Health Economics (6200431)

LECTURE 8
Dr. Butheina Surkhi
Email : balsurkhi@staff.alquds.edu
Faculty Of General Medicine
Al-Quds University
2024
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Health Economics

Demand and supply

Markets

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Learning objectives
✓explain how price is determined by the
forces of supply and demand
✓list and describe the assumptions of a
perfectly competitive market
✓ give examples of markets which are
highly competitive and those less so
✓explain why perfectly competitive
markets are efficient.
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Why is it important to learn about markets?
Understanding the different types of health care markets and the way
suppliers and consumers interact is important for a number of reasons:
1. Many health services wish to weigh up the pros and cons of introducing a
degree of competition into the health care market.
2. Others may be considering the introduction (or extension) of user fees
or of a health insurance scheme.
3. Some providers seek to analyse the effect of government regulation on
the private market.
These different policy initiatives all constitute changes to the health care
market. Analysing their impact is often done using the tools of supply and
demand.
4. It is also important to learn about markets in order to be aware of their
limitations, especially in the context of health care.
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The basic ingredients of a market
There are many types of markets:
➢ A perfectly competitive market (sometimes termed a ‘free market’)
is a market in which there is no intervention or regulation by the
government, except to enforce private contracts and the ownership of
property.
➢ A controlled market (the opposite perfectly competitive market) , in
which the government directly regulates how goods, services and
labour may be used, priced or distributed.

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The basic ingredients of a market
In this chapter we are going to look at how perfectly competitive
markets might work. The reason for this is twofold.
❑First, the interaction of supply and demand in a perfectly competitive
market forms the theoretical building blocks of market analysis.
❑Second, many health systems around the world are currently
implementing or reviewing ‘market-oriented’ reforms within the
health sector. These reforms are based on the idea that markets work
well (or are efficient), which is in turn based on this perfectly
competitive model.
Analysing the impact on markets (including health care) of different
policy initiatives is often done using the tools of supply and demand.
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Market Structure

• How different industries are classified and differentiated based on

their degree and nature of competition for services and goods.
• What is Market Structure?
Market structure, in economics, refers to how different industries are
classified and differentiated based on their degree and nature of
competition for goods and services. It is based on the characteristics
that influence the behavior and outcomes of companies working in a
specific market.

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 each structure: study 1. number of sellers 2. barriers to entry
and exit 3. product differentiation 4. nature of competition 5.
1. Perfect Competition PRICING POWER

• Perfect competition occurs when there is a large number of small

companies competing against each other.
• They sell similar products (homogeneous), lack price influence over
the commodities, and are free to enter or exit the market.
• Consumers in this type of market have full knowledge of the goods
being sold.
• They are aware of the prices charged on them and the product
branding.
• In the real world, the pure form of this type of market structure
rarely exists.

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2. Monopolistic Competition

• Monopolistic competition refers to an imperfectly competitive market

with the traits of both the monopoly and competitive market.
• Sellers compete among themselves and can differentiate their goods
in terms of quality and branding to look different.
• In this type of competition, sellers consider the price charged by their
competitors and ignore the impact of their own prices on their
competition.
• Monopolistic competition is present in restaurants like Burger King
and McDonald's. Both are fast food chains that target a similar market
and offer similar products and services.
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3. Oligopoly
• An oligopoly market consists of a small number of large companies
that sell differentiated or identical products.
• Since there are few players in the market, their competitive strategies
are dependent on each other.
• For example, if one of the actors decides to reduce the price of its
products, the action will trigger other actors to lower their prices, too.
• On the other hand, a price increase may influence others not to take
any action in the anticipation consumers will opt for their products.
• There are many examples of oligopolies in the real world. Examples
include airlines, automobile manufacturers, steel producers, and
petrochemical and pharmaceutical companies.

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4. Monopoly

• In a monopoly market, a single company represents the whole industry.

• It has no competitor, and it is the sole seller of products in the entire
market.
• This type of market is characterized by factors such as the sole claim to
ownership of resources, patent and copyright, licenses issued by the
government, or high initial setup costs.
• All the above characteristics associated with monopoly restrict other
companies from entering the market.
• The company, therefore, remains a single seller because it has the power to
control the market and set prices for its goods.

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https://www.youtube.com/watch?v=frHyR9FiKt4

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Market equilibrium
• We use the term equilibrium to describe a system that is balanced, stable
and in a state of harmony.
• When that system is a market, equilibrium occurs when all participants are
satisfied. They have no reason to change their behaviour and therefore
there is a tendency for production or prices in that market to remain
unchanged.
• At any other price, either consumers or producers are dissatisfied and will
seek to change their behaviour (demand or supply more or less), which will
alter the price until equilibrium is found and no more change occurs.
• For example, if there is excess demand, consumers bid up the price, while if
there is excess supply producers cut the price.
• These two processes continue until equilibrium is restored.
• So the free interaction of consumers and producers in the market
automatically leads to a situation where the quantity supplied matches the
quantity demanded (i.e. allocative efficiency).
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Market Equilibrium
• the supply curve reflects the seller’s
marginal costs (the cost of producing
one extra unit) (MC) and that the
demand curve reflects the marginal
utility (extra benefit) (MB) that
consumers receive from consuming
each unit.
• Figure 7.1 shows that there is only
one price at which the quantity of
check-ups people wish to purchase is
the same as the quantity dentists
wish to sell.
• This is called the equilibrium price
(P1 ).
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Suppose the market for dental check-ups is currently in equilibrium.
What would happen if the city’s dental clinics were to relocate outside
the city?
➢On the supply side it is conceivable that building and land costs are lower
beyond the city limits. These reduced costs may result in an increase in the
quantity of check-ups supplied at all prices.
➢ Demand will also be influenced. For example, if the clinic becomes more
distant and people have to travel further then they may incur higher
transport and time costs. The increasing costs may result in a decrease in
the quantity of check-ups demanded at all prices. The demand curve shifts
to the left.
• The effect of an increase in supply will be a fall in the equilibrium price, as
will the effect of a fall in demand.
• Therefore the overall result of relocation will be a fall in price.
• Two different results are conceivable.

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An increase in the quantity traded A decrease in quantity traded

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Market Equilibrium
• At any other price either
consumers or producers
would be dissatisfied and
seek to change the price.
• For example, if there is
excess demand consumers
bid up the price while if there
is excess supply producers cut
the price. As we said earlier,
these two processes continue
until equilibrium is restored.

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Allocative efficiency
• A situation in which the factors of production have been allocated so
as to reflect what people demand (i.e. demand matches supply).
• Social welfare is maximized as MB = MC in all markets and there can
be no substitution between markets to increase welfare beyond its
current level.
❖MC : marginal cost; cost of producing extra unit
❖MB: marginal benefit

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Perfectly competitive markets and efficiency
➢Allocative efficiency describes a situation where resources are allocated
and commodities distributed in a way that maximizes social welfare.
➢ Social welfare is total social benefit minus total social cost.
➢For a particular market, social welfare is represented by the area below the
marginal social benefit curve and above the marginal social cost curve.
➢Social welfare is maximized at the point where marginal social benefit (MSB)
equals marginal social cost (MSC), the point P*Q* shown in Figure 7.4.
➢If MSB is greater than MSC then you can increase social welfare by
increasing quantity because the extra benefit is greater than the extra cost
and vice versa: if MSB is less than MSC then you can increase social welfare
by decreasing quantity because the benefit lost is less than the cost saved.

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Perfectly competitive markets and efficiency-cont.
➢A free market will be allocatively efficient if demand is equal to MSB and
supply is equal to MSC.
➢On the supply side, the efficiency conditions that allow supply to be equal
to MSC : producers need to be both technically and economically
(productively) efficient.
➢Without these conditions in place there will always be a way of improving
the allocation of resources without making anyone worse off.

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Conditions for perfectly competitive markets
✓A free or perfectly competitive market can only operate efficiently if a
number of important conditions are met, including these four:
✓producers selling the same product (homogeneity);
✓many sellers and buyers;
✓no restrictions on potential sellers entering the market;
✓buyers and sellers well informed about prices.

The health care system in the country where you live and work may exhibit
these characteristics to varying degrees.
For example, it is very common that for some services there is only one
provider.
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Is Healthcare market perfectly competitive?
1- Homogenous products:
➢Assuming a good is homogenous means that a buyer would be indifferent to purchasing
from one supplier or the next and would seek out another supplier only if they could
get a lower price.
➢You may argue that dental check-ups are not very similar even within a relatively small
geographic area.
➢Some dentists may clean your teeth as part of a check-up while others do not. So
treating dental check-ups as the same is a simplification when looking at demand.
➢Most health care services are by nature heterogeneous.
➢ Individual patients typically receive a unique bundle of services that make up their
treatment.
➢In contrast, many health care products, like syringes or over the counter medicines, are
more homogenous.
➢Looking beyond health care, many agricultural goods, such as specific varieties of coffee
beans, apples or tomatoes are examples of homogenous goods. 25
Is Healthcare market perfectly competitive?
2. Many sellers many buyer:
If an individual stand owner decided to raise prices above that of their
competitors, buyers would not patronize their stand but could easily go to
the next noodle stand.
We know that in health care there are some services that are much more
specialized than others and therefore the number of ‘sellers’ is relatively
few.
We also know that in some rural areas travel to other providers may be
prohibitively expensive and in this case the local hospital in effect acts as a
monopoly supplier to the local population.

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Is Healthcare market perfectly competitive?
3. No restrictions on potential sellers entering the market;
In the case of health care, including dentistry, there are clear restrictions on entering the
market, length and cost of training and practice licensing and registration being the most
obvious.

4. Buyers and sellers well informed about prices.

In health care, most medical information is technically complex and so not easily
understood by a layperson.
This is compounded by the fact that many illnesses do not repeat themselves, so that the
cost of gaining information about them is very high.
You could argue that the only way a patient could become fully informed would be by
training to be a doctor!

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Healthcare services are not perfectly competitive
• There are several ways that health services are not perfectly competitive.
1. For some areas of health care there may be many suppliers but for others not.
Generally, primary care is provided by a large number of individual doctors and
small group practices whereas specialist services often have few providers.
2. There are barriers to entry into the health care system. Doctors, nurses and other
health professionals need qualifications and a licence before they can provide
health care, and hospitals entail large start-up investments.
3. Different providers are not selling an identical product. The quality (or at least the
reputation for quality) of care and service is known to vary between providers.
4. For a lot of health care, consumers are not fully informed about what services
they need and cannot be sure about differences in quality between providers.
• The health system in your country might feature these characteristics to a different
extent but it will probably include most or all of them.
• For some services there might be only one provider.
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Cosmetic dentistry – Example
• Clearly there is a demand for cosmetic dentistry – people are willing
and able to pay for it.
• the cosmetic treatment is viewed as something which gave people
‘utility’, i.e. satisfaction, and they consciously compared the
satisfaction gained with that from other purchases and the market is
growing.
• Why is this happening?

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Economic analysis
• The initial supply and demand curves are shown in Figure 7.5 – the
system is in equilibrium.

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Cosmetic dentistry
• The fist change is that technology has
reduced the costs of such treatment –
shifting the supply curve outwards.
• Demand also seems to be growing;
why is this?
• According to a recent national survey,
one in four people dislikes their
appearance suggesting that they
would consider buying this kind of
treatment if they could afford it.
• So consumers are likely to respond to
the lower prices brought about by the
shift in supply – a movement down
the market demand curve.
• This sets up a new equilibrium at P2
and Q2 in Figure 7.6
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Cosmetic dentistry
• The next change is an increase in
consumers’ real income (due to the
reduced cost of treatment) leading to an
outward shift in the demand curve from
D1 to D2 (see Figure 7.7).
• So there is a near equilibrium at P3 and
Q3.
• Suppliers have reacted to the growth of
consumer demand in exactly the way our
theory predicts.
• Dentics has expanded its operations by
opening more shops and providing more
treatments.
• Reduced costs and extra consumer
demand have both led to the allocation of
more resources to cosmetic dental
treatment.
• (Remember that the final outcome will
depend on how sensitive demand and
supply is to factors such as a change in
price.)
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Summary
• The economic framework of demand and supply is a useful way to
think about factors that affect the use and provision of health
services.
• We learned about demand, the supply function and the effect
various factors have on the supply curve.
• This chapter how prices are determined and market equilibrium may
be achieved.
• Examples were used to illustrate that markets do exist in the health
sector but most are far from perfectly competitive.

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Videos
https://www.youtube.com/watch?v=muFSypea2vo&t=35s

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