical costs by reducing length of stay. Hospitals may be able to calculate an average cost per day based on information on the average cost of an inpatient stay and length of stay. However, the costs of each inpatient day in practice differ over the time spent in hospital.

At the beginning of an inpatient stay there are high costs of surgery and perhaps of high dependency care. Reducing the number of low dependency days at the end of the stay will therefore save far fewer costs than might be expected by looking at the average. Incremental costs calculated with respect to an increase or decrease in the number of days would give a correct estimate of the likely savings. Similarly, a marginal benefit is the extra benefit gained by the consumption of one more unit of a good — again, it is not a small or unimportant benefit.

Consider a screening programme which can be carried out with different numbers of sequential tests. The more tests that are carried out, the more cases are detected. A programme that uses one test might yield 10 cases per 1, people tested, while a two-test programme might yield 11 cases. Looking at these in terms of their total yield, the two-test programme looks better than the one-test programme. But incremental principles focus on the marginal benefit, which in this case is 10 cases for the one-test programme and only 1 case for the two-test programme, which does not look so good.

Further use of the concept of the margin is discussed in section 6 , and a specific application of this in health care is discussed in section 8. Economic analysis usually judges the way in which resources are used according to two main criteria: efficiency and equity. Efficiency refers to obtaining the greatest output for a given set of resources. Equity refers to a fair distribution of that output amongst the population. These two concepts have technical definitions, which are described below. The technical definitions of efficiency described here use the labels given by Morris, Devlin, Parkin and Spencer Economists are specialists in the analysis of efficiency and largely agree about what it means, and about definitions of different types of efficiency.

Unfortunately, however, the labels that they give to those types vary. The same concept may be given different names and the same name may be given to different concepts. So, if other texts are consulted, it may be wise to check what is meant if efficiency is referred to, especially if the terms technical or allocative efficiency are used. A very broad definition of efficiency has been given by Knapp : the allocation of scarce resources that maximises the achievement of aims. This is useful, because it suggests that the desire to achieve efficiency arises from the desire to improve the world.

Before examining more precise and technical definitions of efficiency, it is useful to understand an abstract economics idea called Pareto efficiency , which is sometimes also called allocative efficiency, though not consistently. This tries to define a criterion for judging different allocations of resources to different uses which might be widely acceptable. Whether it is widely acceptable or not is debated, but that debate is beyond our aims here. It asserts that we would be able to say that one state of the world is better than another if at least one person is better off under the first state compared with the alternative and no-one is worse off.

This is called the Pareto criterion. If we change from one allocation of resources to another, for example changing the health care system in terms of the kind of care that is made available, and as a result some people get better care and no-one gets worse care, this is described as a Pareto improvement. If it is not possible to make any Pareto improvements, then we have achieved a Pareto optimum. A Pareto optimum is therefore a position where it is not possible to make anyone better off without making someone else worse off.

If the aim is to make people in general as well off as possible and there is no concern about whether some people are better off than others, then a Pareto optimum is efficient. Given a Pareto optimal allocation of resources, that aim cannot be achieved to a greater extent because even if one person, or even many people, could be made better off, we do not know if this is outweighed by the fact that some people, even if it is only one person, are made worse off.

However, there is not one unique Pareto optimum; the existence of a Pareto optimum does not mean that this is the only efficient way in which resources could be allocated. There are many allocations of resources that would be Pareto optimal, some of which would imply great inequalities between different people. If our aims also took account of this, then we might not view all Pareto optimums as efficient.

Pareto efficiency is therefore a contentious idea as a way of thinking about how resources should be allocated at a societal level, but does form the basis of definitions of efficiency in economics more narrowly. We will examine three types:. The concept of technical efficiency is used in analysing the production of health and health care.

Recall from section 1. Production is technically efficient if the most output possible is produced from a given set of inputs, or the fewest inputs possible are used to produce a given amount of output. For example, the number of patients that can be treated in an out-patient clinic depends on the number of medical and nursing staff that are available and other inputs. If the most that can be provided by one doctor and two nurses is 20 treatments each day, then it is technically inefficient to provide 19 treatments using that number of staff or to provide 20 treatments using more staff.

Another way to view this is that an efficient clinic cannot undertake more treatments without employing at least one more member of staff. It is therefore Pareto efficient: production is technically efficient for a given set of inputs if it is only possible to produce more by using more of at least one input. The concept of economic efficiency has several alternative labels.

One of these is cost-effectiveness , but that term should be used carefully, as will be explained in the section on economic evaluation. Technical efficiency is only concerned with how many inputs are used in production, while economic efficiency is related to the cost of those inputs. Economic efficiency is achieved if the most output possible is produced for a given cost, or a given amount of output is produced at the lowest possible cost.

Using the example above, some aspects of the treatment provided in a clinic could be undertaken either by doctors or nurses.

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It might be equally technically efficient for 20 treatments to be provided each day by using one doctor and two nurses or two doctors and one nurse. But if we assume that doctors are more expensive to employ than nurses, then it will be economically efficient to use the extra nurse rather than the extra doctor.

So, although it is necessary to have technical efficiency to be able to achieve economic efficiency, not all technically efficient ways of producing are economically efficient. Another way to view this is that, given the costs of employing staff, an efficient clinic cannot undertake more treatments without them costing more to provide.

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As before, it is Pareto efficient: production is economically efficient for a given set of input prices if it is only possible to produce more by incurring greater costs. Social efficiency is a much broader concept. Both technical efficiency and economic efficiency concern production, and if the supply side of the market achieves economic efficiency in every market, there is allocative efficiency in production for the economy as a whole. An equivalent concept for the demand side of the market is allocative efficiency in consumption where, given prices of goods, consumers maximise their utility.

Social efficiency is where both of these are achieved. It means allocative efficiency in the economy as a whole, which is the same as the overall Pareto efficiency described earlier. Social efficiency is not a concept that has practical use in health economics, but it is an important idea for debates about whether markets should be used in health care.

It can be shown that if markets work perfectly, then they will produce a socially efficient economy.

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  5. To some, this gives a presumption in favour of market provision. However, if markets do not work perfectly they will not produce a socially efficient economy. The questions are then how imperfect markets are and whether there are alternatives, such as government provision, that are better. It is also important as a basis for a form of economic appraisal called cost-benefit analysis, which is discussed in section 5.

    Equity is always an important criterion for allocation of resources. However, it is observable that people attach more importance to equity in health and health care than they do to many other goods and services. Equity is an important policy objective in almost every health care system in the world.


    Economists have created some very useful ways of measuring equity, but apart from that economic analysis of equity is less clear than the analysis of efficiency and there is lower consensus amongst economists about it. It is important to distinguish equity from equality. Equity means fairness; in the health care context this means a fair distribution of health and health care between people and fairness in the burden of financing health care. Equality means an equal distribution, but it may not always be fair to be equal. For example, it might be thought to be unfair both healthy and sick people are given equal amounts of health care.

    However, equity is often defined with respect to equality and inequality. For example, it may be considered equitable that people who have an equal need for health care should have equal access to it. This is a very common definition of equity. However, there could be others, for example:.

    There is a useful distinction when using equity definitions like this, which also has roots in philosophy, between horizontal and vertical equity. Horizontal equity means the equal treatment of equals; for example, do people who have the same health needs have equal access to health care? Vertical equity means the unequal treatment of unequals; for example, do people who have worse levels of health have greater access to health care? There are some equity principles that do not take this form.

    The maximin principle is if there are inequalities in the distribution of resources, these must benefit the least well off.