Health Economics emerged as a specialized sub-discipline within the broader field of economics during the 1960s, characterized by the influential contributions of two prominent scholars, Kenneth J. Arrow (1963) and Mark V. Pauly (1968), whose works were disseminated in the American Economic Review. The groundbreaking article published by Kenneth Arrow in 1963 is frequently acknowledged as a foundational text that catalyzed the establishment of health economics as a distinct academic discipline, wherein he articulated conceptual differentiations between health and other commodities.
In a general sense, economics encompasses the analysis of how individuals and societies opt to allocate limited productive resources across competing alternative applications, and subsequently, how the resultant products from these allocations are disseminated among the constituents of a society. Health care and health are universally recognized as two critical outputs to which all societies allocate productive resources. Consequently, Health Economics can be defined as the examination of how limited productive resources are distributed among various applications for the treatment of illness and the advancement, preservation, and enhancement of health. Additionally, it encompasses the investigation of how health care services, health-related services, their associated costs and benefits, and health itself are allocated among individuals and demographic groups within society.
In summary, Health Economics constitutes a branch of economics that focuses on the examination of resource allocation within the health economy, both to and within its various components.
Key Concepts of Health Economics
Health
Health does not possess a universally accepted definition; however, it encompasses a broad spectrum of physical, mental, and social attributes. In general terms, health is regarded as a significant output to which all societies dedicate productive resources.
Health Sector
Within an economy, various types of health sectors exist. These comprise organized public entities, including governmental health departments and ministries, as well as the private sector, which encompasses health services provided by non-governmental organizations (NGOs).
Resources
A resource is defined as a source or supply from which benefits can be derived. Typically, resources may include materials, energy, services, personnel, knowledge, or other assets that are utilized to generate benefits and may, in the process, be consumed or rendered unavailable.
Scarcity
Scarcity denotes the fundamental economic dilemma, characterized by the disparity between finite—i e., scarce—resources and theoretically unlimited desires. This condition necessitates that individuals make informed decisions regarding the efficient allocation of resources to fulfill basic necessities and maximize the satisfaction of additional desires. Therefore, scarcity inherently implies the necessity of choice.
Opportunity Cost
When economists reference the "opportunity cost" associated with a resource, they are alluding to the value of the next-best alternative use of that resource. For instance, if one allocates time and financial resources to attend a movie, such time cannot concurrently be devoted to reading a book at home, nor can the financial expenditure be redirected towards other purchases. If the most favorable alternative to viewing the film is engaging in reading the book, then the opportunity cost of attending the movie encompasses both the monetary expenditure incurred and the enjoyment forfeited by not engaging with the book.
Efficiency
Efficiency assesses the extent to which resources are utilized to attain a specific outcome. It is a quantifiable concept that can be ascertained by calculating the ratio of beneficial output to total input. This concept encompasses several distinct facets.
The three principal components of efficiency may be succinctly articulated in layman's terms as follows:
- Do not squander resources;
- Generate each output at the lowest possible cost;
- Produce the types and quantities of output that individuals value most.
An optimal allocation of resources is one that concurrently fulfills all three criteria. The initial two criteria pertain solely to production; the third criterion incorporates consumption, thereby integrating the supply and demand dimensions of the output exchange.
1. Technical efficiency
The foremost component of efficiency necessitates that for any specified quantity of output, the quantity of inputs utilized in its production is minimized (this requirement may also be articulated such that maximum output is achieved from any designated combination of inputs). If this combination is not achieved, it becomes feasible either to generate increased output through an alternative resource configuration or to reallocate some of the resources to different applications without compromising any existing output. This component of efficiency is referred to as Technical efficiency. Hospitals that exceed the necessary size to adequately serve their communities exemplify technical inefficiency. Generally, multiple technically efficient combinations of inputs (for instance, combinations of labor and capital) exist for a given output level.
2. Cost-effectiveness efficiency
The second component of efficiency builds upon the first but incorporates the relative costs associated with different inputs. It necessitates that, in addition to achieving technical efficiency, inputs be synergistically combined to minimize the cost of any given output (alternatively, this requirement may be expressed as maximizing output for a specified cost). For instance, if labor is abundant and comparatively inexpensive relative to capital in one economy as opposed to another, then the most economical production methods will utilize a relatively higher proportion of labor in the former economy. This component of efficiency is referred to as cost-effectiveness efficiency.
3. Allocative efficiency
The tertiary dimension of efficiency correlates the provision of outputs with their respective demand by broadening the analytical framework to incorporate the preferences and values held by societal members who utilize these outputs. It necessitates that, in addition to achieving technical efficiency and cost-effectiveness, resources should be allocated towards the production of specific types and quantities of outputs that most effectively fulfill the needs and desires of individuals, or in other words, those that individuals prioritize most highly. The economic term employed to encapsulate this comprehensive notion of efficiency is Allocative efficiency.
It is feasible for a resource allocation to achieve both technical efficiency and cost-effectiveness while remaining allocatively inefficient if producers are delivering an excessive or insufficient quantity of any goods or services in relation to consumer preferences. For instance, if mothers of young children express a preference for counseling services addressing behavioral issues over frequent well-child check-ups, then allocative efficiency could potentially be enhanced by adjusting the composition of primary care services, notwithstanding that the well-child examinations are being conducted in a cost-effective manner.
In colloquial terms, efficiency encompasses both the concept of 'doing things right' (which refers to technical efficiency and cost-effectiveness) and 'doing the right things' (which pertains to allocative efficiency).
Pareto efficiency
The criterion of Pareto efficiency, named after the 19th-century sociologist and economist Vilfredo Pareto, posits that allocative efficiency has been achieved when it is impossible to reallocate resources in a manner that enhances the welfare of any individual without simultaneously detracting from the welfare of at least one other individual.
Relevance of Health Economics
Health economics represents the intersection between health and the resources required for its promotion or preservation. The exploration of health economics holds significant importance and interest for three interconnected reasons. Due to the fact that numerous nations have witnessed rapid escalations in healthcare expenditure over the past five decades, health economics has emerged as a distinct field within the broader discipline of economics. The generation and distribution of healthcare services across populations fall within the purview of health economics, which examines the allocation of resources to, and within, the health economy.
Health economics is pertinent and engaging for three interrelated reasons:
- The magnitude of the health sector in relation to the overall economy (approximately 18% in the United States). The health sector holds economic significance primarily due to its size. As one of the largest service industries, it constitutes a critical sector within developed economies. Currently, its output represents around 7% of GDP in the EU-15, exceeding the approximately 5% attributed to the financial services sector or the retail trade sector.
- National policy considerations arise from the significance individuals place on the economic challenges associated with maintaining optimal health, and;
- Numerous health-related issues possess considerable economic dimensions, including their relevance in personal expenditure, the substantial size of the health sector labor force, the extensive capital investment dedicated to health infrastructure (such as hospitals, nursing home beds, and medical devices), the variable growth in health expenditures impacting funding from governments, businesses, and individuals, and the disparities in the quality of healthcare provision.