OLABISI ONABANJO UNIVERSITY

AGO-IWOYE.

ECO 412: PETROLEUM AND ENERGY ECONOMICS

Dr. O. A. ADELOWOKAN – COURSE LECTURER

Dr. I.A. ODUSANYA – COURSE LECTURER

 Concepts of Demand and Supply in Health Economics

Every individual has a need or a potential need for health care in the form of health promotion,
prevention, cure or rehabilitation. This need is not always translated into a demand for health
care particularly in developing countries for various reasons. Health need is transformed into a
health care demand when a patient seeks a medical care and can back it up with money.
Since all needs and wants of society cannot be met at the same time even in richer countries, so
that opportunity cost are incurred by all users of resources, and the scarcer the resources, the
higher the opportunity costs. In the case of health and health services, these costs are incurred
both by producers of health services, through their use of staff, buildings, equipment and
materials supplies, and by consumers, who use transport to health services, buy drugs, etc.

Demand shifters in Health

The term ‘demand’ is used to describe the relationship between the amount of a good that
consumers are willing and able to buy at various prices. There are two broad reasons why we
might want to analyze demand. First, it can be used to help predict likely reactions and consumer
behavior towards health care. Second, knowing something about people’s demand for health care
or services may say something about how much they value the health care. This can in turn
inform policy decisions such as how much a particular health care services should be subsidized.
As people purchase less health care services at higher prices, the demand curve will be
downward sloping. The responsiveness of demand to health care price is measured by the
elasticity. Other variables also will affect the demand for health care. For example, the amounts
of various health care that people purchase may depend on their incomes; richer people tend to
purchase expensive health care. Demand may be affected by the price of other substitutable
health care. When any other variable affects demand, its effect will be shown as a shift in the
curve. For convenience, we call such variables demand shifters. A list of demand shifters
includes the following.
Income People with higher incomes tend to demand more of most healthcare goods. Such goods
arecalled normal goods. But some goods, such as used clothing or generic brand goods, are
purchased less often when people become richer. Such goods are called inferior goods.
Other Prices: Prices of related goods also will affect demand. Related goods may be either
substitutes or complements. If oranges are regarded as substitutes for apples, an increase in the
price of oranges would cause the demand for apples to increase, shifting the demand curve to the
right. In contrast, a complement is something that is used with apples, such as caramel. If the
price of a complement rises, the demand for apples decreases or shifts left.
Insurance A variable that makes no sense for apples but that is essential on a list of demand
shifters in health economics is insurance. Insurance reduces the price to the consumer at the point
of service; given the lower price, a greater quantity of health care will be demanded. Although
one can treat this as a movement down a given demand curve, we show in a later chapter that this
is equivalent to a clockwise rotation in the original demand curve. Insurance plans have many
complexities beyond changing the consumer’s effective price.
Tastes Many other demand shifters may be grouped under the heading of tastes. Tastes can be
literally what the word means, as when a new recipe increases interest in apples. The term can be
less literal as well, as when we say that an older population has a greater demand for health care
because it has a greater taste for health care.

Empirical Determinants of health care demand

The quantity demanded is conventionally represented by the following function:
Demand = f (P, Y, Pc, Ps, T)

f (. . .) is standard mathematical notation and means ‘is a function of’

P = price of the good
Y = income
Pc = price of complementary goods
Ps = price of substitute goods
T = tastes or preferences

The amount of a particular good that a household will want to buy is a function of the price (P)
of the good. If paracetamol is priced at £1 per pack, you might be prepared to buy more per year
than if it were priced at £10 per pack. For most goods, the higher the price, the less of that good
people will want to buy; the lower the price, the more quantity is demanded.
The amount demanded is also related to the size of a consumer’s income (Y). The higher your
income, the more likely it is that more of a good will be demanded at any given price. Therefore
if your income falls, you might consume less paracetamol per year. The demand for a particular
good is also infl uenced by the relative prices of othergoods (Pc and Ps). For example, if the
price of paracetamol remains fixed at £5 per pack, but the price of a substitute good, say aspirin,
falls, you may now purchase less paracetamol per year than before as it is now relatively less
attractive.
It is important to make a distinction between complementary and substitute goods.
Complementary goods are those bought in conjunction with your product (e.g. a syringe and a
needle). Substitute goods are goods which you can use instead of your good (e.g. if you are
buying paracetamol for a headache then a substitute might be aspirin). If the price of a
complementary good rises then demand for your good may fall. If the price of a substitute good
increases, demand for your good may increase.
The price you are willing to pay for paracetamol is also a function of your tastes or preferences.
If your tastes change (you experience an allergic reaction to paracetamol) then your demand for
it will change and you will be prepared to pay less (or possibly nothing at all) for paracetamol.
Note that your demand for paracetamol is not just a function of your taste for that particular
medicine but also your taste for other goods.

SUPPLY SHIFTERS IN HEALTH

Producers respond to incentives. Producers are willing and able to offer more products for sale at
higher prices than they are at lower prices. The higher price helps cover the higher marginal cost
of producing more items. A lower price does the opposite. A supply curve can be used to show
the positive relationship between price and quantity supplied.A supply curve reflects quantities
produced at each possible price. A change in the quantity supplied follows a price change,
causing a movement along a supply curve. A change in any other factor leads to an increase or a
decrease in supply, resulting in a shift of the supply curve. A supply schedule shows the quantity
produced at different prices.
Supply shifters cause the quantity supplied to change in response to changes in price. Supply
shifters, which change the quantity supplied at every price point, cause the supply curve to move
right or left. If the price of healthcare goes up, the company will be motivated to produce more.
And if the health care price goes down? The company will produce less. Price is not the only
factor to take into account, there are other considerations. If something other than a change in
price happens that affects the amount supplied at each and every price point, it’s known as a
supply shifter because it shifts the whole supply curve left or right.We may likewise generate a
list of supply shifters
Technological Change As technology improves for producing a given product, the good
becomes cheaper to produce. Certainly, technological changes that make products more costly
without improving quality are ignored. As the product becomes cheaper to produce, suppliers are
willing to offer more for sale at a given price. This increases supply, thus shiftingthe supply
curve to the right.
Input Prices If the wages of apple pickers were to rise, this increase in an input cost would
reduce suppliers’ willingness to offer as much for sale at the original price. The supply would
decrease, shifting the curve to the left.
Prices of Production-Related Goods The price of a good related in production, such as cider,
also would be relevant. Because farmers can use raw apples for eating or for cider, generally a
rise in cider prices will cause the supply of apples for eating to decrease, thus shifting the supply
curve to the left.
Size of the Industry As more fi rms (in this case apple growers) enter a market, the supply of the
product will be greater. Thus, entry of fi rms will cause supply to shift to the right.

Weather For a number of products, acts of God such as the weather will tend to affect
production. The direction of the effect is obvious: Good weather increases supply.

Comparative Static Analyses Using Examples in Health Economy

An equilibrium is a static equilibrium. It shows a picture of an unchanging equilibrium at a point
in time. It is more interesting to assess how the equilibrium will change in response to some
economic event. A few exercises help to generate experience with comparative statistics and to
demonstrate the applicability of this analysis:
 1. A national health insurance proposal is passed that provides comprehensive health
insurance to millions more people than currently. How would this affect the markets for
healthcare in the short run?
Answer: According to the competitive model, insurance coverage will probably increase on
average, causing the demand for health care to increase, shifting the curve to the right. This will
increase the equilibrium price of care, as well as the quantity consumed. The result will be an
increase in the total money spent on health care. But recall that the analysis is conducted ceteris
paribus: If an effective cost-control program were put in place at the same time this would
reduce the pressure on costs, perhaps cancelling it out.
2. A new law requires that hospitals hire only nurses with Bachelors degrees. How would
this affect the market for hospital care?
Answer: Hospital markets are not perfectly competitive, but such a law would in effect increase
an input price, shifting the supply of hospital care to the left. Under this interpretation, the
equilibrium price of hospital care would tend to rise and quantity would fall.
3. Suppose that there is a big breakthrough in the technology for Lasik surgery, that is,
surgery designed to correct nearsightedness. Suppose further that this cuts the price of
Lasik to a tenth of its previous level with no loss in quality. How would this event affect
the market for eyeglasses?
Answer: Lasik is a substitute for eyeglasses, and demand for eyeglasses would probably decline.

Price Elasticity of Demand and Determinants in relation to Health Care;

Income Elasticity of Demand, and Cross-Price Elasticity of Demand
We often seek to understand the responsiveness of the quantity demanded to other variables.For
example, if the price of health care rises, will the quantity demanded fall by a large amount or a
small amount? Economists use the term elasticity to describe the responsiveness of any term y
(in this case, quantity demanded of health care) to changes in some other variable x (here, price
of health care).
Elasticity is defined as the percent change in the dependent variable resulting from a one percent
change in the independent variable under study. Percentages allow us to “standardize” our
measure and to eliminate problems comparing different goods or differentunits of measurement.
1 In the case of the price elasticity of demand, it is as follows:
E p= (% change in quantity demanded) ÷ (% change in price)

Or

E p=

Where Δ refers to change in the variable. The price elasticity is always algebraically negative
because an increase in price leads to a decrease in quantity demanded. We derive other
elasticities, such as the income elasticity of demand, similarly.

E p= (% change in quantity demanded) ÷ (% change in income)

Or

EY=

Numerical values for price elasticities are often reported in absolute values, eliminating the
minus sign. Absolute values for price elasticities indicate the responsiveness of demand to price
in that the greater the elasticity, the greater the responsiveness. Absolute values greater than 1 are
considered relatively responsive and are called elastic. Elasticities less than 1 in absolute value
are called inelastic. In the limiting cases, zero price elasticity means that the demand curve is
perfectly vertical, while infinite price elasticity means that the demand curve is perfectly flat.
The importance of price elasticity to policy questions can be illustrated with an example
regarding cigarettes, which are clearly a health concern. Suppose that a state added 50 cents per
pack to its tax on cigarettes. Together with supply-and-demand analysis, our elasticity concepts
help us identify the main policy issues. Lawmakers hope that such a tax increase will curb
smoking and bring in tax revenue, but these tend to be contradictory goals. The exact effects will
be difficult to predict unless reliable estimates are available of the cigarette price elasticity. If one
discovered that demand is perfectly inelastic, tax revenue would be at a maximum but with no
effect on smoking or health. Alternative scenarios of increasingly elastic demand create bigger
reductions in smoking but at the cost of decreasing tax revenues. Thus, the more elastic the
response, the greater the effectiveness of an excise tax in inducing people to reduce their levels
of smoking. Lewit and Coate (1982) indicate that teenagers, for example, are more responsive to
cigarette prices than are adults. In such cases, taxes on cigarettes will be relatively more effective
with teenagers.
Market demand elasticities vary by industry and by product. Those goods and services that we
call necessities tend to have elasticities less than 1 in absolute value, while luxuries are more
elastic. Short-run elasticities are generally smaller in absolute value than long-run elasticities.
Further, goods that cost only a tiny fraction of one’s income motivate little or no “shopping
around,” making their demand elasticities very small in absolute value.