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page 1The Economics of Health Care1. The problems of health care2. The free market approach3. The case against a free marketWelcome to the Office of Health Economics’ interactive e-source‘The Economics of Health Care’. It is aimed at post-16 students ofeconomic courses, although it contains much that should also beof interest to anyone wishing to understand the basic principles ofhealth care economics.This e-source represents the third edition of ‘The Economics ofHealth Care’. The second edition, launched in 1999, has beenfully updated and extended.4. Health care in the UK5. Health care - further questionsAppendix. StatisticsThis e-source is split into five units, which are shown on the left.In these units, we will show how economists have approached theproblem of health care. This involves introducing and explainingthe economic theory which underpins health economists’ analysis.Much of this theory will look familiar to economics students scarcity, supply & demand and market failure. But this is not justclassroom theory - this is theory applied to actual problemsleading to concrete policies. This e-source should bring thistextbook theory to life and it will give you a much deeperunderstanding of the kind of problems and challenges that themodern health service faces.There is also an appendix with six sets of data which are relevantto this e-source and will interest students and teachers.ForewordThe future of health care and the state of the National HealthService are daily news items. Discussion of health care arousesgreat passion - who gets health care and how much they get isboth a moral and practical challenge to a civilised society and ofpersonal interest to us all. We don’t want to get ill and we want tobe properly treated if we do. Economics as a discipline canprovide great insight into these issues. The fundamental problemof scarcity requires choices. Even if our preference is to spendmore on health care, there are limits as to how much of ournational income we can spend on its provision. However much wedo decide to spend, we want to spend it efficiently so that we getmore health care for a given commitment of resources.
page 2This e-source was written by Martin Green of Watford GrammarSchool and prepared by ISE Ltd for the Office of HealthEconomics (OHE). Please contact ISE Ltd or OHE with anycomments about the e-source or its contents respectively:Office of Health Economics,12 Whitehall,London SW1A 2DYe-mail: ohe@oheschools.orgIndustry Supports Education15 High StreetWilburton,Nr Ely, Cambs.CB6 3RBe-mail: ise@oheschools.org
page 31. The problems of health carei. Approaching the problemsii. Scarcity - health care dimensioniii. Scarcity - a theoretical approachiv. Trade-offsv. Using the theoryvi. Case study - Child Bvii. Approaches to rationingviii. Questions and activitiesHealth care is something which touches all of our lives.Everybody visits the doctor and dentist and many of us have beentreated in hospital. The future of the National Health Service(NHS) consistently surfaces as one of the most important issueswhich people believe is facing Britain today.Yet health care seems to be in almost permanent crisis – thereare shortages of hospital beds and patients are left to lie incorridors while politicians argue endlessly over whether more orless is being spent on the NHS. Why is it that health care is sucha controversial area? Why is there never enough money to giveus the level of health care we want?To answer these questions we need to introduce and apply arange of economic concepts. Each of the sections listed on theleft develops part of the answer.
page 4i. Approaching the problemsHow can we resolve the kind of dilemmas expressed in theseheadlines?Asking people what they thinkThis is the approach Ann Bowling of the King’s Fund took. Sheset out to discover what ‘ordinary people’ thought should be thehealth service priorities by conducting a detailed survey of theresidents of a part of London. Below are some responses takenfrom the survey.***** Angela Martin*“I think life saving treatments for children are mostimportant. We've had our time now”“If a child is really unable to survive it really does seem abit naive to plough a lot of money into it”“If people don’t lead healthy lives why should the healthauthority waste money on making them aware”“The most important thing is to cure people who have lifethreatening illness and then help people to lead a good life”“Instead of curing it prevent it. There’s no guarantee thatyou can cure someone so it is better to prevent illness”“Care of the dying is most important - why should peoplesuffer?”Many economists would argue that the problem with theseresponses is that they mix up opinions and value judgements withfacts. Economists believe that it is important to distinguishquestions of fact from value judgements and opinions.Fact or opinion? Angela MartinA statement such as “Specialist in heart-lung transplants resignsfrom the NHS in protest at lack of funding” is a positive statement:it can be shown to be true or false and is not dependent upon thevalue system of the observer. In contrast, “Health care is a basicright and should be provided free” is a normative statement. Itcannot be proved true or false: our view of it depends on ourvalue system. One of the things which makes the debate over theprovision of health care difficult to resolve is that positive andnormative issues are very much intertwined. Sorting out fact fromopinion is a first step but it does not explain why there are notenough beds in hospitals or why people might be refusedtreatment. To analyse this we need to explore the idea of scarcity.
page 5ii. Scarcity - the health care dimensionScarcity has two sides: the infinite nature of human wants and thefinite or limited nature of resources available to produce goodsand services. What does this mean when related to health care?We’ll examine the wants first.The wantsIt is estimated that by 2031 the over65s will be 23% of the UKpopulation.19481999Number of elderlypeople in the UK inmillions(defined as aged 65and over)5.39.3As % of population10.715.6Why do people demand health care? The simple answer is thatthey want to be healthy. This desire to remain healthy has led to acontinuous growth in the demand for health care. However, thereare also a number of specific reasons why the demand for healthcare has expanded so dramatically in developed countries overthe last 40 years:Changes in the age structureIncreasing real incomesImprovements in medical technologyLet’s look at these in more detail.Changes in age structureChanges in the age structure of the population have increasedthe demand for health care. Countries like the UK have an ageingpopulation.If you visit your doctor (generalpractitioner, GP) you will go to thesurgery (land and capital), have yourappointment verified by the receptionist(labour), be examined by the doctor(enterprise and labour) who might use astethoscope (capital) to listen to yourchest before prescribing a course ofantibiotics (land, labour, capital andenterprise) to treat your chest infection.Elderly people require more health care than other age groups.For instance, in 1998/99, 39% of NHS hospital and communityhealth services expenditure was used for treating people aged 65and over, even though they are only 16% of the total population.Only 11% of the population were 65 or older when the NHS wasfounded in 1948.Increasing real incomesIncreasing real incomes have led to an increase in people’sexpectations of health care. Many of us are now not prepared toput up with the pain, discomfort and lack of mobility associatedwith afflictions like severe osteoarthritis of the hip - we demand ahip replacement operation. In the USA, people suffering from mildosteoarthritis of the knee often have an operation rather than giveup playing golf.Improvements in medical technologyImprovements in medical technology have continuously increasedthe range of treatments possible. A good example of this is theway in which the development of kidney dialysis machines haslargely prevented kidney failure from killing people. As well as
page 6new and more effective medicines allowing us to treat conditionswhich were previously incurable, many new treatments now makechronic diseases like asthma manageable for patients, enablingthem to have a good quality of life.The resourcesThe other side of the scarcity equation relates to the finite natureof resources. The term ‘resources’ covers all inputs used toproduce goods and services. Economists also refer to these asthe factors of production. They are divided into four categories:1.2.3.4.land - the physical resources of the planet includingmineral depositslabour - human resources in the sense of people asworkerscapital - resources created by humans to aid production,such as tools, machinery and factoriesenterprise - the human resource of organising the otherthree factors to produce goods and services.We can see all four factors at work in the production of healthcareIt is fairly obvious that the available quantity of these factors islimited, therefore there is some maximum quantity of health carethat can be produced at any one time. We can explore this ideatheoretically by using what economists call a ProductionPossibility Frontier (PPF).
page 7iii. Scarcity - a theoretical approachScarcity has two sides: the infinite nature of human wants and thefinite or limited nature of resources available to produce goodsand services. We can explore this idea theoretically by using whateconomists call a Production Possibility Frontier (PPF).PPFs in health careHeart bypass surgery is about tostart.Let us start by looking at the production of health care within asingle hospital and in particular at the ability of a specific hospitalunit to carry out surgical procedures such as heart bypassoperations. Suppose the heart bypass unit has 10 surgeonsworking in it, and assume that the only factor which affects thequantity of operations provided is the number of surgeonsassigned to them.If all the surgeons are assigned to heart bypass operations thenthe unit can carry out 50 heart operations per week. If, on theother hand, all the surgeons are assigned to other operations,then the unit can carry out 50 of these other operations per week.Figure 1 shows the production possibility frontier for this unit. Thegraph charts all the possible maximum combinations ofoperations that the unit can achieve given the quantity andproductivity of resources available.50OtheroperationsThe shape of the graph403020100Figure 1010203040Heart operations50What determines the shape of the graph? Look at the graph onthe left (Figure 1). It is a straight line, with a gradient of -1. Thisreflects the fact that if we transfer one surgeon to heart bypassfrom other operations, we get five more heart bypasses but welose five of the other operations, i.e. the trade-off between the twopossibilities is one to one. This is what is called the marginal rateof transformation, MRT.In fact it is highly unlikely that the marginal rate of transformationwould be constant. The surgeons carrying out heart bypassoperations would be working with a fixed quantity of operatingtheatres, heart monitors, and other inputs. So the more surgeonscarrying out bypass operations, the less equipment each onewould have. Therefore, the output per surgeon would fall.So, the number of additional bypass operations carried out by anextra surgeon is different depending on how many surgeons arealready doing bypasses. If there are already a lot of surgeonsdoing bypass operations, the extra one creates only a small
page 8increase in the number of bypass operations. This bends the linedownwards, making it concave. This increase is smaller than ifthere were only a few surgeons already doing bypass operations.This phenomenon is called the Law of Diminishing Returns andmakes the PPF concave to the origin (like Figure 2).50OtheroperationsEfficiency15 10A C50B05101520Heart operationsNow look at point A in Figure 2. It corresponds to 14 bypassoperations combined with 10 other operations. This lies within thePPF in this case (the curve passing through points B and C).Clearly this is a possible combination in the sense that thehospital has enough resources to achieve it, but is it an efficientcombination? What do we mean by efficient?Figure 2The definition of efficiency used by economists is named after theItalian economist, Vilfredo Pareto, who formulated it. He said thatan allocation of resources is efficient if it is impossible to changethat allocation to make one person better off without makingsomeone else worse off. Look at combination A again. Obviouslyit would be possible to re-organise the hospital’s resources toincrease the number of other operations without having to reducethe number of heart operations. This is shown by point B on thediagram. Moving from combination A to combination B is clearly insociety’s interests: we are getting an extra four other operations,i.e. more medical care from our scarce resources.Opportunity costIn fact at point B we are getting a maximum combination possible,given the resources we have. It is a Pareto efficient allocation. Ifwe choose to move from combination B to combination C, thenalthough we are getting five more bypass operations this hasbeen at the expense of nine other operations. Thus moving fromcombination B to C involves a cost, which economists call anopportunity cost. Formally, this is defined as the benefit given upby not choosing the next best alternative. In this case theopportunity cost of moving from point B to C is nine otheroperations. All combinations which lie on a PPF are, by definition,pareto efficient.
page 9Getting more treatmentThere are only two ways that society can get more treatment:A.By improving the productivity of the factors of production,so that the same quantity of factors produces more treatments.For example, Figure 2 showed surgeons being able to produceeither 20 heart bypass or 20 other operations. Increasedproductivity of surgeons carrying out heart bypasses results inthe PPF pivoting outwards, e.g. to 28 heart bypasses or 20 otheroperations as in Figure 3a.Otheroperations25Heart surgeons becomemore productive201510500510152025B.By increasing the quantity of the factors of production.The initial position is again 20 heart bypass or 20 otheroperations. When more surgeons are allocated to all operationsthen the PPF shifts outwards, e.g. to 24 heart bypass or 24 otheroperations as in Figure 3b.30Figure 3aOtheroperations25The cost of more treatmentMore surgeons forall operations20The PPFs we have been using relate to choices between differenttypes of health care. But we can equally use PPF analysis toillustrate the trade-off between health care and all other goods.Such a PPF is shown in Figure 4.151050051015202530It is unlikely that society would choose either point A or B, butthey and all points between are feasible. The question is howdoes society decide between them.Figure 3bA - all healthcare and noeducation, police etc.60Healthcare 50403020100B01020304050All other goodsFigure 460
page 10iv. Trade-offsAllocation of health careGiven scarcity, what we need is an allocation or decision makingsystem to determine how much of which kinds of health care isprovided. There are three possibilities: the free market; thecommand system; and the mixed system.The free market would allocate health care resources according toconsumers’ purchasing behaviour, while the command model woulduse planning to allocate health care according to some predetermined criterion such as ‘need.’ The mixed system would combineparts of the free market with elements of the command model.EfficiencyHow can society decide which of these systems is most suitable inany given case? There are two criteria that economists use to assessthe performance of an allocation system. The first is efficiency: doesthe system produce an allocation which is Pareto efficient (and thuson the economy’s PPF). If the allocation is efficient then the economyis producing exactly the quantity and type of health care that societywants (allocative efficiency) and it is producing that health care forthe lowest possible cost (productive efficiency).EquityThe second criterion is equity: does the system produce anallocation which meets society’s requirement for justice? Clearly,this is a normative issue: the decision made depends uponpeople’s values. However, it is a very important consideration formany people when they consider the allocation of health care. Itis possible to argue, for instance, that notions of social justicewere the single most important influence on the setting up of theNational Health Service in the UK.Equity is a difficult concept to analyse but it helps if wedifferentiate between horizontal and vertical equity. Horizontalequity is concerned with the equal treatment of equal need. Thismeans that to be horizontally equitable, the health care allocationsystem must treat two individuals with the same complaint in anidentical way. Vertical equity, on the other hand, is concerned withthe extent to which individuals who are unequal should be treateddifferently. In health care it can be reflected by the aim of unequaltreatment for unequal need, i.e. more treatment for those withserious conditions than for those with trivial complaints, or bybasing the financing of health care on ability to pay, e.g. viaprogressive income tax.
page 11v. Using the theoryA unique hospital unit forchildren with severelearning disabilities andextreme behaviourproblems faces closure sothat much of its 350,000annual budget can bediverted to run a scannerin another department.Article from The Guardian 8/1/92.Is this the result of not enoughresources or does it just reflect thetransfer of resources to a moreefficient use?What has the economic analysis in the previous pages added toour understanding of health care problems? Take the newspaperreport on the left. What can we say about this?Firstly, the statement is positive and so capable of being analysedobjectively.Secondly, the conflict has been partly brought about by the effectsof developing medical technology - without the development ofthe scanner we would not have had the conflict.Lastly, PPF analysis makes it clear that this situation reflects oneof two possibilities. Either the hospital is operating on its frontier,or it is operating at some point inside its frontier. In the first case,either we have to find some way of deciding between the twoefficient allocations (scanner versus children’s unit) or we have todevote more resources to medical care in this hospital (shift thePPF outwards). In the second case, since the initial allocationwas inefficient, there may be no need to choose between the twopossibilities. If we just remove the inefficiencies we may thenhave enough resources to have both the scanner and thechildren’s unit.Debate on the NHSThis may seem rather simplistic but it does relate directly to thedebate about changes in the NHS. The government has tended toargue that existing allocations have been inefficient, so that it ispossible to get more from existing resources. Critics of their policyhave argued on the other hand that the problem is a lack ofresources.
page 12vi. Case study - Child BHealth care rationing hit the headlines in March 1995 with thecase of Child B. Some of the newspaper headlines are shown onthe left.The caseChild B, or Jaymee Bowen as she was later revealed to be, wassuffering from leukaemia. She developed acute lymphoblasticleukaemia when she was five and received a bone marrowtransplant. She appeared to recover but in January 1995, whenshe was 10 she was diagnosed as suffering from acute myeloidleukaemia. NHS consultants at both Addenbrookes and the RoyalMarsden hospitals said that she had only about eight weeks tolive and that the only possible treatment, intensive chemotherapyand a second bone marrow transplant, was very unlikely tosucceed, unpleasant and not in her best interests.Her father refused to accept this and sought opinions from otherdoctors in Britain and the United States. He found a consultant inLondon who was prepared to treat his daughter in the privatesector, but Cambridge and Huntingdon Health Authority refused togrant the 75,000 needed for the treatment. Jaymee Bowen’sfather challenged this refusal in the High Court. The Court ruledthat health authority should reconsider its decision but this wasimmediately overturned on appeal.The case attracted much publicity and an anonymous privatebenefactor paid for the treatment Jaymee’s father wanted her tohave. Intensive chemotherapy met with only limited success andso the consultant decided to treat Jaymee Bowen with anexperimental treatment, donor lymphocyte infusion. Jaymee wentinto remission and survived longer than the experts had expected.However, in May 1996 she died.Newspaper responseThis case demonstrated how difficult it can be to make rational,reasoned choices - particularly when the media become involved.There was an enormous amount of media attention - with 149articles being published over the six day period of the case. Manyarticles suggested that NHS funds were wasted on less worthyuses - funds which could have been used to treat Jaymee Bowen.Examples of less worthy uses of NHS funds cited by the papersincluded administration, managers’ cars, abortions, cosmeticsurgery, sex change operations and health education ‘propaganda’.
page 13For a number of papers the case provided evidence of rationing‘creeping into the NHS’. For instance “The case has brought intosharp and public focus the simple, central truth of modern stateprovided medicine. The National Health Service cannot possiblyafford what is now medically possible” The Independent 11.3.1995and “These latest examples raise fears that rationing of life savingresources is not just creeping into the NHS but is alreadyentrenched” The Daily Telegraph 11.3.1995.AnalysisEntwistle, Watt, Bradbury and Pehl, reviewing this mediacoverage, are concerned by “their selective presentations”. Theyconclude “Decisions about the treatment of seriously ill childrenand the rationing of health care are both complex andemotive.Publicity brought the case and some of the issues itraised into the open, but it did not necessarily leave people wellinformed. In particular, the question of whether the treatment wasin the child’s best interest was relatively neglected. Child Bbecame “the girl refused treatment on the NHS” .The currentclimate.means that even cases that are primarily about clinicaleffectiveness and a patient’s best interests come to be seen asexamples of rationing.”ConclusionThis case raises many questions, some of which have beentouched on in this unit. However, you also should look at Unit 2for a free market perspective and Unit 3 for some thoughts onwhether individuals can decide what is in their own best interest.The Child B case was seen by many as an example of healthcare rationing. How could such rationing be organised? Look at‘Approaches to rationing’ on the next page for some thoughts onthis.
page 14vii. Approaches to rationingIt has been increasingly accepted at both local and national levelin the UK that rationing is inevitable in the NHS. This has led toinitiatives to explore the best way of making such decisions. Oneapproach has been to use surveys of randomly sampled adults.One such survey carried out in Great Britain in 1995/6 generateda 75% response rate and most of the people surveyed thoughtthat surveys like this should be used in the planning of healthservices. The list below shows how this sample thought healthcare services should be prioritised.Priority rating of health services1.2.3.4.5.6.7.8.9.10.11.12.Treatments for children with life-threatening illnessesSpecial care and pain relief for people who are dyingPreventive screening services and immunisationsSurgery such as hip replacements to help people carry outeveryday tasksDistrict nursing and community services/care at homePsychiatric services for people with mental illnessesHigh technology surgery, organ transplants and procedureswhich treat life threatening conditionsHealth promotion / education services to help people leadhealthy livesIntensive care for premature babies who weigh less than680g with only a slight chance of survivalLong stay hospital care for elderly peopleTreatment for infertilityTreatment for people aged 75 and over with life threateningillnessCitizens’ juriesThe case of Jaymee Bowen (Child B) outlined in the previoussection, made the issue of health care rationing in the UKheadline news. Cambridge and Huntingdon Health Authorityresponded to this ‘trial by tabloid’ by setting up a citizens’ jury tohelp decide health care prioritisation. Sixteen ‘jurors’ sat for fourdays hearing advice from expert witnesses. They were asked toconsider how priorities for health care should be set, according towhat criteria and to what extent the public should be involved.Most thought that there should be an element of publicinvolvement in developing rationing guidelines, but only alongsideother interests. Nobody voted for the involvement of politicians ina national council for priority setting.One option is to ‘let the market decide’. This is explored in Unit 2‘The free market approach to health care’.
page 15viii. Questions and activitiesQuestions1. Look at the following statements and see if you can decidewhether they are positive or normative:A.B.C.D.E.F.Junior doctors ought not to work up to 80 hours a weekThe long hours junior doctors work do not interfere withtheir ability to provide effective medical treatmentThe waiting times for routine surgery are shorter for privatepatients than for NHS patientsNHS doctors should not be allowed to treat patientsprivatelyA hip replacement is not a life-saving operationHip replacements should not be provided by the NHS.2. Why do you think that economists believe that it is important todistinguish between positive and normative statements? Do youthink it is possible to ever be completely positive?ActivitiesA1. Set up a survey to try to discover which health care prioritiespeople in your school or college think are most important. Youcould do this by interviewing a sample of students or you couldconstruct a questionnaire.A2. Research how demand for health care has changed in yourarea. Your local library should have information about the healthcare services available. Try to answer the following questions.Has the number of old people changed significantly in the last 10years? What about new treatments - does your doctor offer stresscounselling for instance? Has your local hospital introduced newequipment such as body scanners?
page 16Questions3. a) The graph in Figure 5 on the left shows a PPF. Identify thefollowing ions.C40b) Which of these are feasible and which are efficient?3020A10F06015404001020 30 40 50Heart operations604. Why is it unlikely that society will choose either combination Eor F in Figure 5?Figure 5ActivityA3. Many hospitals have been reduced in size or closed down.Research why this happened. Try to relate it to changes in thetrade-off between hospitals and other forms of health care.Questions5. Which do you think is more important - that we treat all patientswith kidney failure in the same way or that we make sure that wedevote more health care resources to kidney failure than to plasticsurgery? Justify your answer.6. Do you think that the rich should contribute more to thefinancing of health care than the poor? Justify your answer.Type in your answers, then click here to compare your answerwith our guide answer.
page 172. The free market approachi. What is a market?a. Demand - analysing the buyersb. Supply - analysing the sellersOne way in which the problem of scarcity can be overcome is tolet people buy the health care they want. This is what happenswith most cosmetic surgery. “A man can have a facelift, a nosecorrection and his eyes tightened up. His whole face can berebuilt for a third of the cost of the front end of an expensive carrespray” - The Guardian 7.6.91c. The marketd. How a market allocates resourcese. Case study - cosmetic surgeryf. Elasticityg. Markets as dynamic systemsii. Health care - case for a free marketCase study - health care in the USiii. Questions and activityAll these treatments and more are available if you want to buythem and have the money to pay for them. This kind of healthcare is sold just like any consumer good. People buy thetreatment because they gain satisfaction from it, in just the sameway that they would gain satisfaction from a car or a new dress.As consultant plastic surgeon David Sharpe puts it “There’snothing wrong with having plastic surgery, even if you don’t needit. It’s like buying a Porsche. You don’t need one. It just makesyou feel better”.The market for cosmetic surgery shows that it is possible to buyand sell health care. To understand how such a market mightwork as a resource allocation system, we need to look at thedifferent elements involved in any market. Look at ‘What is amarket’ to see what these elements are. Even if a market canwork for cosmetic surgery what about the rest of health care?Look at ‘Health care - case for a free market’ for some views onthis.
page 18i. What is a market?OverviewFor many people the word market conjures up a picture of a townsquare with lots of small stall holders selling everything from fruitand vegetables to meat and fish. For economists, the term has amuch wider meaning. It is used to describe any process ofexchange between buyers and sellers. Formally, a market can bedefined as any set of arrangements which allows buyers andsellers to communicate and
'The Economics of Health Care'. It is aimed at post-16 students of economic courses, although it contains much that should also be of interest to anyone wishing to understand the basic principles of health care economics. This e-source represents the third edition of 'The Economics of Health Care'. The second edition, launched in 1999 .
