|Health Economics for Developing Countries: A Survival Kit (London School of Hygiene and Tropical Medicine, 1998, 134 p.)|
In order to use scarce resources as efficiently as possible, an efficient information system is required - to bring together the values of the alternative uses of resources (products) with their production cost, and to co-ordinate the many decisions of consumers and producers. The price system, although imperfect (see Chapter 4), attempts this difficult task and plays a central role in economic analysis. It influences many health and health care programmes either directly or indirectly (e.g. through markets for personnel, drugs etc.). It is thus important to consider the workings of the price system, through an examination of demand and supply. An idealised model of demand, supply and the price system is presented, before considering its relevance to health care.
In economics, the quantity of a particular good demanded is seen as a variable determined by a range of factors.
The demand function summarizes this relationship:
Qd = f (P, RP, Y, T, ...)
The quantity demanded (Qd) is some function of the price of the good (P); the prices of other related goods (RP); income (Y); and the organizational and institutional structure of society and preferences and tastes of individuals (T) which will depend on many socioeconomic and cultural factors. Of these, prices and incomes are the most useful for theoretical analysis. The demand function can represent the demand of an individual, or of all individuals demanding a particular good - in which case it is simply the sum of individual demands.
The relationship between demand and price is often portrayed as a demand curve (Figure 2). It illustrates how much would be demanded at each price. For most goods, more is bought as the price falls and so the demand curve will slope downwards.
In using a two-dimensional drawing of the demand curve it is assumed that the other factors (RP, Y, T) remain constant. This helps to clarify different aspects of demand, but modern econometric techniques allow more sophisticated estimation of the impact of the different variables on demand.
It is also important to know about the responsiveness of demand to changes in any of the variables. Responsiveness is measured by economists and referred to as the elasticity of demand; it is reflected in the shape of the demand curve.
Price elasticity of demand is measured by expressing the percentage change in quantity demanded (Qd) as a proportion of the percentage change in price (P).
If the percentage change in Qd is greater than the percentage change in price the demand for a good is elastic, Ed > 1. If the percentage change in quantity demanded changes by less than the percentage change in price (Ed < 1) the demand is inelastic. If the percentage change in price evokes a similar change in percentage quantity demanded then the demand is unitary elastic, (Ed = 1). Elasticity will depend upon the ease with which goods can be substituted for one another.
Income elasticity of demand measures the response in quantity demanded (Qd) which arises from changes in income (Y).
Cross-elasticity of demand measures the response in quantity demanded of good A (Qda) which arises from changes in the prices of other goods or services (Pb).
It measures the degree of association amongst goods, i.e. whether they substitute or complement (need to be used with) each other.
In economics, supply is used in a sense symmetrical with demand. The quantity of a good that producers offer for consumption is seen as determined by certain economic variables, of which the most important is the price at which the good can be offered.
The supply function relates the quantity supplied to the variables likely to affect it.
Qs = (P, RP, C, RC, T,.......)
The quantity supplied (Qs) is some function of the price of the good (P), relative prices (RP), costs (C), relative costs (RC), and tastes (T) which will include socioeconomic and cultural factors.
The supply curve (Figure 3) shows the relationship between price and the quantity supplied. It will normally slope upwards indicating that more will be supplied if prices rise.
The ease with which quantity supplied will respond to changes in price is measured by the elasticity of supply, and it is reflected in the shape of the supply curve.
The elasticity of supply is roughly measured by expressing the percentage change in quantity supplied (Qs) as a proportion of the percentage change in price (P).
Like the elasticity of demand, it is described as elastic where (Es > 1) and inelastic where Es < 1. Elasticity will depend upon the ease with which quantities of goods or services can be produced. In some cases over an appreciable time span it may be difficult to obtain any more goods, irrespective of the price offered, e.g. agricultural crops or production where the scale of activities is fixed in the short term.
Equilibrium in a market is achieved when supply equals demand (Figure 4). Price and quantity will adjust until the point is reached where buyers and sellers are content to exchange a given quantity (q1) at a given price (p1).
At p2 suppliers will be willing to supply more than buyers are willing to purchase at that price. There will be excess supply and pressure to reduce prices. At p3 buyers will be willing to buy more than suppliers are willing to offer and there will be pressure on prices to rise - excess demand.
If factors in the equation other than price change, the supply/demand curve will shift. Assume a change in fashion (T) for a good, leading many people to want more of it at any price (Figure 5).
A new equilibrium (E1) is reached after the demand curve has shifted outwards, and price and quantity have risen, the extent depending on the size of the shift and the elasticity of supply and demand. An example of this is the impact of the 1966 relaxation of the papal instruction to 'eat no meat on Friday', which resulted in a reduction in fish consumption and a 20% price fall for some fish (e.g. haddock & whiling). Another example might be a change in supply conditions. Perhaps a new technique is available which enables more to be supplied at any price, i.e. the supply curve slips downwards (Figure 6).
In this case the supply curve has moved down and demand has remained unchanged. The new equilibrium (E1) will be arrived at with prices lower and quantity purchased greater than before. The extent of the change will again depend upon the elasticity of supply and demand.
Some additional examples (Figures 7 and 8) show the effects of different elasticities. At any particular point on the curve the responsiveness is reflected by the slope of the curve, i.e. the demand and supply curves become steeper as they represent less response of quantity demanded/supplied to price changes.
5. Supply, Demand and Policy
Supply and demand analysis can be used to consider policy changes such as the introduction of a tax on production and consumption of a good or subsidy on price or a policy of price controls.
Figure 9 shows the effect of a tax. Price has risen and quantity purchased has fallen. The extent of the rise or fall will depend upon the tax change and the relative elasticities of the supply and demand curves.
Figure 10 shows the effect of a subsidy. Price has fallen and quantity purchased has risen. Again the extent to which changes occur depend on the responsiveness of demand and supply.
Figure 11 shows the effects of the imposition of a price control (p2) above equilibrium price (p1). Price has risen and quantity demanded has fallen but excess supply (q1 - q2) is available; unless this is managed there will be pressure on the market to bring down prices.
Figure 12 shows the effects of the imposition of a price control (p2) below equilibrium price (p1). Price has fallen and quantity has fallen. At this price there will be excess demand (q1 - q2) and pressure to bid up the price unless some form of rationing is introduced.
Taxes and subsidies can be used to promote health. For example, taxes can be imposed on health-damaging substances (e.g. cigarettes) or on polluting industries, thus raising their price and reducing consumption/production. The extent of the reduction will depend on the relevant elasticities. Similarly, subsidies can be used to promote consumption or production by in effect lowering the price of health-promoting activities (e.g. zero-priced ante-natal screening or dental and eye checks).
6. Externalities and Demand/Supply Analysis
Values, as expressed by the amount people are willing to pay, reflect only the private assessment of values and no account is taken of society's values. If there is a difference between the individual's and society's valuation of a good or service, externalities exist, i.e. factors are important that are external to those taking part in the transaction.
6.1 Demand or consumption externalities
If there are positive external benefits from the consumption of a good or service, society's demand curve will be to the right of the individual demand curve e.g. immunization, preventive medicine (figure 13); if there are negative external benefits from the consumption of a good or a service, society's demand curve will be to the left of the individual demand curve e.g. smoking and consumption of fat (figure 14).
In either case, without intervention, over- or under-consumption would occur.
6.2 Supply and production externalities
A similar situation might occur on the supply side (Figure 15). The costs which underlie the supply schedule only represent the private costs borne by the supplier. There may be costs borne by others as a result of the activity undertaken when producing goods e.g. river pollution, noise pollution or the use of scarce resources.
Alternatively, the process may provide benefits in terms of amenities that can be used for other purposes and society's costs would then be below private costs (Figure 16).
Again, over- and under-consumption would occur if no intervention takes place. Intervention may take the form of taxes or subsidies of services, legislation to control output or price, or direct intervention in production and distribution of services.
7. Is There a Demand for Health Care?
7.1 Need, utilization and demand
It can be argued that the demand for health care is fundamentally different from the demand for 'supermarket' type goods. As discussed in Chapter 4 there are a variety of characteristics that distinguish health care from other goods and there are a number of failures specific to the health care market. One of the most significant of these is that supply and demand do not interact in the conventional manner. For example, because of uncertainty and information gaps, the supplier is directly involved in the decision whether or not to consume health care. Traditional demand analysis has, thus, been amended to allow for this difference by considering, for example, the existence of an agency relationship between doctor and patient and of supplier-induced demand. In particular, the concept of need has been used to gain a better understanding of decisions in the health care sector, and it is introduced here in order to show some of the complexities of the theoretical debate about whether or not there is a demand for health care.
Need can be defined in a variety of ways. A common definition is that of normative need, which is assessed by an expert on the basis of a comparison of the actual situation with a technically determined standard. Alternatively, need can be defined as felt need i.e. assessed by the individual. These needs can conflict if the consumer is not the best judge of her/his own needs, as may be the case with respect to health.
Normative need and demand differ in principle. Demand reflects individuals' wants, backed by a willingness to pay for them, and so health care may be (normatively) 'needed' but not 'demanded' (e.g. early treatment for hypertension); or it may be 'demanded' but not (normatively) 'needed' (e.g. cosmetic surgery). In contrast, it can be argued that demands are the expression of felt needs - expressed through a willingness and ability to pay.
The decision to use health care reflects a combination of normative and felt need, because for consumption decisions in the health sector consumers often rely on information provided by the supplier in addition to/supplemented by their own preferences. Relatively few studies of demand for health care have been done but it is also possible to glimpse the demand curve for health care through a study of utilization data. From the limited evidence on the demand for and utilization of health care in developing countries, a number of tentative conclusions can be drawn which are not surprising given the economic theory of demand. The main findings are that:
- higher income status is associated with greater demand for health care and, in particular, for modern health services
- price helps to determine health care demand and price rises may reduce the demand of lower income groups more than that of upper income groups
- poor physical access (increasing the time costs of seeking care) reduces demand
- the perceived efficacy and quality of care are important influences over the decision to demand care from any particular provider.
The relative importance of some of the factors influencing demand may differ from theory. For example, where beliefs about illness causation imply certain treatment options, price and income are much less important in health care utilization decisions.
These beliefs might be incorporated in item T of the demand function ('the organizational and institutional structure of society, preferences and tastes'). In practice, however, it is difficult to account for them and adequately to include them in health care demand analysis. The links between the variables of the health care demand function also make it difficult to isolate the impact of any one. Illness causation beliefs may well be linked to income level (a proxy for socioeconomic status and education); income level is itself linked to ill-health and so both directly and indirectly influences the demand for health care.
7.2 Health care planning and the demand for health care
Despite the theoretical debate about the existence and nature of the demand for health care and practical difficulties of estimating demand functions, it is possible to build up a picture of demand by analyzing information about both utilization and need. The quantity of services required to meet demand can also be determined from such an analysis. An assessment of normative need requires consideration of the likely levels of need within the target population (e.g. based on risk factors). Assessment of fell need is based on direct questionnaire surveys. Utilization data can be drawn from service-based statistics or from household surveys.
Such information about demand is especially relevant to broad planning decisions, for example, concerning health financing options (e.g. whether or not to introduce user fees). However, a more realistic view of health care must be taken for detailed planning. This view should take account of the fact that the consumer's demand for health care is a demand not only for treatment but also for information and support; and that it is partly a reflection of consumer desires, and partly a result of the actions of the consumer's agents (relatives, friends and health professionals).
8. The Supply of Health Care
Three peculiarities of the supply of health care complicate its analysis:
- complexity of product: health care is not a simple product, but a related bundle of goods and services directed towards the same objective of improving health. In many cases these goods and services are joint products and the supply and costs of one are not independent of the others. They also have a quality dimension that is difficult to measure objectively
- complexity of organization: commercial, private non-profit and public institutions are found side by side supplying health care to the same, or overlapping, markets. Little is known of the determinants of the behaviour of non-commercial institutions
- specialized input markets: the key inputs of the health care industry are produced in 'dedicated markets', of which the most important (professional labour) is often tightly controlled by the professionals.
Because of its special features, measuring and modelling supply can be as difficult as measuring and modelling demand. Very little is known about how different types of supplier behave. More attention has been devoted to measuring costs within the health care market and inputs into health care production (see Chapter 7). Even so, only limited cost data is currently available for developing countries, particularly for hospitals and for immunization services.
However, the potential value of cost analyses for planning and management purposes is increasingly recognized. For example, cost data can be used:
- in the assessment of operational efficiency
- to determine the resource requirements for alternative planning options (especially recurrent resource requirements)
- to fuel the debate about alternative financing mechanisms and the necessity of cost-recovery.