Review of the Last Lecture

• began our discussion of information asymmetry in the healthcare market • Two aspects to the information asymmetry i) HC providers more knowledgeable about HC ii) HC providers more knowledgeable about HC => HS • Since the patient’s demand for HC is a derived demand (from demand for HS) HC provider can control the position of the demand curve => makes the demand curve endogenous • information asymmetry leads to market failure unless the healthcare provider is a perfect agent • continue with this discussion today 317_L21, Mar 4, 2008, J. Schaafsma 1

Policy Response to Information Asymmetry in the HC Market

•Information asymmetry introduces a conflict of interest for the HC provider  self interest (income)  patient’s interest

Policy response to info asymmetry

associations   certification by professional assures quality and provides assurance higher price reflects higher quality.

• Also avoid exploitation (professional ethics/discipline) /// •by definition  supplier-informed demand is the goal of the agency role 317_L21, Mar 4, 2008, J. Schaafsma 2

Consequence of Certification HC Providers

• Certification (credentialing) of HC providers confers control over entry into the profession and over the behavior of the profession’s members. • Certification creates scope for exercising monopoly power by the professional organization that controls certification (restrict entry and limit competition among members) • Thus, certification to address market failure from information asymmetry may introduce another source of market failure => monopoly power 317_L21, Mar 4, 2008, J. Schaafsma 3

HC Provider as Perfect Agent

• Information Asymmetry not a problem if provider is a perfect agent • Perfect agent  chooses for the patient what the patient would have chosen for him or herself if the patient had had the same medical knowledge as the provider  demand curve is where it should be •however, unlikely HC provider is a perfect agent • in real world  agency relationship is incomplete • Demand curve can be shifted by HC provider advice; i.e. demand is endogenous  normative and positive implications  to be discussed later when we look at the theory of the practitioner firm /// 317_L21, Mar 4, 2008, J. Schaafsma 4

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Evidence in Support of SID

price controls on physicians have often led to increased utilization per patient (boost income by increasing utilization if P fixed) • • substantial variation in HC utilization across regions with similar populations but different DOC/POP ratios is often attributed to SID empirical evidence that clinical decisions for a patient influenced by financial incentives for the doctor, e.g., 1. Salaried GPs provide less care per patient than fee-for-service GPs 2. HMOs have lower hospitalization rates than fee-for-service patients 3. Monitoring, e.g. in Sask, in 1974 hysterectomy rate  by 1/3 when Drs, but not patients, informed that the procedure would be monitored. /// 317_L21, Mar 4, 2008, J. Schaafsma 5

Counter Argument to SID

• if Drs. can induce demand, how come they don’t own the world?

• i.e.  if physician behaviour isn’t constrained by autonomous consumer demand what does limit the P they can charge for a given Q, or the volume of services demanded at a given P (Diagram)? => will look at some possible answers when we look at theories of the practitioner firm /// 317_L21, Mar 4, 2008, J. Schaafsma 6

Alternative Explanations for the Link between Supply and Demand

• Doc/Pop ratio  (i.e.increased supply)  time to see Dr.  own time price   less travel time and waiting demand shifts to the right, i.e., demand more HC at each price for HC since overall cost  .

• as Doc/Pop   quality of care   Dr. takes more time with each patient  WTP   shifts demand to the right perceived • End of our discussion of info asymmetry and market failure in the HC sector./// 317_L21, Mar 4, 2008, J. Schaafsma 7

Evaluating Healthcare Programs: Section VI of the Course outline

• Will look at three methods of analyzing healthcare programs - cost-benefit analysis - cost-effectiveness analysis - cost-utility analysis • discuss - how to conduct each type of analysis - issues that need to be addressed in conducting the analysis - strengths and weaknesses of each method of analysis /// 317_L21, Mar 4, 2008, J. Schaafsma 8

Cost-Benefit Analysis: CBA

• CBA is a method for assessing the economic viability of a project.

• A project generates a flow of: annual costs: C 1 , C 2 , C 3 , …,C T annual benefits: B 1 , B 2 , B 3 , …,B T • the C’s and B’s must be expressed in dollars • in CBA these flows are expressed as present values of the costs and of the benefits => need a discount rate r • r is the rate at which we discount a dollar to be received(spent) one year from now, e.g., if r = 0.05 a dollar one year from now is worth 1/(1.05) = $0.952 today, a dollar two years from now is worth 1/(1.05) 2 = $0.907, etc. • in general, the present value of a dollar of costs(benefits) incurred(received) n years from now is 1/(1+ r) n 317_L21, Mar 4, 2008, J. Schaafsma 9

The Present Value of the Benefits and of the Costs, and the NPV

-compute the present value of the benefits (in $s): PVB = B 1 /(1+r) + B 2 /(1+r) 2 +…+ B T /(1+r) T =  t B t /(1+r) t t = 1, …, T - compute the present value of the costs (in $s): PVC = C 1 /(1+r) + C 2 /(1+r) 2 +…+ C T /(1+r) T =  t C t /(1+r) t t = 1, …, T compute the net present value  NPV = PVB – PVC /// 317_L21, Mar 4, 2008, J. Schaafsma 10

The Net Present Value Criterion

-if NPV > 0 project is economically feasible - if NPV = 0 indifferent - if NPV < 0 project is not economically feasible - if funds are limitless  implement all projects that are economically feasible - if funds are limited  implement the set of projects that maximizes NPV for the available funds. /// 317_L21, Mar 4, 2008, J. Schaafsma 11