Health Economics

By; Tilahun Hailu

BSc,
MPH in Health Economics
Phone No-+251900404066/+251928381527
Email: [email protected]/[email protected]
Course Description
 This course deals with:
 the relevance and contribution of economics to health and
population policy;
 the theories in economic that applies to public health, the
formulation and application of economic models to public
health; and
 The techniques of conducting economic analysis in public
health programs.
 This course focuses on managing resources for achieving
goals and maximizing benefits and accountability for money
spent in public health.
Learning objectives
o At the end of the course, the student must be able to:
 Understand concepts of economics and its significance.
Apply economic techniques to the planning and managing of
health programmes and health services

Unit-one
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Introduction to economics and health economics
Introduction
 This unit addresses the questions of whose responsibility health
should be and how the expense of providing health care should
be met.
 In most economies, we find a mixture of market provision and
government-organized provision of goods and services.
 So where should health care fit in? Is it too important to leave to
profit-seeking private firms selling their services to consumers?
 You will certainly be aware that providing health care is very
expensive, so relying entirely on market provision would put it
beyond some people’s means.
What is Economics?
The discipline of economics is
built upon two immutable facts:
1. Limited resources
2. Unlimited “wants”

Scarcity

Choice
• Economics is a social science
involving the study of choices
and what necessitates those
choices.
• Economics studies how individuals and organizations in society
engage in the production, distribution and consumption of
goods and services
• Economics is also concerned with the efficient use of limited
resources to achieve maximum satisfaction of economic wants
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 • Due to the concept of scarcity, every economy must address
three main questions:
 What to make?
 How to make it? And
 For whom should it be made?

Three Basic Questions of Economics

1. What to produce? (optional)
2. How to produce?

3. For whom to produces?

Health economics
o Health economics is broadly defined as the application of the
theories, concepts and techniques of economics to the health
sector.
o It is thus concerned with such matters as:
 the allocation of resources between various health-promoting
activities;
 the quantity of resources used in health delivery; the
organization and funding of health institutions;
 the efficiency with which resources are allocated and used for
health purposes
 The effects of preventive, curative and rehabilitative health
services on individuals and society.
Classification of economics
1. Macro economics
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 2. Micro economics
Other classification
I) Positive
II) Normative
Macroeconomics: concerned with the behavior of the economy as a
whole or with the broad aggregate of economic life.
• That is aggregate level of economic activity including
unemployment, inflation, government, expenditures, and
banking
• The study of the behavior of the entire economy
 national income
 the trade balance
 the overall rate of inflation
 level of unemployment
Micro economics: analyses the choices made by individual
economic agents (house hold and firms) and the outcomes of
those choices as seen in the functioning of markets for specific
goods and services.
• E .g. How purchasing decisions of consumers are
influenced by changing prices & income

Micro economic agents

 Firms
 Produce and sell goods and services
 Buy inputs (labor, capital and raw materials)
 Consumers
 Buy goods and services
 Sell inputs (labor services, loanable funds)
Positive economics
 Describes, explains and predicts economic facts and
behaviour.

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  Deals with objective scientific explanation of economic
happenings such as:
 What will be the effect of higher taxes on tobacco consumption?
How does a higher price for bread affect the demand for bread?
 What is the percentage of unemployment?
 How many people earn less than 40 birr/day?
Normative economics
 Deals with what decisions ‘should be’ or ‘ought to be’ made. It is
prescriptive by nature, and involves ethics, and value judgments.
 Examples of normative questions are:
 Should the government give money to poor people?
 Should the government give free health service to all (both rich and
poor)?
In recent times, most economists have come to feel that economics can
never be wholly value-free, however, so the positive/normative
distinction is by no means clear or universally accepted
Definition and basic concepts of economics
Scarcity- is the lack of enough resources to satisfy all desired uses
of those resources
 That is, we cannot have everything we want because relative to
our wants, Economic Resources are limited in supply
(availability).
 Thus it is the foundation of economics
Resources-Are factors of production that are used to produce goods
and services with which we satisfy our needs.
 Inputs that are needed to produce outputs
Four Basic Factors of Production:-
Land : refers to all natural resources such as crude oil, water, air,
and minerals.
Labor : refers to the skills and abilities to produce goods and
services.
Capital: refers to goods produced for use in the production of other
goods, e.g., equipment, structures.
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Entrepreneurship: is the assembling of resources to produce new or
improved products and technologies. (know how, managerial
capacity)
The economy is an abstraction that refers to the sum of all our
individual production and consumption activities.
 The economy is us - the aggregation of all of our supply and
demand decisions.
Utility: is the economic term for satisfaction obtained by
purchasing a particular good or service.
Marginal: is the economic term for “extra”
Marginal utility: extra satisfaction from consuming a bit more of
goods and services.
Total utility: a total satisfaction gained from consuming the whole
amount of goods and services
Law of diminishing marginal utility: — This is an economic law
that states that the utility of any good declines the more one
consumes of it. In other words, the more we have of a good the
less we desire it.

Opportunity cost is the value of the next best alternative that is

being given up. It is the best un-chosen alternative .
Efficiency is a level of performance that describes a process that uses the
lowest amount of inputs to create the greatest amount of inputs
 Efficiency also can be stated as the act of being
adequate in performance with a minimum of waste, effort, time
Production possibility frontier (PPF) is a graphical demonstration that
illustrates the basic economic concepts of scarcity, choice and
opportunity cost.
 The model assumes a simplified economy producing only two goods
(Krugman and Wells, 2009, p. 25).
 The concepts of scarcity and choice can be illustrated using a model
known as a production possibility frontier (PPF).
 It examine the trade-offs that any economy faces in choosing how to
use its resources.

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 Assumption:
 the quantity and quality of economic resources available for use
are constant
 technology does not change
 there is full employment of resources
Production is efficient in the sense that no more of one good could be
produced without producing less of the other

• Table 1 Production possibilities of food and clothing

combination Quantity of food(tons) Quantity of clothing(meters) in thousand
A 18 0
B 17 1
C 15 2
D 12 3
E 7 4
F 0 5

Class activity
1. Draw a production possibility frontier (PPF)
2. What is the opportunity cost of increasing the production of quantity
of cloth from 0 to 1? And what is the opportunity cost of increasing
the production of quantity of food from 3 to 4?

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 Comment
1. PPF curve


A

movement from one point to another on the PPF requires a

reallocation of resources (inputs) from the production of food to
the production of clothing or vice versal
2. To produce one thousand meters of cloth, we must give up
producing one tons of food (production rate falls from 18 to 17).
This loss of production is the opportunity cost. To increase the
number of production of cloth from 3 to 4 thousand of meters –
we must incur an opportunity cost of losing five tons of food
production (prevention rate falls from 12 to 7).
 PPC also shows whether outcomes (of allocation decision) are
Efficient or Inefficient.
 Efficiency means getting the maximum output of a good from

the resources used in production.

 Every point on a production possibilities curves is efficient.
Inefficiency
 Recall that a production possibilities curves shows potential output, not
necessarily actual output.
 Thus if we are inefficient, actual output will be less than the potential
output.

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  Any point inside the PPC represent inefficient outcomes, for
example point H in side PPF curve
 Countries may end up inside their production possibilities curve if all
available resources are not used.
 ……Unemployment
Economic growth is an increase in output (real GDP) - an expansion of
production possibilities.
 PPC also shows Economic Growth or Decline
 A point outside the production possibilities curve suggests that
we could get more goods than we are capable of producing!
 With more resources or better technology, production
possibilities curve may shift outward.
 Such a shift represents Economic Growth
Economic Growth
PP2

PP1

0 Quantity of clothing Application of

the production possibility frontier to the health
sector
 The PPF above models production in the whole of a simplified
economy producing just two goods. We can use a similar model to
represent choices for production within a single sector of the economy,
such as the health sector.
Example: Suppose that the health sector is supplied by a single provider
with a fixed amount of resources and that its services can be split into
two: disease prevention and disease control.
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 1. Draw a production possibility frontier (PPF) for this health care
provider based on the data in Table 2.
2. Label on your PPF an efficient combination, an inefficient but attainable
combination and an unattainable combination

Combination Disease prevention (No. of Disease control (No.

preventions) of patients cured)
1 30 0
2 26 6
3 20 10
4 12 13
5 0 15

3. What is the opportunity cost of increasing the number of patients

cured from 0 to 6? And what is the opportunity cost of increasing
the number of patients cured from 13 to 15?
4. From your answer to 3, what do you conclude about how the
opportunity cost of providing more disease control changes as
more resources are moved from prevention to control?

Unit -two
Models of Demand, Supply and production
Of Health care
Theory of demand
• Quantity demanded is the amount a consumer is willing and
able to buy at a certain price
• Demand = Need + ability and willingness to buy a good.
Note: Demand is different from need
 Need
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  Basic (natural; default) requirements for survival
 Regardless of willingness or ability to pay
o Demand is expressed only by spending money
 Need is someone subjective idea and money is not a factor,
but demand is objectively observable behavior in the market
 Based on that definition, which of the following do you have
a demand for?

D = f (P), ceteris paribus

This is read as: quantity demanded is a function of price, all other
influences held constant.
 The Law of Demand states that as prices rise, quantity
demanded decreases. As prices decrease, quantity
demanded increases. There is an inverse relationship
between prices and quantity demanded.
 Demand is backed by the following three factors:
• ability to pay for the good desired,
• willingness to pay the price of the good desired, and
• availability of the good itself
 Demand and quantity demanded are two different concepts

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 Whereas demand refers to the relationship between the price of
a commodity and its quantity demanded, other things being
same
 The quantity demanded refers to a specific quantity which a
consumer is willing to buy at a specific price.

The Law of Demand •

Demand Curve
Activity: draw
demand curve

Determinants of Demand
 We already know that quantity demanded is changed or
influenced by price. Demand, on the other hand, is changed by
these six factors:
 1)Consumer preferences :Personal feelings toward the value
or desirability of various products
 As preferences increase quantity demanded increase
 Successful advertising may shift the entire demand curve for a
good to the right while bad publicity, arising perhaps from

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 research suggesting a product is harmful to health, may shift the
curve to the left.
 2)Population size :We would expect the overall quantity
demanded of a good at each price to increase as the population
increases
3) Consumer’s income: we must consider the two types of
goods:
■ Normal good—any good that consumers purchase more of as
their incomes increase. Examples: luxury cars and gourmet
meals.

■ Inferior good—any good that consumers purchase less of as

their income increases. Examples: Example ; Meat vs legumes
( shiro)
4)Prices of other goods
■ Substitutes :Goods that can be used in place of other goods.
The substitution effect occurs because the price of the desired
item is too expensive, so consumers find a close alternative to
the initial item. Examples: Plane vs. bus, Bonesetter
(Wogesha) vs physiotherapy, butter vs. margarine
■ Complements: Goods used along with an identified good. If
the price of one good rises then the demand for the
complementary good will fall.
Example:Fuel and Car
5)Socio-economic factors
• For some products, there may be what James
Duesenberry (1949) called a ‘demonstration effect’
whereby consumption by an individual is influenced by
the buying habits of others.
6)Expected future prices

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 • If consumers expect the price of a good to rise, they may
increase current demand. If, conversely, they expect the
price to fall, they may delay consumption
A change in quantity demanded versus a change in demand
 A point on the demand curve shows the quantity demanded at a
given price. A movement along the demand curve shows a
change in the quantity demanded.
The entire demand curve shows demand. A shift of the demand
curve shows a change in demand.

Movement in demand curve

1. Movement along the demand curve
 If the price of a good or service changes but other influences
remains the same, there is a movement along the demand
curve(Change in quantity demanded)
2.Shift in the demand curve
 Changes in any of the determinants of demand other than
the price of the good itself lead to shifts of the demand
curve
 Change in demand
In ward shift of demand curve
 When demand decreases, the demand curve shifts to the
left and the quantity demanded is less at each price
Out ward shift of demand curve
 When demand increases, the demand curve shifts to the
right and the quantity demanded is greater at each price
Movement in demand curve…

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Movement in demand curve…….
Out ward shift of
In ward shift of
Demand curve demand curve
 Income ↓
 Price of substitute↓  Income ↑
 price of substitute↑
 Price of complement ↑
 price of complement ↓
 Population↓  population↑
 Expected price ↓  expected price ↑
 Tastes ↓  Tastes ↑

Demand for Health Care

The following factors influence the demand for health care:
• • need (as perceived by the patient);
• • patient preferences;
• • income;
• • price/user charge;
• • travel cost and waiting time;
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• Quality of care (as perceived by the patient
Group Activity..5 minutes
• From what you have read in this chapter and from your experience,
in what ways do you think that the demand for health care is
different from the demand for other goods and services?

Feedback… 
 We demand health care not because we get satisfaction out of it. We
demand it because we get satisfaction from the activities that we can do
when we are healthy
 The demand for health care is often for a single one-off intervention
rather than multiple or repeated requests

 Patients’ perceptions of their need and of their capacity to benefit, both

of which shape their demand, may be strongly influenced by their
doctor – the supplier of health care.
 Health care is extremely heterogeneous

Demand for health

 Major purpose of demand analysis in medical care is to determine those
factors that, on the average, most affect a person’s utilization of medical
services
 Demand analysis seeks to identify which factors are most influential in
determining how much care people are willing to purchase

Demand for health care…

 Michel
Grossman developed a model of demand for health care
 Demand for medical care is derived from the more basic demand for
health

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1. Health is a consumption commodity; it makes the consumer feel better. It
means that health-related activity will improve the quality of life, prevent
discomfort or illness, for example, physiotherapy.
2. Health is an investment commodity; a state of health will determine the
amount of time available to the consumer. It means, being unhealthy
brings discomfort, loss of income from reduced work hours, an increased
number of sick days and absence from schools

Demand for health care…

Demand for health care…

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 Demand for health care…
 Services in area 1 reflect unmet need. Ideally a rational
supplier would want to address/meet all the needs created
 Services in area 2 are services that the doctor/supplier thinks
that health care delivery facility or the organization can supply,
but that the clients/customers cannot afford to buy (for example,
an expensive drug)
 Services in area 3 are those a patient needs, and is also willing
and able to buy, but that the service/supplier could not make
available (for example, chemotherapy for cancer patients in one
of the remotest parts of Ethiopia).
 Services in area 4 are those for which there is a private market:
they are supplied and demanded, but are medically seen as not
necessary (for example, extra ultrasounds during pregnancy).
 Service area 5 is the optimal place, where the patient gets what
he or she needs and is able to pay for and suppliers are able and
willing to provide it.

Class activity
Figure below shows the market demand curve for dental check-ups and
the current price charged per check-up, p1

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1. Suppose there is a health promotion program advocating
regular dental check-ups
i. What is the effect of this program on demands dental
check-ups, ceteris paribus
ii. Draw the diagram
2. Suppose that the dental clinic relocates to an area outside the
city, such that it is far from the majority of the population,
ceteris paribus
i. What is its effect on demands of dental check-ups, ceteris
paribus
ii. Draw the diagram
Answers
1. The health promotion programmer, if effective, will result in an
increased preference for dental check-ups. This means that
quantity demanded increases at each price level – that is, the
demand curve shifts to the right (from D1 to D2 on Figure 2).
We assume that the price remains at p1.
2. If the clinic becomes more distant from the people it serves then
this means that travel to the clinic becomes more expensive in
terms of time and transport costs. Travel to the clinic can be
considered a complement to the check-up. The increasing cost
of travel will result in a decrease in quantity of check-ups
demanded at all prices. The demand curve shifts to the left
(from D1 to D3 in Figure 2).

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 Figure 2: Changes in the demand for dental
health check-ups

Supply
 Supply is defined as the quantity of a good or service that
producers are willing and able to offer at each of a range of
prices.
 The supply curve is A line showing the number of units of a
good or service that will be offered for sale at different prices at
a given time
o The DEPENDENT variable is the quantity supplied.
o The INDEPENDENT variable is the good’ own price
 The Law of Supply says that an increase in a good’s own price
will result in an increase in the amount supplied, holding
constant all the other determinants of supply.
 The Law of Supply says that supply curves are positively
sloped

A SUPPLY CURVE
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 A supply curve must look like this, i.e., be
positively sloped.
Supply
Own price

Quantity supplied
Teff Market
At a higher price, firms want to sell more.
Own price
Suppl
y
Phisher

p0
Teff
Quantity supplied
Q Market

Movement in supply curve

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I) Movement along a supply curve (or change in quantity
supplied)
 If the quantity supplied increases or decreases due to rise or
fall in the prices of the commodity alone, it is known as
movement along a supply curve
II) Shift in the supply curve (or change in supply)
 If more or less quantity of a commodity is supplied due to
changes in factors other than the price of the commodity
concerned, it is known as shift in the supply curve or change
in supply

The “Standard” Model Of Supply

 The DEPENDENT variable is the amount supplied.
 The INDEPENDENT variables are:
 the good’s own price
 the prices of inputs used in its production
 the technology of production
 Government(taxes and subsidies)
Other determinants of market supply
 Prices of inputs: If unit prices of inputs such as labor and
capital rise, the supply curve will shift upwards or leftwards.
 Technological progress: Increased efficiency through the
introduction of new technology will reduce production costs
and cause a downward or rightward shift of the supply curve.
 The number and size of firms in the market: Since we are
considering a market supply curve rather than that of an
individual supplier, the entry of new firms will lead to a
rightward shift of the supply curve.
 Unexpected events: Events such as poor weather may affect
production of some goods, shifting the supply curve. For
example, crops may be destroyed by adverse weather conditions

22
 Prices of other goods(substitutes and goods in joint supply)
: If the profitability of another product that a firm could
alternatively produce increases, the firm will shift resources to
the production of this other good, leading to a leftward shift of
the supply curve for the original good. Production of certain
goods entails the simultaneous production of others, those in
joint supply
Government (Taxes and subsidies): If a firm is producing a
product that yields a high social cost, then the government can
choose to limit the firm’s supply by increasing taxes. The opposite
can happen if a firm is producing a product with a high social
benefit: the government can either lower taxes or increase
subsidies to the firm, thereby increasing the firm’s supply
Market equilibrium
 In the methodologies of economics, the concept of equilibrium
occupies an important place. It is employed in almost every
theory of economics in the fields of price, income, and growth
 The word equilibrium means a state of balance
 It refers to the balance between opposite forces of demand and
supply and is termed as market equilibrium
 The point at which supply and demand curves intersect is called
market equilibrium (competitive market )
 It is when the quantity demanded equals the quantity supplied

EQUILIBRIUM PRICE
The equilibrium price of a good is:
– a price at which quantity supplied equals quantity
demanded.
– a price at which excess demand equals zero.
– No shortages or no surplus are found at the equilibrium
price.

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 – Equilibrium means a state of rest where there is no
pressure or tendency for change in price.
Market equilibrium
 Excess demand exists when, at the current price, the quantity
demanded is greater than quantity supplied
 If at a given price of a commodity, demand is in excess of
supply,
 Competition among buyers will push the price up to the point at
which demand becomes equal to supply
Excess supply
 Exists If at a given price, the quantity supplied of a commodity
exceeds the quantity demanded, competition among sellers will
push the price down to the point at which demand becomes equal
to supply
Market equilibrium …

Graphical Presentation of Market Equilibrium

24
 Example...
Table 1: Demand schedule for condoms Table 2: Supply schedule for condoms

The only price that satisfies both sides in the market is 6. At this price,
Answer
producers wish to supply 4000 and consumers wish to buy 4000. Figure 3
shows the same information graphically. This mutually acceptable price is
known as the equilibrium price.

Figure 3: Equilibrium in the market for condoms

Answer
The only price that satisfies both sides in the market is 6. At this price,
producers wish to supply 4000 and consumers wish to buy 4000. Figure 3
shows the same information graphically. This mutually acceptable price is
known as the equilibrium price

25
 Figure 3: Equilibrium in the market for condoms
Equilibrium…
Consumer surplus
 Difference between what consumers would be willing to pay and what
they actually pay
 Value to buyers minus amount paid by buyers
 Receive ‘free of charge’ and is known as the consumer surplus
 The area below the demand curve and above the price
How the Price Affects Consumer Surplus
Price Consumer Surplus at Price
P1

D
e
m
Quantity
an Equilibrium...
d
Producer surplus
o Difference between the price suppliers would be willing to sell and
what they actually sell
o Amount received by sellers minus Cost to sellers
o The area below the price and above the supply curve measures the
producer surplus in a market
How the Price Affects Producer Surplus
Price Producer Surplus at Price
26 P1
 Supply

B
P1
C

How the Price Affects Producer Surplus

A
0 Quantity
Q1
Consumer and Producer Surplus in the Market Equilibrium
Social welfare
 Consumer surplus plus producer surplus
 Efficiency - the property of a resource allocation of maximizing
the total surplus received by all members of society
 Equity – the fairness of the distribution of well-being among the
various buyers and sellers
 Always there is trade-off between efficiency and equity

D
P A Supply
ri
c
e Consumer
S
Equilibrium u E
E
P rProducer
r p
Surplus
i lP D
c u1 27
e
C
e s m
a Quantity
 B
0 Equilibrium
P
Government may intervene in the market in many ways; one of
r
Effects of Government i Intervention on Market Equilibrium
the more prominent cways is of price control
 This policy eof price-control may have two variants:
 Maximum price and
 Minimum price.
Effects of Government Intervention on Market Equilibrium…
Maximum Price Fixation (Price Ceiling)
 Sometimes the supply of a commodity is so short that it
creates shortages in the market and common consumers
are unable to get the commodity from the market
 Competitive prices are so high that they become out of
reach for common consumers, only the rich can purchase
and consume the commodity
 In such a situation government comes forward and fixes
the maximum price for the commodity. This process is
known as price ceiling

Effects of Government Intervention on Market Equilibrium…

Minimum Price Fixation (Price Floor)
 Whenever government feels that the competitive price
determined by the forces of demand and supply in a free market
is not fair from the producers’ point of view,
 Government announces a minimum price to protect the interests
of the producers
 This is also termed as support price or price floor. It is very
common with governments these days to protect the interests of
the farmers

Elasticity
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  Elasticity is a term widely used in economics to denote the
“responsiveness of one variable to changes in another.”
 Elasticity is the concept economists tells us just how much or
more the consumer will buy at each price level
 Use to describe the steepness or flatness of curves or functions.
 It is unit less, different from slope
Elasticity can be categorized
1. Elastic
 The quantity demanded or supplied responds to price changes in
a greater than proportional manner
 Elasticity value is between one and infinity
2. Perfectly elastic
 Elasticity value is infinity
3. in elastic
 A given percentage change in price will cause a smaller
percentage change in quantity demanded or supplied
 Elasticity value is between zero and one

4. Perfectly inelastic
 Quantity demanded or supplied did not change with price
change
 Elasticity value is zero
5. Unitary elasticity
 A given percentage change in price leads to an equal
percentage change in quantity demanded or supplied
 Elasticity value is equal to one
Types of Elasticity
 There are four major types of elasticity:
 Price Elasticity of Demand.
 Price Elasticity of Supply.
 Income Elasticity of Demand.
 Cross-Price Elasticity of Demand.
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Price elasticity of demand
 Measures the responsiveness of quantity demanded to
changes in a good’s own price.
 The price elasticity of demand is the percent change in
quantity demanded divided by the percent change in price
that caused the change in quantity demanded.
Important points:
 The more expensive the good, the more likely it is to be
elastic.
 The more important a good is to an individual, the more
likely the good will be inelastic.
o For example If a diabetic’s medication increases in price,
chances are the good will be inelastic because of its
importance to the diabetic.
 The more time consumers have to adapt, the more likely they
will find cheaper substitutes.
Using the Midpoint Formula
Elasticity = X 100

 % change in p = , ∆P = P2 - P1
X 100 P2 +P1
2

 % change in Q =
= ∆Q = Q2 -
Q1
Q2 +Q1/2
NOTE: ED is expected to be negative. Thus, price elasticity of
demand is often quoted in terms of absolute value (that is,
omitting the minus sign).
Price elasticity of demand is classified as follows:
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 • The demand is inelastic if 0<|ED|<1
• The demand is elastic if 1<|ED|<¥
• The demand is unit elastic if |ED|=1
• Єd is ~ ∞ demand is perfectly elastic
• Єd is ~ 0 demand is perfectly inelastic

Income elasticity of demand (YED)

 Show elasticity of demand to change in
consumers’ incomes
 Computed as the percentage change in quantity
demanded divided by the percentage change in
income
• Income elasticity of demand = Percentage change in
quantity
Demanded
Percentage change in income
I) A normal good: anything that increases in demand when
income increases.
- have positive income elasticity of demand
II) Inferior good: is products you buy less of when your income
increases
- have negative income elasticity
Examples..
Given the data in Table below answer the following questions.

31
 1. What is the price elasticity of demand for a price increase from
birr 1500 to birr 2000?
2. Over this range of prices, is demand price elastic or price
inelastic?
Table: Price of surgery and quantity of service demanded

Answers
 A price rise from 1500 to 2000 is a proportionate change of
(2000 – 1500) / ((2000 + 1500)/2) = 500 / 1750 = 0.2857.
 The corresponding fall in quantity demanded is a proportionate
change of (200 – 300) / ((200 + 300) / 2) = -100 / 250 = -0.4. So
the price elasticity of demand is: -0.4 / 0.287 = approximately -
1.4.
Since the absolute value is greater than 1, demand over this range is
price elastic.

2. If the price of eye tests fell by 20% and the quantity of eye
tests bought rose by 30% then calculate the value of PED?
Answer
PED = % change in quantity demanded
% change in price of the good
• So, if the price of eye test fell by 20% and the quantity
bought rose by 30 %, then the PED would be 30%/20%
= 1.5
• PED is elastic
32
Exercise….

Exercise….
Based on the above demand curve
1. Calculate the price elasticity of demand for an increase in price
from point G to point H? Is that price elastic or in elastic?
2. Calculate the price elasticity of demand for an increase in price
from point A to point B? Is that price elastic or in elastic?
Cross elasticity of demand (XED)
 measures the consumer purchases in one product when there is
a price change in another product
 Computed as the percentage change in quantity demanded
divided by the percentage change in price of other goods
 XED = % change in quantity demanded for product 1
 % change in price of product 2
o Substitute goods: If Pepsi increases its price and it causes

consumers to buy more Coke, this results in a positive cross

elasticity of demand, meaning that consumers have substituted
Coke for Pepsi because of a price increase.
33
 o Cross price elasticity of demand is positive
o Complementary goods: If an increase in the price of a product

leads to a decrease in demand for another product, then

 The two goods must be complements.
o Cross price elasticity of demand is negative,
Elasticity of Supply
 If the amount put on the market is highly responsive to price
changes, the supply is elastic.

Price elasticity of Percentage change in quantity supplied

supply =
Percentage change in price

 Price elasticity of supply is always positive, reflecting the

positive relationship between price and quantity supplied

Exercise
1. Calculate price elasticity of supply from the supply curve
below?

S'
Exercise…..
Pric
e S
PE’ =
$2.50
PE =
$2.00
34
 D
QE’ = 7 QE = 10 Q (millions)

Unit-3
Health and Development
(Macroeconomics)
Health and Development

Session outline
 Definition of health, economic growth and development
 Indicators of economic growth and development
 Impact of health on economic development and vise
versa
 Definition of poverty
 Sources of poverty
Definitions of health and development
 Health is “a state of complete physical, mental and social
well-being and not merely the absence of disease or infirmity”
(WHO)
 -It sees the health of an individual or community as being

concerned not only with physical (and mental) status, but also
with social and economic relationships
Perspectives of health
35
 1. Health as human right
ii. Health is a right analogous to justice or political freedom
iii. Enjoyment of the highest attainable standard of health is one
of the fundamental rights of every human being without
distinction of race, religion, political belief, economic or
social condition’ (WHO)
iv. Government is seen as having a responsibility to ensure this
v. According to such a view a government will be particularly
concerned with issues of equity in health and health care
2. Health as consumption good
 health is seen as an important individual objective
 Not comparable with justice, but rather with material aspects of
life.
 Government has no special responsibilities in the promotion of
health, but leaves decisions to individual consumers
 The role of the state under such a view might be limited to
ensuring that the health care provided is of an adequate quality
Perspectives of health
3. Health as an investment
 Health is an important in put for development because of its
consequence on the overall production through its effect on the
productive ability of the productive force
 Investment in health is an investment in economic development
 Illness may affect overall production, either through
absenteeism or by lowering productivity through its debilitating
effects
Determinants of health
1. Socio economic and cultural factors: economic status,
education, culture etc..
2. Genetic factors
3. Behavioral factors…life style, exercise, diet, etc…
4. Environmental factors….pollution, exposure to toxins,
occupational hazard
36
 5. Health system factors….availability, accessibility of health
care services, approach of health professional
What is Macroeconomics?
Macroeconomics is an overall view of the economy’s
performance and examines the behavior of the whole economy
at once.
o It is concerned with
 aggregate output
 unemployment
 inflation
 the balance of international payments
 and economic growth
Development and economic growth
Economic growth
 It is an increase in a country’s productive capacity
 Increase real GDP or GDP per capita and GNP
 Sustained rise in real national income over a period of years
 Outward shift in the production possibilities curve
Development
 Is a broader concept in which equity in growth is considered
and the welfare aspect is addressed
Economic development …….
 Economic growth + fundamental changes in the structure of the
economy, like
1. Rising share of industry, along with the failing share of
agriculture in GNP and increasing percentage of people who
live in cities rather than the countryside
2. Passing through periods of accelerating, then decelerating
population growth, during which the age structure of the
country changes dramatically
3. Changes in consumption patterns (people no longer spend all
their income on necessities, move on to consume durables and
leisure-time products)
37
 4. Meeting the needs of the present without compromising the
ability of future generations to meets their own needs
(sustainability)
5. Participation (mainly) by the citizens of the country in the
process as well as the benefit

Economic development VS economic growth

Economic development
Economic growth
 Broad concept
 Narrow, part of development  Encompasses the total well-being of the
 Concerned with the increase individual, a community or a nation
in per capita  Concerned with the total person (his
Earnings of the people
 Economic growth is possible
,
 economic,social political, physiological,
psychic and
without development
 Environmental requirements)

Economic growth
GDP (Gross domestic product)
 The total market value of all finished goods and services
produced within the territory of a given economy during a
given time period
GNP (Gross National Product)
 The total value of goods and services produced using resources
owned by residents of a nation wherever in the world those
resources are located
 GNP=GDP+NFIA
NFIA??=net income from abroad=Factor income earned from
abroad by residents – Factor income of non-residents in
domestic territory
 Sustainable increases in GDP or GNP are called economic growth.
38
Factors to be considered while calculating NI
1. Include only those goods and services which can be
measured by Money.
2. Market price of final goods and services alone will be
considered...

3. Productions done in current year alone are considered.

4. Services which are done free of cost are not considered.
5. Illegal activities/underground economy are not
included
Measurement of GDP and GNP
• There are three approaches to measuring GNP or GDP:
1. adding up the value of all the output produced;
2. adding up all the expenditure made on goods and
services; and
3. Adding up all the income earned.
Measurement of GDP and GNP…
1. Output approach: the value of all the output produced by
factors of production located in the national economy
 we count all final goods rather than intermediate
goods(avoid double-counting)
2. Expenditure approach: is aggregate of Personal
consumption (C):, Gross investment (I):, Government
(G):and Net exports (X):export minus imports).
 GDP expenditures =C + I + G + X
3. Income approach: is aggregate of Wages to employees,
Rents, Interest, Profits
Economic growth rate
• Growth rates are usually measured as percentage changes
over a year
• Growth rate(g) is calculated by:

39
 g = (Xt+1 – Xt) X 100 / Xt
• Where Xt+1 is the value of GDP in the year whose
growth rate we wish to calculate and Xt is the value of
GDP in the previous year

Activity

Calculate the GDP rate of growth for each year relative to the
previous year for the above hypothetical economy

Nominal GDP Vs. Real GDP

 Nominal GDP :values goods and services at current prices(it is
unadjusted for inflation)
 Real GDP :values goods and services at constant prices which is
adjusted (inflated or deflated) to reflect changes in the price level
 Is the monetary value of currently produced goods
and services measured at constant price ( base year price )
 However using GDP as a monetary measure has some
drawbacks:
 Nonmarket transactions: GDP cannot measure transactions that
have no real paper trail, such as housework. Home owner does

40
 for his or her own home and the labor that business owners
perform for their own businesses.
• Mental or physical health: GDP cannot measure stress-
relieving activities, such as vacations, exercise, and
laughter.
• Underground economy: GDP cannot measure illegal or
unreported activities.
• Distribution of income
 How is the income distributed?
• Quality of life
 Can changes in economic growth measure
changes in the quality of life?
Measuring economic development
o The level of human development (HD) of various countries is
often measured using the human development index (HDI)
 developed by UNDP
o The HDI is a composite index combining
 Longevity - Life expectancy
 Knowledge -Access to education, literacy rates
 Standard of living - GDP per capita:
Purchasing Power Parity (PPP)
 Income index (INI)
INI = log(CPCI) - log( LPCI)
log(MPCI - log(LPCI)
 Where CPCI = current per capita income, LPCI = the lowest per
capita income as observed over the past generations in any
country and MPCI = maximum per capita income that a country
could reasonably aspire to over the coming generation.

41
  Note: According to the UNDP, LPCI = 100 PPP and
MPCI = 40000 PPP.

Measuring economic development….

Life expectancy index (LEI)

 current life expectancy (CLE) , lowest life expectancy as observed

over past generations in any country (LLE) , range of life expectancies
expected over the previous and next generations (RLE)

Measuring economic development….

Education index (EI)

To calculate EI, we need first to calculate two indices: adult
literacy index and gross enrolment index

42
 Measuring economic development….
Education Index

Measuring economic development……

• UNDP categorizes(ranks) countries into three groups:
• low HD (0.00 to 0.499)
• medium HD (0.50 to 0.799)
• High HD (0.80 to 1.0).

Ethiopia???
UNDP 2016….HD=0.448 and rank 174/185

Health and Development

 The relationship between health and economy is bidirectional
 HEALTH Development
 Improving the health is an end in itself (a fundamental goal of
economic development ) and
 A means to achieve other economic development goals

43
 Group discussion
1. Discuss on impact of health on economic development
and vise versa?

Impact of health on Development

Healthier population is likely to :
 Be more productive
– will have good attendance at work
– will have better skill level
_ No loses due to cost of illness
 Have increased life expectancy
–may lead to decreased in time preference
– increased in investment

Impact of Development on health

Poverty at house hold level
– Poor diet
– Poor housing and sanitation
– Poor individual and group attitude
Poverty at country level
– Low allocation of resources to public health
program
What is poverty?
Definitions of Poverty
 Poverty is the state of having little or no money and few or no
material possessions.
wordnet.princeton.edu/perl/webwn
 Poverty (also called penury) is: (extreme poverty)

44
 o deprivation of common necessities that determine the quality
of life, including food, clothing, shelter and safe drinking
water, and
o Deprivation of opportunities to learn, to obtain better
employment to escape poverty, and/ or to enjoy the respect of
fellow citizens.
en.wikipedia.org/wiki/Poverty

Definitions of Poverty…
 Poverty is the state of living on less than $2 a day, according to
the World Bank. Poverty can also represent a lack of
opportunity and empowerment, and bad quality of life in
general. library.thinkquest.org/05aug/00282/other_glossary.htm
 Poverty is an income level defined by the Census Bureau that
determines a family’s poverty status. This level is adjusted
yearly as changes occur in the national economy’s Consumer
Price Index and costs of living.
www.marketresearchterms.com/p.php
 Poverty is a difficult concept to operationalize.
 It has a political implications - governments are supposed to
deal with it.
 It has social implications - poverty can be a source of shame
and low status for individuals
Poverty and source poverty
 Absolute Poverty is a condition in which a person or a family
does not have the means to satisfy basic needs for food , water,
clothing and shelter (Seebohm teal,)

45
 ABSOLUTE POVERTY

If you live in absolute

poverty you have none of
these basic things for
living.

Poverty and source poverty…

Relative poverty
• Relative poverty is when people are compared to those around
them, or to what others might reasonably be expected to afford
(Abel- Smith ,1965 and Peter Townsend )
• Measured in terms of inequality
• It can include lack of:
– Educational opportunity
– Material possessions
– Health care
– Good quality housing
– Civil Rights
– Social opportunity

Subjective poverty
 This is a little used concept, but is based on the notion of felt
poverty.

46
  People feel poor if those around them have more than they
do.
 The people against whom one measures oneself are known as
the reference group.
 In the past, people may have been deprived, but not felt poor
because they were unaware of what others have.
 Could television have a role in creating subjective poverty?
Contributing Factors to Poverty
 Family destruction and weakness
 Education deprivation
 Lack of jobs - under and unemployment
 Lack of community/economic development
 Lack of income and wealth creation
 Lack of minority businesses
 Health status and care - disparities
 Disproportionate representation - criminal justice system
Main causes of poverty
 Unemployment
 Conflict(Violations of human rights, inadequate system
of social protection)
 Inequality
 Poor education and Lack of infrastructures
 Climate change. .... ...
 Limited capacity of the government(poor leadership, bad
governance)

The Cycle of poverty (Neil Reardon)

Large families
Born poor
47
Family break up
 Bad nourishment
Early parenthood
How true is this
Bad area to live in picture of why Ill health
people are
Unemployment poor?
Misses school

Criminal record

Few qualifications

Criminality for money

Low paid, difficult work

Basic elements of poverty reduction program

 To ensure equitable development of the country:
o Plans for establishing of a national fiscal council could be a good
instrument for creating policies for harmonized development of
the country
o Future distribution of international aid between the entities
should consider higher poverty rates
 Implementation of fiscal reforms will lead to:
o Incremental of public revenues, and accordingly incremental of
revenues for programs for poverty reduction
o Reduction of corruption which especially hurts the poor
 Reorganization of social protection system which will:
o Provide greater funds for civil beneficiaries
o Harmonize level of social protection within the country
o Establish the children protection fund

48
Basic elements of poverty reduction
 Remove all forms of ethnic discrimination:
 Related to this, it is especially important to implement decision
of Constitutional Court on constitutive status of all ethnic
groups within the country.
 This would provide proportional employment for all ethnic
groups within public administration
 Faster growth of private sector will contribute to growth of
employment, which will especially benefit the poor
 It will be especially important to strengthen government
capacities for analyzing the poverty and monitoring instruments
 Partnership of government and civil society in poverty
reduction.
Unit-4
Health Care Financing
Financing
 Financing is raising revenue to pay for a good or services.
 Health financing is a process of revenue collection, risk
pooling, and purchasing goods and services for the purpose of
improving the health of a population.
What does HCF address?
 Health Care Financing addresses:
 How much resource is needed?
 Where does the money come from?
 How is it collected?
 How risks are pooled?
 Who manages it?
 How is it re-distributed to the third-party payers and

49
 How is it used to pay the providers for their services

 Health care financing reform is an alternative arrangement for

mobilizing, collecting, paying and managing health resources in
order to increase efficiency, promote equity and improve access
and quality of health services in a sustainable manner.
Factors Affecting HCF
 Demographic change
 Economic recession
 Rising expectations
 Concerns about equity
 Disease pattern change
 Efficiency
 Displacement effects

Functions of Health care financing

The following are the three functions of health financing:
 Resource mobilization; mechanisms for collecting money to
be spent on health. General revenue, insurance schemes,
community financing
 Risk-pooling; the process of creating a common pool of
money so that the financial risks entailed by certain high-risk
individuals are mitigated by money from lower-risk
individuals.
 Resource allocation (also known as provision): allocating the
mobilized (& pooled) resources to service providers.
50
Revenue collection
 The means by which a health system collects money from
individuals, households or external sources.
Ways of revenue collection mechanisms for health care financing:
1. Taxation
2. voluntary/compulsory insurance
3. Medical savings accounts
4. Out of pocket payment
5. External donation (grants/loans)
Sources of health care funding
1. Public Sources
– Direct government budgeting
– National health services and public health
services system
– Social health insurance sponsored or
mandated by the government
– Community financing
2. Private Sources
• Direct payment by households
• Private voluntary health insurance
• Employers based health insurance
• Payment by community and other local organization
3. External Financing
 Foreign aid for development loans
 From bilateral aid program me or international NGOs
Health Care Financing
51
  USA spends 17% of its GDP on health
 Netherlands spend 12% of GDP on health
 Ethiopia spent approximately 3.8% of its GDP on health in 2012
(WHO, 2013)
 The health care expenditure of sub-Saharan African countries is
suboptimal
Total health expenditure as a percentage of GDP

Sources of Health Financing in Ethiopia

 The federal and regional governments (government block grants) 21%
 Grants and loans from bilateral and multilateral donors 39%
 Households (out of pocket) 37%
 Local and international non-governmental organizations , private
contributions 3%
Health Insurance
Introduction
 Health insurance is now becoming a major agenda in many developing
countries as the costs for health services coverage by the community is
becoming beyond reach especially for the poor.
 Health is different from other goods in which it is usually unpredictable
and uncertain
• for how long someone will live,
• how healthy someone will be in the future,
• when someone might be unhealthy,
• how much health care someone might need, and
How much change in health will affect future income

What is Insurance?

52
  Insurance is reducing risk by combining a group of risks so
that the accidental losses to which the group is subjected
become predictable within narrow limits.
 It is pooling of fortuitous losses by transfer to an insurer, who
agrees to indemnify insured persons for such losses and render
services connected with the risk.
What is Health Insurance?
 Health insurance is a means of pooling risk across different
population groups as a means of avoiding the financial burden
of unanticipated and catastrophic conditions in health.
 It is a means by which individuals pay money to insurance
company to avoid the risk or uncertainty associated with ill
health.
 The insurance company collects the money from the
individuals, tries to maintain or increase its value through
investment, and pays claims when asked by the insured persons.
Health market failures in health insurance
Health insurance challenged by market failure due to
1. Information asymmetry in health markets
 It exists between insurance companies and insured people,
between doctors and patients, even between health providers
and funders or governmental bodies
 Potential beneficiaries have better information than the insurer
about their health status. As a result, premiums for higher-risk
patients will be under-priced, encouraging such patients to over
insure while the opposite holds for low-risk patients.
 This phenomenon reduces the efficiency of health insurance
markets

Health market failures in health insurance….

I. The agency relationship
53
 Formed whenever a principal delegates decision-making
authority to another party, the agent.
 In this relationship however, the principal has limited
information about the effort and decisions made by the agent,
and all he or she can observe are the outcomes
 In the physician–patient relationship, for instance, the patient
(the principal) delegates authority to the physician (agent), who
in many cases also will be the provider of the recommended
services
Health market failures in health insurance….
 One problem which may arise is what is called supplier-
induced demand (SID)
 When physicians abuse the agency relationship with their
patients in order to generate demand for personal gain; this is
made possible because physicians are more fully informed
than patients
Health market failures in health insurance…
ii. Adverse selection
 Adverse selection in health insurance exists when you know
more about your health status and your likely use of health
services than your insurance company.
 Insurers deal with the problem by trying to design risk classes
that group similar risks together. They then charge premiums
that reflect this differential risk

Information asymmetry in health markets…

iii. Moral hazard in insurance markets
• It is simply an application of the law of demand. The law of
demand states that at a lower price, people buy more of a good
• Unnecessary use health care services
54
 Solution
Insurance policy that discourage over utilization of resources and
unnecessary claims
– co-insurance, co-payments, deductibles, pre-admission
certification and gate keeping
2. Externalities

 Externalities can lead to a

divergence between private
and social costs
 output decisions take into
account only private costs of
production, and not full
social costs
Example; vaccination
Figure a positive consumption externality in a market for vaccinations
The Demand for health Insurance
 The demand for health insurance results from the demand for health,
and is affected by
 premium loadings,
 wealth or income of individuals,
 expected loss due to the event occurring,
 the information or perception of individuals about the risk, and
 Availability of indemnity mechanisms such as co-insurance and
deductibles.
 Non-monetary Losses (examples: pain and suffering)

Factors Affecting the Demand for Insurance

 Premium Loadings
• As loading increases, quantity of insurance purchased
generally falls.
 Income and Wealth
• More wealth is usually associated with more assets to lose
and therefore more insurance coverage
55
 • Larger income losses due to illness will increase the demand
for health insurance
Factors Affecting…
• Information
 Individual’s perception of risk
Risk neutral ==> individuals may accept the uncertain
outcome and may not buy insurance policy.
 Underestimate the true risk ==> buy less
insurance
Risk aversion ==> prefer certain outcome to an uncertain
outcome with the same expected value
 Overestimate the true risk ==> buy more
insurance
• Non-monetary Losses
 Examples: pain and suffering
 Demand for insurance against non-monetary
losses differs from demand for insurance against
monetary losses
Factors Affecting…
• Probability of ILLNESS
 Consumers demand more insurance for events
most likely to occur
 Consumers demand less insurance for events
least likely to occur
 Consumers more likely to insure against random
events
Co-insurance, co-payment and deductibles
 Co-insurance and co-payments are payment mechanisms
in which the insured person shares the losses when events
occur
 The percentage paid by the insured person is the
coinsurance rate and the amount paid by the insurer is co-
payment

56
  Deductibles are another payment mechanism in which
some amount of the cost of health care is paid by the
insured person irrespective of co-insurance.
Types of health insurance
1. National health insurance
• usually financed through general taxation
• Government-managed health insurance
• Comprehensive coverage regardless of health status or
affiliation
Disadvantage
• May not be sufficient if not assisted by other insurance
schemes
2. Social health insurance
• financed via payroll taxes collected from employers and
employees
• Formal sector employees
• Mandatory membership
• High level of risk-sharing due to large and varied risk
pool
• Premiums proportional to income and not profit-oriented
• Generates relatively stable revenues
Disadvantage
• Complex to manage and low income countries lack the
capacity to do so
• Moral hazard
3. Private health insurance
 Increases financial protection and access to quality health
services for those able to pay
Disadvantage
Premium based on risk profile
Efficiency is generally related to maximizing profits
Big risk of adverse selection
Particularly inequitable unless poor people are subsidized
57
 Coverage usually limited to a small percentage of the
population due to premium levels, selection methods, and
voluntary nature
Probability and private insurance
 Insurance works on the basis of probabilities
 The probabilities of particular occurrences can become
rather stable and predictable for large groups of people
 No individual knows whether they will fall ill and be
unable to work next year, but it is possible to work out
with reasonable precision
 What percentage of a large group of people, who are
similar in age and general health, will become ill over the
period.
Probability and private insurance…
 Formally, if the probability of requiring a given
compensation Z is p, and the administrative
costs plus profit are A, the premium is: pZ + A
 An individual will pay if they can afford it and the
insurance company will accept the premium if they think
that, on average, they will make a profit
 That is the principle of private insurance. To make it
work, several conditions are essential.

First, enough people have to be insured to make the calculated

probabilities reliable.
 This condition is called the ‘law of large numbers’.
 In small groups of people, the proportion that will be ill at any
time will vary greatly from year to year. However, with very
large groups, the average sickness rate becomes much more
predictable. As a result, risks can be pooled efficiently
 Second, the probability that any one individual needs
compensation has to be independent of the probability of the
same problem for others.

58
 If your friend becomes ill it must not influence your state of
health. Otherwise, the insurance company might have to pay
out to a large number of people simultaneously so the amounts
it will have to pay out will not be stable.
 Second, the probability that any one individual needs
compensation has to be independent of the probability of the
same problem for others.
If your friend becomes ill it must not influence your state of
health. Otherwise, the insurance company might have to pay out
to a large number of people simultaneously so the amounts it will
have to pay out will not be stable.
 Third, the probability of the insured disaster must be less
than one.
 If p = 1 the problem is certain to happen
 If you are already sick or disabled, health insurance to cover
the condition would cost at least as much as the treatment.
 This means the most vulnerable people in society can find it
difficult to buy certain forms of insurance
Probability and private insurance…
 Fourth, people must not be able to influence the probability
of the insured event occurring
 Hence pregnancy is hard to insure against, and so is
unemployment. This could be source of market failure

Activity 1
1. Suppose a group of people that includes you has a 1 in 100
chance of being ill in any year, and that the average cost to the
insurance company is 2500 birr per illness episode, plus 5 birr
per person for administration and to make a profit.
What annual premium will the insurance company charge
4. Community based health insurance
59
  Targets the low-income market, not for profit and reaches
the informal sector
 Risk premiums are based on the risk profile of the
community and not of individual members, which means
a higher level of risk sharing
 Has ability to improve access to services for poor people,
but not the poorest
 Promote equity
4. Community based health insurance…
Limitation
• The poorest people are excluded unless subsidised
• Prone to adverse selection due to voluntary membership
• Financially vulnerable unless supported by government
funding
• Often has limited administrative capacity

Unit-5
Allocating resources for health care
Learning Outcomes
After studying this unit, you will be able to:
Knowledge and understanding
 identify the main categories of costs in economic evaluation in
the health sector
 describe the range of indirect costs which are potentially
relevant for purposes of economic evaluation
 explore ways of examining and estimating the economic costs

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 discuss the advantages and disadvantages of different methods
of data collection used to estimate the value of resource costs
 explain the main methods used to value non-market activities.
Cost concepts
What is cost?
 Cost means the amount of expenditure incurred in obtaining
the services of a factory of a production
 A cost is “the value of economic resources used as a result of
producing or doing thing costed.”[W.M. Harper]
 A cost unit is “a unit of product, service or time in relation to
which cost may be ascertained or expressed.”
Cost concepts...
 Costs of different categories and a perspective should be
specified.
 Once a perspective is chosen, the costs and consequences
associated with a given product or service can be identified and
measured.
 To carry out this measurement, we need to decide which
resources to include, how to measure resource use and how to
value the resources used.

Uses of Cost Data

 Accountability
 Assessing efficiency
 Assessing equity
 Assessing priority
 Making cost projection
 Considering cost recovery

Types of cost…
Based on perspective…
a. Health service costs/provider perspective/
b. Costs borne by patients and their families/patient
perspective
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Types of cost…
A. Health Service Costs/provider perspective/
Health service costs include:
 Staff time, medical supplies (including drugs), bed and food
services in the case of inpatients, use of capital equipment, and
overheads such as water, heating and lighting
 These items may be divided into variable costs, which vary
according to the level of activity (for example, staff time) and
fixed costs, which are, incurred whatever the level of activity
(for example, heating and lighting)
b. Cost Borne By Patients and Their Families/patient
perspective/
 Direct medical costs: are those immediately associated with
an intervention:
Eg-medications, supplies, laboratory tests, Healthcare
professionals’ time, hospitalization
 Direct non-medical costs: might include transportation, food,
Care for family members ( e.g. children), home aides
 Indirect costs: lost wages (morbidity), lost work /leisure time
for care givers, income forgone because of premature death
(mortality), patient’s work loss due to treatment.
Intangible costs: pain, suffering, inconvenience, grief
Total, average, marginal and incremental cost
o Fixed costs; cost that does not change/vary with increases or
decreases in the amount of service,provided in the short run
 Fixed costs are born irrespective of how much
output is produced.
 Example: rent, buildings, machinery
o Variable costs; are those costs that are directly related to how
much out put is produced
 Example: the costs of supplies, fuel, fee for
service and food.

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Types of cost…
Total, average, marginal and incremental cost…
Total cost [TC] is a measure of all costs entailed in producing a
given level of output.Total cost is the sum of fixed and
variable costs
TC=(Q1*P1)+(Q2*P2)+….+(Qn*Pn)
Where Tc= total cost
Q1= quantity of resource1, 2…. Qn
P1= price of resource 1, 2…Pn
 E .g The overall cost of providing an immunization service
 Average cost ; is a measure of the total costs of production
associated with each unit of output.
 Average costs indicate the resource requirements for each unit
of out put
 AC = TC/Q

Budget
The only financial statement that reflects plans for the FUTURE
 A detailed plan that describes how resources will be
obtained and how they will be used
 A tool for communicating operational objectives
 The means by which to allocate resources among
competing demands
 Source of feedback on performance of your plan
Why budgeting?
 Planning
 Feasibility
 Monitoring and accountability
 Prioritization
 Compare alternatives

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  Helps support funding requests
Investing in a good budget in the planning
Stages will save time and resources and improve
Effectiveness throughout the project.
Types of budget
1. Operating Budget
 Day to day operations of the organization
2. Capital Budget
• Includes long-term purchases that will not be used
up this year
3. Project Budget
• Reflects financial information for a specific project
and its activities
Methods for developing a budget
1. Incremental budgeting
2. Request-by-exception budgeting
3. Forecast budgeting
4. Zero-based budgeting

Incremental budgeting
 This approach assumes that the previous year should
provide a base for the next year.
 So the previous year’s expenditure is used as a basis with
incremental amounts added for the new budget.
 It has the advantages of making any changes in a stable
and gradual way, and of being simple to operate and easy
to understand.

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  Its disadvantages are that it assumes activities and
services will continue in the same way, and so provides
no incentive for developing new ideas
Request by Exception
 Start with last period’s budget (actual or predicted).
 Departments may request changes for specific items,
but must demonstrate the financial benefit associated
with the expense.
 Advantages
• Straightforward
• Limits expense
• Aligns with strategic planning goals
• Disadvantages
• Must be creative to advocate for projects that do not show
financial benefit

Forecast Budgeting
 Set volume and productivity goals first, then create budget
 Advantages: aligns with strategic planning
 Disadvantages: requires many assumptions about growth rates,
productivity, etc.

Zero budgeting
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 This alternative approach involves starting as new with revenue and
costs for each area of activity.
 It does not consider data from the previous year. Each department starts
with a budget of zero.
 The advantages are that it involves managers across the organization in
both setting priorities and budgeting, and that it limits expenses.
 Disadvantage is that it is time consuming,
Ethiopian fiscal practice and financial regulation
Definition of some key terms:
 Fiscal year: A specified 12-month period during which operational and
financial performance is measured.
 Annual fiscal plan: Includes the preparation of annual estimates for the
upcoming fiscal year of revenue, expenditure and financing.
 Budget cycle: The preparation, review, approval, appropriation and
execution of the annual budget.
 The Ethiopian budgeting cycle includes: budget preparation (proposed);
budget compiling and approval; budget execution; budget audit
(closing).
5.3 Ethiopian fiscal practice and financial regulation
o Financial calendar: Defines and adequately schedules tasks to be
performed, the time frame for each task and the institutions responsible
to perform each task so that plan and budget are systematically
prepared, approved, appropriated and executed.
o The Ethiopian budget year: Begins on Hamle 1 (8 July) of the previous
year and ends on Sene 30 (7 July) of the following year.

Efficiency is a level of performance that describes a process that uses the

lowest amount of inputs to create the greatest amount of outputs
 Efficiency also can be stated as the act of being
adequate in performance with a minimum of waste, effort, time.

Types of efficiency
1. Cost efficiency is achieved when each level of output is produced at
the lowest possible total cost
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2. Technical efficiency
 When it uses the minimum possible quantity of inputs (land, labour
and capital ) to produce a given quantity of output for each technique
of production
 Technically efficient does not mean that it is cost efficient. It is
necessary but not sufficient.
 The total cost of producing a certain level of output by one
technically efficient method may be greater than that of producing it
by another
Example:
 Firm A 1000 tone of corn and 100 worker
 Firm B 500 tone of corn and 300 worker to yield 4000
cornflakes
 Corn price ($5per tone)
 Worker price ($10 per tone)
3. Allocative efficiency :means that the quantities of each good and
service produced are distributed in such a way that it is not possible to
improve the utility of any consumer without decreasing the utility of at
least one other
4. Economic Efficiency
 Economic efficiency refers to the achievement of maximum
benefits, or maximum utility, with a fixed amount of resources.
 Combination of cost efficiency end technique efficiency
A situation can be called economically efficient if :

 No one can be made better off without making someone else worse
off
 No additional output can be obtained without increasing the amount
of inputs
Efficiency
CALCULATING EFFICIENCY

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The efficiency of a process is calculated by dividing the output by the
input, and then multiplying the result by 100
Efficiency is usually given as a percentage and
can be computed with the following formula:
Efficiency = Work Output / Work Input
Causes of inefficiency in health care
Health facility inefficiencies are often due to a combination of possible
reasons
 Mainly due to gap or in sufficient six Health building blocks (lack the
proper health governing system, and lack of Trained Health workers
that cover the gap and deliver the services needed, etc ) (WHO, 2015 )
CAUSES INFFIECENCY IN HEALTH CARE…
I) Poor organization of services or work processes
II) Insufficient equipment, supplies, or infrastructure
III) Poor time management
IV) Inadequate staffing
V) Low health worker motivation/know-do gap
VI) In security / Disease outbreaks and famine
WAYS TO IMPROVE EFFICIENCY
IN HEALTH CARE
• Train the workforce
• Improve motivation
• More capital equipment
• Use better quality raw materials

Unit-6
Economic Evaluation
Economic Appraisal / Evaluation
 Systematic and comparative analysis of 2 or more courses of
action in terms of both costs and consequences or benefits

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  Economic evaluation is therefore an effort to analyze inputs
(resources) and outputs (changes in health outcomes)
simultaneously, and
 It helps decision makers assess whether a certain level of output
is worth the amount of resources expended to produce it (given
that resources are scarce and can be used for alternative
purposes).
Economic evaluation…
 Systematic assessment of:
• Relevance
• Adequacy
• Progress
• Efficiency
• Effectiveness
• Impact of a course of action.

Why Should Economic Evaluations Be Conducted?

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Nature of Economic Evaluation

Impact on health  Survival

Program A status  Quality of life
 Hospitalisations
 Drugs, procedures
Impact on health care costs etc.
Target patient Impact on health  Survival
group status  Quality of life

 Hospitalisations
 Drugs, procedures
Program B etc.
Impact on health care
costs
Importance of Economic Evaluation
• All type of health services are faced with choices about the best
way to use limited resource to achieve their objectives
• Complete economic evaluation aims to:
• Clarify
• Quantity
• Value all of the relevant options and their
inputs and consequences

Why Economic Evaluation?

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Advantages to conducting an economic evaluation
 Advantages to conducting an economic
evaluation include:
1. Forcing one to systematically consider
the costs and outcomes that might result
from implementing a particular program
or intervention;
2. Allowing one to objectively compare
alternatives (competing programs or
interventions); and
3. Providing information that can be
used by decision makers to maximize the
benefits of public health funding.

Disadvantages to conducting an economic

evaluation
 Disadvantages to conducting an economic evaluation include:
1. Often time-consuming or require data that are difficult to
collect;

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 2. Cannot consider all the possible factors that might
inform a particular decision (e.g., patients' rights, equity,
etc.);
3. Dangerous when conducted poorly - may produce
misleading results.
Main Methods of Economic Evaluation
Partial Versus Full Evaluations
There are two different general categories of
economic evaluations - partial and full.
 Partial evaluations assess either the cost or the outcome
components of programs and possible alternative
interventions, or they assess both costs and outcomes of a
single intervention (program without comparative
reference to one or more alternative interventions).
 Full evaluations assess both costs and health
outcomes of an intervention or program. They
compare these across the possible
implementation of possible alternative
interventions.

Economic Evaluation Methods

 Program Cost Analysis
 Cost-of-Illness Analysis
 Cost minimization analysis

Full
Econo
mic -
72Evalu
ation

 Cost-Effectiveness Analysis
1. Program cost analysis
 It estimates total costs of running a program
(Personnel,training,supplies,overhead, etc.)
 Usually reported as:
• cost per client
• cost per service
 Program cost analysis is important for;
 Budgeting, to show accountability, assess efficiency, assess
priorities, know project costs, etc.
E.g Hospital program budget, Teaching-learning program budget
2. Cost-of-Illness Analysis
 Cost of illness estimates total costs incurred because of a disease
or condition
(I.e. medical costs, productivity losses, etc)
 Generally reported as
• annual total cost
• average patient lifetime cost
• Used to show potential benefits of prevention efforts

3. Cost-minimization analysis/CMA
 CMA involves comparison between two or more alternative
interventions whose outcomes are assumed to be exactly the same
 The technique is used to identify the least costly intervention.
Examples:

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 i. Can be applied when comparing two drugs of equal efficacy &
equal tolerability
i. Vaccine delivery by nurse practitioners vs. MDs
ii. radioactive vs. non-radioactive tests
iii. genetic versus clinical test
3. Cost-minimization analysis…
Advantages
• Simple to carry out, requires costs to be measured but only that
outcomes can be shown to be equivalent
• Avoids unnecessarily quantifying of data
Disadvantages
• Can only be used in narrow range of situations.
• It requires the outcomes to be equivalent
4. Cost-Effectiveness Analysis/CEA/
 CEA is a method used to compare net cost of an intervention to
effectiveness where effectiveness is measured in natural health
outcomes (i.e., cases averted, years of life saved)
 Used to compare results of target intervention with other
interventions having the same outcome, but in different degrees.
 So given a fixed budget, the intervention that maximizes the
effectiveness of the expenditure can be determined by CEA
 Derives a ratio of cost per unit of outcome
 Cost per individual tested for HIV/AIDS
 Cost per case of HIV/AIDS prevented
 Cost per year of life saved
4. Cost-Effectiveness Analysis/CEA/…
Decision rule:
• Two programmes A (comparator) and B.
• If Outcome B = Outcome A => Compare costs (CMA).
• If Outcome B > Outcome A and Cost B < Cost A, B is dominant.

• If Outcome B > Outcome A and Cost B > Cost A, we have to make a

decision.
• In order to make a decision on which intervention to choose, a cost-
effectiveness ratio (CER) should be calculated.
4. Cost-Effectiveness Analysis…
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• Average cost effectiveness ratio (ACER):- it is an index used to make
comparison of the costs and consequences/benefits of independent
interventions, i.e.,
For example, if effectiveness is measured by length of life, ACER it
is defined as:
ACER = costs in units of money ⁄ benefit in life years gained
CEA Steps
i. Estimate the Net Cost (numerator)
ii. Estimate the Net health outcomes (denominator)
iii. Calculate CE Ratio
 Net Cost / Net Health outcome
 (i.e., $$/case prevented, $$/life year saved)
Activity 2
 Suppose we have a health problem affecting 100 people that can be
treated by one of three healthcare interventions A, B and C. The costs
and benefits obtainable from each are shown in Table 1.
 Compare the ACER values of these interventions and complete the final
column. Which intervention would be preferred according to CEA?

Table 1 Costs and benefits of alternative interventions

Comment

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 Table 2 Cost per life year gained of alternative interventions
 Intervention A will be preferred as it has the lowest ACER - that
is, the lowest cost per life saved.
Advantages of cost-effectiveness analysis
 CEA is relatively easy to undertake.
 It is also less expensive to carry out than CBA.
Limitations of cost-effectiveness analysis
1. CEA is uni-dimensional - it considers a single benefit/outcome of an
intervention and ignores other potentially important outcomes.
 It does not show the multiple effects or consequences of a particular
intervention.
o Hence, it may result in misleading conclusions.
2. It can`t compare Health programmes with different objectives/outcomes
 The comparison has to be between interventions with common effect
or the same objective.
 But that is not a situation most health policy makers often find
themselves in.
Activity
 Suppose that we have a 1 million birr budget to be used for a
healthcare project and that the alternative outcomes from different
uses of this budget are:
1. used for control of Malaria, it can save 10, 000 lives per year

2. used for HIV/AIDS programme, it will reduce the stigma against HIV
victims by 60%

76
 3. used for vaccination, it will improve life expectancy of a given nation
by 20 years
4. used to treat heart attacks, it can save 100 lives per year
5. Used to improve child nutrition, it can reduce child mortality by 40%.
Which of these projects can be compared using CEA?

Comment
 Only projects 1 and 4 are comparable by CEA, because in both the
objective is same - the number of life saved per year.
 All the others have different objectives.
Clearly, 1 would be preferred to 4 as the cost per life saved is 100 birr for 1
whereas it is 10,000 birr per life saved for 4.

5. Cost-Utility Analysis (CUA)

 This is a method used to compare net costs & benefits of interventions
where net benefits are expressed as the number of life years saved
adjusted to account for loss of quality of life.
 Utility is a term used by health economists to refer to the subjective
level of wellbeing that people experience in different states of health.
 CUA is multidimensional and incorporates considerations of quality of
life as well as quantity of life using a common unit.
 Result: Cost per unit of consequence (e.g. cost/QALY).
Cost-Utility Analysis (CUA)
Example 1: QALYs
o Assume that a patient receives no treatment; his/her life expectancy is 3
years with a quality of life of 0.45.
o If the patient was to receive a new intervention which was expected to raise the
life expectancy to 8 years and the quality of those years to 0.70.
o Then the gain from the intervention would be:
o 3 x 0.45 = 1.35 QALYs(without the intervention)
o 8 x 0.70 = 5.60 QALYs(with intervention)
o Intervention = 4.25 QALYs gained

QALYs
With treatment X
Without treatment X Estimated survival
Estimated survival 77 = 10 years
= 5 years Estimated SG utility
Estimated SG utility = 0.7
= 0.5
 Preference elicitation methods...
Utility estimates can be obtained through direct measurement or by
input them from the literature or expert opinion
There are three main methods for direct measurement used in cost
utility analysis.
These methods range from 0 representing death or the worst health
state to 1 or 100% for full health or best attainable health state
o Visual Analogue Scale (VAS)/ Rating Scale
o Standard Gamble (SG)
o Time Trade-off (TTO)

Visual Analogue Scale (VAS) 100

90
 Individuals are asked to indicate where on the line
80
between the best & the worst imaginable health
states they would rate a pre-defined health state. 70
VAS... 60

We would like you to indicate on this 50

scale how good or bad is your health 40
today, in your opinion. Please do this by
drawing a line from the box below to 30
wherever point on the scale indicates
how good or bad your current health 20
state is
10
Your own health state 0
today
Standard Gamble (SG)
78
  Usually involves asking respondents to identify what risk they are
willing to take to achieve the benefits of a particular intervention
 Respondents might be asked to state if they would be willing to receive
an hypothetical AIDS vaccine if it had an associated 5% (1% or 10%)
risk of death
 Gives estimate of relative preferences for different health
states Alternative 2: 95 Complete health
Uncertain outcome
%
5%
100%

Alternative 1: Limited
Certain outcome
health
Time Trade-Off (TTO)
 Usually involves asking respondents if they would be willing to trade-
off the benefits of an intervention if it involved a shortened life
 Respondents might be asked to state if they would be willing to take
drugs if doing so made them completely healthy but shortened their life
by 2 (1 or 5) years
Elicits preferences for different health states

Time Trade-Off (TTO)

Alternative 2
Healthy
1.0
Alternative 1
VALUE
hi
State
i
Time
0 x
Dead

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Cost-Benefit Analysis (CBA)
 A method used to compare costs & benefits of an intervention
where all the consequences & benefits are valued in monetary
terms
 Assesses whether a project/ program is desirable through the
use of decision criteria.
 Cost-benefit analysis is the most comprehensive form of
economic evaluation.
[E.g. if the benefit cost ratio [benefits divided by costs] is greater
than one, the project/ programme is worthwhile]

 An EE method that standardizes both costs & benefits into

monetary values.
 Results are expressed as
 Net Benefits = (Benefits – Costs)
 Benefit Cost Ratio = (Benefits / Costs)
 Best used when a policy maker has:
 broad perspective
 concerned about the potential changes in societal
welfare

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 Four differences between CEA and CBA
CEA CBA
• Typically calculates the ‘price’ of a QALY • Typically determines ‘in advance’ the marginal
or a life and leaves the decision unstated value o f a benefit
• Often C EA is applied a t a highly Example:
disaggregated level QALY or a life year, and then calculates net
• some of the conversions might be more benefits
difficult to carry through • could be applied at a much more aggregated
level,
• CEA would look at the marginal CE ratios
• has the advantage that all types of benefits
along the different dimensions are converted into a common metric
The difficulty lies then in determining • involves adding up all benefits and costs from
incremental costs in the case of joint all dimensions of a project and comparing
production. them against each other

Economists view of the world…

 Pessimist: bottle ½ empty
 Optimist: bottle ½ full
 Economist: bottle ½
WASTED!!

Many Thanks!!

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