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1. Econ 4999
Health Economics
Lecture 1:
Introduction

2. Class information
 Class website
http://www.colorado.edu/ibs/hb/barham/cours
es/econ4646/
 Readings section requires a password:
Username: econ4646
Password: econ4646
 Syllabus: Updated version on class website

3. Outline
■ What is health and health care?
■ What is health economics?
 Why is it important?
 What makes the health care market different
from the market or other goods?
 What type of questions do health economists
ask?

4. What is health
 Health is a multifaceted concept and not
easily measurable.
 WHO definition:
 Health is a state of complete physical and mental
well-being and not merely the absence of disease
or infirmity (WHO, 1948)
 Refer to peoples’ health status (how healthy
they are).

5. What is health
 Important part of human capital
 Human capital: value of learning, experience and
ability embodied in workers which increases
productivity and income.
 Asset: accumulates and depreciates
 Individual or households can improve their
health through use of health care, diet ..
 Production of health
 Health Production Functions
 Determinants of health

6. What is health care?
Definition: The prevention, treatment, and
management of illness and the preservation
of mental and physical well-being through the
services offered by the medical and allied
health professions.

7. What is health care?
 Important difference between health and
health care
 Health care can be traded on the market but
health cannot.
 Demand health care to improve our health
 Demand for Health Care
 Health care markets differ from markets for
other commodities
 Role for Government

8. Roots of health economics
Emerged as a sub discipline of economics in
the1960s with the publication of two
important paper:
1. Kenneth Arrow (1963) “Uncertainty and Welfare
Economics of Medical Care” The American
Economic Review.
2. Mark Pauly (1968) “The Economics of Moral
Hazard: Comment” The American Economic
Review.
 Concerned with the health market not with health
or health status.

9. What is health economics?
1. Health economics is the study of how
(scarce) resources are allocated to and
within the health economy.
 Production of health care (doctors, specialists,
or nurses).
 How do we distribute health care across the
population?
 Based on who can pay or who needs it or
some combination.
 How much money should the government
spend on health care?

10. What is health economics?
2. Demonstrates the magnitude and
importance of the health sector
e.g. How fast it might be growing and why
3. What makes it different from other markets
and how our analysis may need to adjust
4. Models the determinants of health status
and looks and how government policy might
improve health status in short and long run

11. Why is it important?
1. The size of the health economy is large and
growing
2. Role of government in the health care markets
3. Health care market is difference from other
markets
4. Externalities

12. Why is it important?
1. Health economy is large and growing
Figure 1-1
US Health Expenditures Shares, 1960-2003
0
2
4
6
8
10
12
14
16
1960 1965 1970 1975 1980 1985 1990 1995 2000
Year
Expenditures
as
a
%
of
GDP
Source: Organization for Economic Cooperation and Development, Health Data 2005.

13. The size of US health economy
 GDP: The market value of final goods and
services produced within the borders of a
country in a year.
 1980s: Rise in shares
 Increase in insurance coverage and FFS
system
 Introduction of more market based policies
 1990s: Expenditures flattens out
 Managed care introduced
 Could just be an decrease in the
denominator.

14. National US Spending on Health
Care
Year NHE Growth % GDP
1960 36.7 5.1
1970 73.1 10.6 7.0
1980 245.8 12.9 8.8
1990 696.0 11.0 12.0
1995 990.3 7.3 13.4
2000 1310.0 7.0 13.4
2006* 2077.5 7.3 16.0
Per Capita
Nominal Real
143 483
348 897
1067 1295
2,738 2095
3,698 2427
4,672 2713
6,830 N.A.
(In billions of dollars); * = projection
Numerator is increasing
NHE = National Health Expenditures

15. Out-of-Pocket and Federal
Expenditures -Table 1-5 FSG
Total Out-of- Third Federal
Pocket % Party % %
1960 25.0 12.9 52 12.1 48 2.2 9
1970 67.3 25.1 37 42.2 62 15.6 23
1980 233.5 58.2 25 175.2 75 66.1 28
1990 669.6 137.1 20 532.3 80 181.9 27
2003 1614.2 230.5 14 1384 86 507.5 31
(In billions of dollars)

16. Medical care prices (CPI), 1960-
2004
1960 1980
2004
ALL
Hospital
services
Presc. drugs

17. Personal Consumption, 2001
Food and Tobacco 15.3
Housing 14.3
Medical Care 18.2
Hospital and nursing 7.3
Transportation 11.4
Household Operation 10.7
Recreation 8.5
Clothing 5.9
Other 15.6
Source: FSG Table 1.2

18. Personal Expenditures
 Medical care is the largest category.
 Most of this is for hospitals/nursing homes
 Need to think how policy affects this category
 Uninsured go to emergency rooms
 In 1960 food was 25%, housing 15%, and
medical care 5%.
 There has been a big shift in spending
patterns. May represent a richer society.

19. Personal Expenditures
What have we not accounted for in personal
expenditures?
 Opportunity cost of your own time
 Time spent caring for sick or disabled
 Decreased with more spent on nursing home?
 Very important in developing countries

20. US compared to OECD countries
Table 1-1: health expenditures % GDP, OECD
 Health expenditures grew rapidly between
1960-1980 for most countries.
 Rates continued to rise in1990s in US.
 US is the biggest spender.
 Twice as much as the UK (national health
insurance).

21. Questions for you to think about
1. Why do you think health care spending is
higher in the US than in other countries?
2. Is the fact that the US population spends
more per capita on health care than people
in any other developed country evidence of
a failure of the US system?

22. Why is it important?
1. The size of the health economy is large and
growing
2. Role of government in the health care
markets

23. Role of Government
Participate because of market failures
 Demand side
 Provision of insurance
 Effort to affect health behavior
 Supply side
 Price controls
 Restriction of entry/exit
 Subsidize research
 Tax policy
and much more …

24. US health care spending, 2003
Government is 45 % of total health spending
Source: DHHS, http://www.cms.hhs.gov/statistics/nhe/historical/chart.asp

25. Percent of health care expenditure
60%
40%
20%
80%
Private Federal State and local

26. Why is it important?
1. The size of the health economy is large and
growing
2. Role of government in the health care markets
3. Medical Market is difference from other
markets

27. How is the medical care market
different from other markets?
1. Presence of Uncertainty
 Demand is irregular and uncertain
 Accidents, can you deny someone lifesaving
care if they don’t have the money?

28. How is the medical care market
different from other markets?
 Supply–hard to understand the product
 Asymmetric information
 When we are sick we don’t understand the
treatment we need and must trust our doctor in their
diagnosis.
 Different doctors may suggest different treatments
due to uncertainty of outcome.
 Hard to judge quality
 Governments establish licensing requirements to
ensure minimum level of quality

29. How is the medical care market
different from other markets?
2. Prominence of Insurance
 People buy insurance to cover themselves
against the risk of illness.
 With third party financing most of the cost of
medical care, individuals are insulated from
the full cost of the care they receive.
 Demand for medical care may rise if you don’t
pay the full cost.
 Treatment recommendations are adjusted to
insurance status.

30. How is the medical care market
different from other markets?
3. Large role of not-for-profit providers
 Economists usually assume firms maximize
profits.
 There are many not-for-profit hospitals (85%).
How should economists model their behavior?
4. Role of equity and need
 Belief that people ought to get health care
whether or not they can afford it.
 Economists need to take this feature of the
good into consideration.

31. Why is it important?
1. The size of the health economy is large and
growing
2. Role of government in the health care markets
3. Medical Market is difference from other
markets
4. Externalities

32. Externalities
 Communicable disease
 A disease that is transmitted through direct
contact with an infected individual or indirectly
through a vector (e.g. mosquito).
 Significant reduction in their spread account for
much of the improvement in health in developed
countries
 Malaria, TB, vaccine preventable diseases
 Still a significant problem in less developed
countries

33. Externalities
 Individual behaviors (smoking, over eating)
 Direct impact on health of person and others
 Impacts the cost of health
 premiums –i.e. lung cancer
 Impact on demand for health care

34. Cause of death
14
48
43
77
9
9
0
10
20
30
40
50
60
70
80
90
Developed Regions Developing Regions
Percent
Communicable Non-communicable Injuries
Source: http://ucatlas.ucsc.edu/health.php

35. Causes of Death in US, 2000
Source: Mokdad et al, 2004

36. What questions do health economics
ask?
 What role should the government play in
health?
 What health care investments should a
developing country make?
 What advertising should be banned?
 What is the optimal design for health
insurance?
 Why has health care become so expensive?

37. What questions do health economics
ask?
 Does health care early in childhood lead to
improved cognition and higher incomes in
the future?
 Have Medicare and Medicaid increased
utilization and improved health outcomes?
 Do different methods of doctor payment
change quality of care, outcomes or costs?