Objective. Sessions on Economics. Types of Economic Analysis. Session 2

Transcription

1 Objective Sessions on Economics Pharm 532 Lou Garrison, Ph.D. April 9-23, 2007 Understand the basic principles of economics as applied to health care and integrate there principles into policy analysis. 1 2 Types of Economic Analysis Session 2 Normative Positive Behavioral Well-being vs. Health vs. Medical Care 3 4

2 Review Key Concepts to Remember Taxonomy of Public vs. Private Goods Surplus social, consumer, producer Economic rents Pareto optimal Efficiency Technical, Cost, Economic; Static vs. Dynamic Private vs. public goods Information asymmetry Deadweight loss Rent-seeking Nash equilibrium 5 6 Summary by Quadrant NE underconsumption; need variable pricing SE free riding no market supply SW overconsumption Externality an valued impact (positive or negative) resulting from any action (whether related to production or consumption) that affects someone who did not fully consent to it through participation in voluntary exchange. Good having impact is a byproduct of consumption or production. Can be positive or negative. Involve attenuated property rights Could involve missing missing market 7 8

3 Externalities Negative Externality: Efficiency Loss 9 10 Positive Externality: Efficiency Loss Market Responses to Externalities Will the market product an efficient output level in the presence of externalities? Coase Theorem when property rights are defined and costless to enforce, costless bargaining can lead to efficient outcome. Okay for a party of two: less applicable with large numbers. Works sometimes in neighborhoods,e.g., agree to convenants. Can be capitalized into land values

4 Market Failure Natural Monopoly Natural Monopoly Allocative Inefficiency (DWL) Average cost declines over relevant range of demand Contestable Markets Contestable markets : low barriers to entry and decreasing average costs imply threat of entry. How would threat of entry affect a natural monopoly? Is this applicable to branded drugs? Monopolies and X-Inefficiency Natural monopolies may not have strong incentive to be cost-efficient, especially if regulated. Would you expect an unregulated natural monopoly to exhibit X- inefficiency? Any implications for drug companies with blockbusters? 15 16

5 Information Asymmetry Uninformed Demand Not an issue of information as a public good. Differences in information about quality of a good among buyer, seller, and agent Diagnosing Information Asymmetry Useful to distinguish goods: search vs. experience vs. post-experience goods. What affects market failure? Search goods consumer pays a search cost. Experience goods what can the market do to overcome the issues? Post-experience goods what are the issues? Risk vs. uncertainty Other Limitations as Rationale for Public Policy Chapter 6 Examine two fundamental assumptions: 1. Participants in markets behave competitively 2. Individual preferences are fixed, exogenous, and fully rational 19 20

6 Thin markets: Few Sellers or Buyers When are participants not price takers? Imperfect competition Pure monopsony Oligopoly 4 firms with 40% recognition of dependence Basis for anti-trust law Preferences Where do preferences come from? Are they endogenous? Stable? Effect of advertising? Addiction? Utility interdependence other regarding Process regarding perceived fairness of process can matter. Are all preference legitimate? Uncertainty Can extend model to handle multiple periods and uncertainty. Do efficient and complete insurance markets exist in the real world? Insurers need to know probabilities Uncertainty and lack of independence can result in risk premium Incomplete insurance markets Adverse selection Moral hazard Underinsurance 23 24

7 Subjective Perception of Risk People make systematic errors in assessing probabilities. Heuristics used. Expected utility hypothesis questioned Rationality of Decision Making Prospect Theory Endowment effect Behavioral economics Intertemporal Allocation Social marginal rate of time preference indifferent between exchanging current for future consumption. Equilibrium with market rate of interest Capital markets in theory, efficiency required. Irreversible consumption of natural resources Option demand Market rate of interest vs. social rate of time preference Other Issues Adjustment costs costlessly moving from one equilibrium to another? Economy not static; sticky prices. Macroeconomic dynamics business cycle not fully understood, but accept monetary and fiscal policy

8 Summary of Market Failures For Next Time Arrow Uncertainty and the Welfare Economics of Medical Care How the medical care industry differ from the norm of the competitive model. First Optimality Theorem: If a competitive equilibrium exists at all, and if all commodities are infact priced in the market, then the equilibrium is necessarily optimal in the following precise sense (due to V. Pareto): There is no other allocation of resources to services which will make all participants better off

9 Second Optimality Theorem Pareto Efficiency If there are no increasing returns in production, and if certain other minor conditions are satisfied, then every optimal state is a competitive equilibrium corresponding to some initial distribution of purchasing power. Operationally, the significance of this proposition is that if the two optimality theorems are satisfied, and if the allocation mechanism in the real world satisfies the conditions for a competitive model, then social policy can confine itself to steps taken to alter the distribution of purchasing power. 33 Source: Katz and Rosen, Microeconomics 34 Pareto Improvement Source: Katz and Rosen, Microeconomics 35