health systems administration

University of Detroit MercyHSA 461

HEALTH ECONOMICSLecture 2b

Fall 2007 Maia A. Platt

Textbook: J.W. Henderson, Health Economics and Policy, 3e, South-Western, a division of Thomson Learning

Chapter 2

Using Economics to Study Health Issues

Supply and Demand Analysis

1. How to Read Graphs2. Demand and Supply:

The Law of Demand The Law of Supply Equilibrium

3. The Competitive Model

Chapter Overview

Goal of this section

The chapter continues to expand on the relevance on Economics in health care.

It introduces the fundamental economic model of supply and demand, and examines its use in the study of health care issues.

Supply and Demand: Overview

Demand and Supply are considered by many to be the two most useful concepts in Economics.

This chapter will first outline the general principles of S&D analysis, and then apply them to the healthcare sector

Demand

A consumer’s / household’s decision about the quantity of a particular good/service to demand depends on:

1. The price of the product in question.2. The income available to the household.3. The number and type of consumers desiring

the commodity4. The prices of other products (substitutes and

complements) available to the household.5. The household’s tastes and preferences.6. The household’s expectations about future

income/ wealth, and prices.

Demand in Product/Output Markets

Quantity demanded (Qd) is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price (P).

Changes in Quantity Demanded Versus Changes in Demand

The most important relationship in individual markets is that between market price and quantity demanded.

Changes in Quantity Demanded Versus Changes in Demand

We use the ceteris paribus or “all else equal” device, to examine the relationship between the quantity demanded of a good per period of time and the price of that good, while holding income, wealth, other prices, tastes, and expectations constant.

Changes in Quantity Demanded Versus Changes in DemandChanges in price affect the

quantity demanded (Qd) per period

Changes in income, wealth, other prices, tastes, or expectations affect demand (D).

Price and Quantity Demanded:The Law of Demand

A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices.

Demand curves are usually derived from demand schedules.

PRICE (PER CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS


The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS


The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.

• This means that demand curves slope downward.

Shift of Demand VersusMovement Along a Demand Curve

• A change in demand is not the same as a change in quantity demanded.

• A higher price causes lower quantity demanded and a move along the demand curve DA.

• Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from DA to DB.

A Change in Demand Versusa Change in Quantity DemandedTo summarize:

Change in price of a good or service leads to

Change in quantity demanded(Movement along the curve).

Change in income, preferences, orprices of other goods or services

leads to

Change in demand(Shift of curve).

Other Determinantsof Household Demand

• Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time.

The Impact of a Change in Income• Lower income decreases

the demand for most goods and services in the economy, including medical care

• Higher income increases the demand for most goods and services in the economy, including medical care


Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up.

Substitutes

Consider Aleve and Advil: common OTC pain killers. They can be consumed interchangeably, or instead of each other they are substitutes

Demand for Advil therefore depends not only on price of Advil, but on price of Aleve too

if PAdvil QdAdvil DAleve

instead

if PAdvil QdAdvil DAleve

instead


Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

For instance, if you undergo a hip-replacement surgery requiring hospital stay – you consume not only medical services, but also “room-and-board” services in that hospital too. Your bill will be sure to include a bundle of charges for various services, that must be consumed together.

Complements

Such goods or services that are consumed together are complementsif PRoom&board Qd

Room&board Dhip surgeries together

if PRoom&board QdRoom&board Dhip surgeries

together

The Impact of a Changein the Price of Related Goods

• Price of hamburger rises

• Demand for complement good (ketchup) shifts left

• Demand for substitute good (chicken) shifts right

• Quantity of hamburger demanded per month falls

Supply in Product/Output Markets

Supply decisions depend on profit potential.

Profit is the difference between revenues and costs.

• A supply schedule is a table showing how much of a product firms will supply at different prices.

• Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.

PRICE (PER

BUSHEL)

QUANTITY SUPPLIED

(THOUSANDS OF BUSHELS

PER YEAR)$ 2 0

1.75 102.25 203.00 304.00 455.00 45

CLARENCE BROWN'S SUPPLY SCHEDULE

FOR SOYBEANS

Supply in Product/Output Markets

Price and Quantity Supplied:The Law of Supply

• A A supply curvesupply curve is a graph illustrating how is a graph illustrating how much of a product a firm will supply per much of a product a firm will supply per period of time at different prices.period of time at different prices.

0

1

2

3

4

5

6

0 10 20 30 40 50Thousands of bushels of soybeans

produced per year

Pric

e of

soy

bean

s pe

r bus

hel (

$)

PRICE (PER

BUSHEL)

QUANTITY SUPPLIED

(THOUSANDS OF BUSHELS

PER YEAR)$ 2 0

1.75 102.25 203.00 304.00 455.00 45

CLARENCE BROWN'S SUPPLY SCHEDULE

FOR SOYBEANS

Price and Quantity Supplied:The Law of Supply

The law of supply states that there is a positive relationship between price and quantity of a good supplied.

This means that supply curves typically have a positive slope.

0

1

2

3

4

5

6

0 10 20 30 40 50Thousands of bushels of soybeans

produced per year

Pric

e of

soy

bean

s pe

r bus

hel (

$)

Other Determinants of Supply

• The cost of producing the good, which in turn depends on:• The price of required resources / inputs (labor,

capital, and land),• The technologies that can be used to produce the

product,• The prices of related products.• Producers’ expectations about future [prices

and availability]• Number of producers in the market

• A higher price causes A higher price causes higher quantity higher quantity suppliedsupplied, and a , and a move alongmove along the the demand curve.demand curve.

• A change in determinants A change in determinants of supply other than price of supply other than price causes an causes an increase in increase in supplysupply, or a , or a shiftshift of the of the entire supply curve, from entire supply curve, from SSAA to to SSBB..

Shift of Supply VersusMovement Along a Supply Curve

• In this example, since the factor affecting supply is not the price of soybeans but a technological change in soybean production, there is a shift of the supply curve rather than a movement along the supply curve.

• The technological advance means that more output can be supplied at any given price level.

Shift of Supply Curve for SoybeansFollowing Development of a New Seed Strain

To summarize:

Change in price of a good or service leads to

Change in quantity supplied(Movement along the curve).

Change in costs, input prices, technology, or prices of related goods and services

leads to

Change in supply(Shift of curve).

Shift of Supply VersusMovement Along a Supply Curve

Market Equilibrium

Market equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.

At equilibrium, there is no tendency for the market price to change.

Market Equilibrium

Only in equilibrium is quantity supplied equal to quantity demanded.

• At any price level At any price level other than other than PP00, such as , such as PP11, quantity supplied , quantity supplied does not equal does not equal quantity demanded.quantity demanded.

Excess Demand

Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price.

• When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.

Excess Supply

Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price.

• When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

Changes in Equilibrium

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity.

Changes in Equilibrium

Lower demand leads to lower price and lower quantity exchanged.

Lower supply leads to higher price and lower quantity exchanged.

Review Terms and Concepts

complements, complementary goods

demand curve

demand schedule

equilibrium

excess demand or shortage

excess supply or surplus

firm

households

product or output markets

profit

quantity demanded

quantity supplied

shift of a demand curve

substitutes

supply curve

supply schedulesupply schedule

incomeincome

inputs or resourcesinputs or resources

law of demandlaw of demand

law of supplylaw of supply

market demandmarket demand

market supplymarket supply

movement along a movement along a demand curvedemand curve

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