Health Economics Part I – Introduction

This post is the first in a series of articles exploring concepts of one of the lesser known fields of economic study – health economics. When one thinks of economics their mind usually turns to concepts of trade, resource allocation, and other similarly business-related concepts. However, ideas of supply and demand have gone beyond traditional goods and services and onto the more human notion of health. Health economics bridges the gap between philosophical ideas and concrete answers. Concepts such as the value of a human life are explored through a scientific lens. Health economics is also a growing field – medical practices are increasingly required to show the benefits of new treatments and technologies in tangible ways. My health economics lecturer often finds herself swamped by the growing numbers of requests from local hospitals for cost-benefit analyses of their proposed projects. Thus, if you’re looking for a new, intriguing field of work, you might find health consultancy a promising profession. To give you an overview of health economics I’ll start with a discussion about a critical point within the field: the demand creation problem.

Health economists do not claim that the entirety of the health industry can be quantified economically. However, they attempt to understand the health care market by modelling it as a competitive market driven by traditional forces. In reality, the health care industry is far from a competitive market as it is characterised by asymmetric information (doctors know far more than patients about the patient’s problem, range of available treatments, and chances of success) as well as imperfect information (even doctors can’t be 100% certain about the diagnosis or proposed treatment plan). Now, this is true for other markets, but in medical care the consequences for consumers of poor choices are more dire than in other markets.

Let’s compare the health industry to the car repair industry. The typical individual does not know as much about cars as their mechanic. Therefore, the individual must trust their mechanic’s advice, and therefore the mechanic can generate demand for their own services by advising the consumer that they need ‘x’ service. This advice can only be assessed using information that the individual can glean from other sources. In terms of car repair, more weight can be given to this self-gleaned information because the potential consequences of refusing the mechanic’s advice are not as serious as the potential consequences of refusing the advice of a medical professional.

This begs the question, are there any limits on a physician’s ability to create demand for their own services? There are at least three factors that limit the amount of self-induced demand creation possible:

  1. The more sources of information that consumers have access to, the lesser the possible demand creation;
  2. Demand creation is limited by the negative response consumers have to incorrect information; and
  3. If greater weight is placed upon the ‘reputation’ of the physician by the patient a constraint is placed upon the amount of demand physicians can create for themselves. Reputation is essentially a combination of information about the physician’s quality of care, cost, and outcomes that consumers can glean about healthcare providers. The weight of reputation is directly correlated to the quality and quantity of data available concerning those factors available to consumers.

However, self-induced demand is not the only difficult-to-model demand factor in the health care market. Another issue affecting the demand side of the health industry is consumer tastes. For instance, patients may become used to certain methods of treatment leading them to prefer a certain process rather than a certain outcome. Patients may experience high tech treatment at a clinic and then begin to pursue this high-tech treatment even though its outcomes do not necessarily differ from traditional treatment methods. There are also various other factors such as consumer irrationality, addiction, and externalities that further alter demand for medical care.

But why does it matter if medical care demand is hard to model? The many issues surrounding the drivers of demand in the medical market have implications in the wider world due to the huge amount of global health care expenditure. Centers for Medicare & Medicaid Services provides reliable information on total U.S. health care expenditure, and the World Health Organisation provides information about global health expenditure if you’re interested in viewing the raw data for the various aspects of health expenditure worldwide. These expenditures beg questions about what insurance schemes are most cost-effective? Can costs be modelled accurately for national health care expenditure to predict the cost of nationwide health care schemes like the UK’s NHS or Australia’s Medicare? Additionally, the patient does not necessarily care about limiting their usage of health care services if they are paid for by insurance or government schemes. This moral hazard further skews cost predictions. Thus, the smorgasbord of non-traditional demand creation factors create a difficult environment for cost modelling in the health care market.

The practical solutions to the issue of self-induced demand are a frequent discussion point among health economists. The optimal outcome is to find the most cost-effective method of providing adequate health care, be it through insurance or a government-wide system. To identify the best approach, data analysis is required. Unfortunately, the information that one can glean about the quality of health care providers is poor due to the lack of information that can be garnered through tracking patient health outcomes. It is almost impossible to isolate the benefits of medical care due to the large number of factors that impact patient health after undergoing a procedure. Additionally, outcomes are very individual specific, therefore the data for individuals is not helpful in modelling policy decisions.

Thus, between the unreliability of data and the difficulty in modelling the health care sector as a traditional industry, the healthcare debate rages on. HMOs (Health Maintenance Organisations) and PPOs (Preferred Provider Organisations) that implement demand-side limits on expenses such as deductibles and co-payments are one proposed solution. Another is nationwide healthcare coverage. Each policy has its benefits and detriments.

In the next article, we will explore some of the observed outcomes from different nationwide policies around the globe, focusing primarily on my home country of New Zealand.

Dean Franklet is a recently graduated economics and finance master’s student from the University of Canterbury where he was President of the largest commerce society on campus. Spending his life in Texas and then New Zealand with a few other stops along the way, he gives a unique global viewpoint to portray in his writing.

Image: Pexels

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    This post is the first in a series of articles exploring concepts of one of the lesser known fields of economic study – health economics. When one thi
    [See the full post at: Health Economics Part I – Introduction]

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