Health Economics, with Guy David, PhD

By: Penn Medical Ethics & Health Policy Online

Hello, and welcome. Now that we covered the relationship between supply and demand, you should have a better understanding of how markets function with and without government intervention. To analyze economic market, we must be able to define who is selling, who is buying, what is being sold, and what is its price. In many industries, the answers to these questions are fairly obvious.

Let's think about the shirt I'm wearing. In the clothing industry, we can easily identify the seller, the buyer, and most importantly the product that is being delivered. We would argue that the clothing manufacturers are producing and selling clothes while the public is buying, oftentimes to retailers. Now, let's map this logic to health care, which exists because we all want to be healthy, right? But what is health from an economic perspective? Is health an output, like my shirt? Or an input, like the fabrics that make up this shirt? Who produces health? Is it sold on the market? And if so, what is the price of health? Let's start with the issue of output versus the input. If you answer that health is an output, you are correct. If you answer that health is an input, you are also correct. Health happens to be one of those conditions that serves both as a goal and as a means to other goals. Health or being healthy is an output from several perspectives.

From an individual, perspective it's an output in that it's a goal we all put resources behind. We exercise, we eat healthy, and use medical care to elevate our health. Being in good health care is a desirable output. But individuals are not the only ones thinking of health as an output. If we look at it from the perspective of providers, their core business is to deliver care that improves the health of their patients.

This is one of the reasons many economists believe doctors should be paid based on their success in making their patient healthier and not based on the number of services they provide to patients. The current payment system suggests that health is an output, because it's reflective of the care provided to patients. At the same time, health can be viewed as an input. But what would health be producing? Well, from an individual perspective, the healthier we are, the more productive we are in the workplace and outside of it. Healthier workers lose fewer days to illness and earn more money. At the same time, being healthier helps make the most out of our leisure activities. But individuals are not the only ones thinking of health as an input. If we look at it from the perspective of payers, their core business is to spread financial risk from health care utilization.

Health Economics, with Guy David, PhD

Naturally, what makes an insured member more or less risky is their underlying health condition. Therefore, faced with other selection, insurance companies will have to properly assess the underlying health of their member population. Failure to do so may lead payers to experience financial losses, as we've seen with the number of plans offered on state insurance exchanges. Health is therefore an input because insurance companies base their decisions on the health status of their members. So health is both an input and an output, and that clearly makes economic analysis of health care markets more challenging.

But it is even more complicated than that. Let's revert back to the questions of sellers and buyers in health care markets. You might say, the answer is simple. The physician is the seller.

The patient is the buyer. One is selling a service. The other one is purchasing it. But the patient-physician relationship is far more complicated than it would seem at first glance. The reason for that is, again, the role of health in economics.

Recall our discussion of supply and demand. Suppliers in economics are represented by a supply curve. They make decisions about the quantity supplied at any given price point.

And, moreover, they have control over the quality of their services. Consumers, on the other hand, make decisions on the quantity demanded. Since price is observable to consumers, their desires and valuation of the service allows them to determine how much they would spend. These desires and valuation constitute what economists call willingness to pay. Here is a simple example relying once again on the straightforward interpretations of the clothing industry. A consumer is interested in purchasing a brand new shirt.

While our consumer is no expert on shirts, they do control one important aspect of the transaction, their willingness to pay. At the same time, the producer can alter the quality of the shirt to affect the consumer's valuation of the product. An Oxford blue shirt at Walmart costs $15 while a shirt just like that at Ralph Laurent would cost $73 on sale. It sounds trivial, but for economics to work, the sellers must control aspects of the product or the service while the buyer decides how much they are willing to pay for this product or service. Now let's go back to health. First of all, patients, or buyers in our example, rather than physicians or suppliers have major influence over their health. Sure, physicians have control over quality aspects of medical care, but they have little influence over their patients adherence to a healthy and active lifestyle, a key determinant of health.

In that sense, consumers in health care markets exert influence over the supply curve, and that is not how economics is supposed to work. Now, let's look at the other side of the equation. Who decides how much to spend? In our shirt example, it was the consumer, but here physicians rather than patients have a major influence over purchasing decisions. Patients, both insulated from the actual cost of care through insurance or lacking medical expertise to determine the level of care appropriate for them, will be heavily influenced by advice from their doctors. In that sense, suppliers in health care market exert influence over the demand curve. And again, that is not how economics is supposed to work.

Therefore, we find ourselves in a world where the sellers can manipulate aspects of demand and buyers can manipulate aspects of supply. That, in turn, changes the fundamental notion of equilibrium we discussed in the previous segment. And this is before we even enter this health insurance into the mix. But not to worry, now that we understand the nature of the complexity, we can start taking steps to have it all make sense.

In the next segment, we will discuss a key contribution to understanding the role of health in economics, Grossman's 1972 human capital model, where health, in addition to being viewed as an output and as an input, is also viewed as a durable capital stock.

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