Health Economics (6200431)

LECTURE 5
Dr. Butheina Surkhi
Faculty Of Medicine
Al-Quds University
2024
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Health Economics

Demand and supply

Measuring Demand

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Learning objectives
✓describe how to measure demand in practice
✓define price elasticity of demand (PED)
✓calculate PED over a portion of the demand curve
✓ describe the relationship between PED and revenue
✓ discuss issues concerning imposing (or increasing)
taxes or health service charges
✓describe how demand theory can be used in health
service planning
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The demand for health care
➢Several factors can increase the demand for healthcare services:
1. Population Growth: As the population grows, there are more people
requiring healthcare services, which increases overall demand.
2. Aging Population: As the population ages, the prevalence of chronic
illnesses and age-related conditions rises, leading to an increased need
for healthcare services.
3. Lifestyle Changes: Changes in lifestyle, such as sedentary habits,
unhealthy diets, and increased stress, can contribute to a rise in chronic
diseases and healthcare demand.
4. Advancements in Medical Technology: New medical technologies and
treatments lead to increased demand for healthcare services as more
conditions become treatable.
5. Health Insurance Coverage: Expanding health insurance coverage allows
more people to access healthcare services, leading to increased demand.

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The demand for health care-cont.
6. Awareness and Education: As people become more aware of health issues and
the importance of preventive care, they may seek out healthcare services more
frequently.
7. Epidemics and Pandemics: Outbreaks of infectious diseases can significantly
increase the demand for healthcare services as affected individuals seek
medical attention.
8. Increased Focus on Mental Health: A growing recognition of mental health
issues leads to higher demand for mental health services and support.
9. Lifestyle Expectations: In societies with higher living standards, people often
have greater expectations for their health and well-being, resulting in increased
healthcare demands.
10. Preventive Care Initiatives: Public health campaigns promoting preventive care
and regular check-ups can lead to higher demand for healthcare services.
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Elasticity and the responsiveness of demand
➢It is important to know about the responsiveness of demand to changes in
certain variables so that appropriate policies can be designed to alter it if
required.
➢Responsiveness is measured by economists and referred to as the elasticity of
demand; it is reflected in the shape and slope of the demand curve.
➢ The responsiveness of quantity demanded to a change in price is called price
elasticity.
➢ Elasticity can be measured for changes in income (income elasticity) and for
changes in the price of other goods (cross-price elasticity).
➢Demand elasticity can be useful for policy-makers and planners to know what will
happen if prices rise or fall.
➢Will there be a big change or a little change in the quantity demanded in
response to price changes?
➢The amount of health care demanded is sometimes measured by the quantity of
services used, such as inpatient days or outpatient visits.
➢ More often, it is measured by the total cost of the services.
➢Either of these measures can be used to estimate demand elasticity. 6
Inelastic and elastic demand
• Elasticity provides a way of measuring how sensitive demand (or
supply) is to factors such as a change in price.
• For many goods and services a price increase means that people buy
less, but in some cases the price rise has very little impact on
quantities consumed.
• Price elasticity of demand allows us to calculate how much demand
changes as a result of a change in price.

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1- Perfectly inelastic
• In Figure 4.1(a), the quantity
demanded is constant regardless of
the price.
• If the quantity demanded remains
constant when the price changes,
then the elasticity of demand is zero
and demand is said to be perfectly
inelastic.
• One good that has a low elasticity of
demand is insulin. Insulin is of such
importance to some diabetics that a
price change is unlikely to have
much effect on the amount patients
will purchase.

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Unit Elastic
• If the percentage change in the
quantity demanded equals the
percentage change in price, the
elasticity of demand is 1 and
demand is said to be unit elastic.
The demand curve in Figure
4.1(b) is an example of unit
elastic demand

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Perfectly elastic
• If the quantity demanded is
infinitely responsive to a price
change, then price elasticity of
demand is infinity and demand
is said to be perfectly elastic.
• The demand curve in Figure
4.1(c) is an example of perfectly
elastic demand,
• Such as luxury goods (gold,
jewels, luxury cars).

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Price elasticity of Demand(PED)

1. Between the examples shown in parts (a) and (b) of Figure 4.1 are the more general
cases when the percentage change in the quantity demanded is less than the
percentage change in price. In these cases, the price elasticity of demand is less than
1 and demand is said to be inelastic. Petrol and tobacco are examples of goods that
are typically inelastic in demand.

1. Between the examples shown in parts (b) and (c) of Figure 4.1 are the general cases
when the percentage change in the quantity demanded exceeds the percentage
change in price. In these cases, price elasticity of demand is greater than 1 and
demand is said to be elastic. Cereal and shampoo are examples of goods typically
with elastic demand. In health care, the demand for some forms of cosmetic surgery
is elastic.
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Calculating price elasticity
There are three points to note before we calculate price elasticity.
➢First, price elasticity of demand is calculated by dividing the proportionate change in
quantity demanded by the proportionate change in price.
➢ Note that elasticity is different to the slope of a demand curve.
➢‘Slope’ measures the absolute change in one variable given an absolute change in
another variable (e.g. change in quantity demanded divided by an initial change in
price).
➢Elasticities do not depend on the types of measures used and are most useful when
you want to compare the responsiveness of demand in different markets. ‘Slopes’ on
the other hand are dependent on the unit in which the good is measured.
➢ Consider a demand curve for paracetamol that has quantity measured in terms of
number of grams of paracetamol. This will be much steeper than a similar demand
curve that has quantity measured in tones of paracetamol.
➢However, for each price level the elasticity will be the same for both curves. 12
Calculating price elasticity-cont.
➢Second, price elasticity of demand will always be negative. This indicates
that as the price of a good increases, all other factors held constant,
consumers will demand less of that good.
➢When we analyse price elasticities we are concerned with their absolute
value, so we ignore the negative value.
➢ Third, the magnitude of the elasticity estimate provides a measure of how
responsive demand is.
▪ If the value of the price elasticity estimate is greater than 1 in absolute value, then demand is said to
be elastic.
When demand is elastic, consumers are very responsive to changes in price. As such, a small price
change will lead to a relatively large change in quantity demanded.

▪ In contrast, if the value of the elasticity of demand estimate is less than 1 in absolute value, then
demand is said to be inelastic and consumers are not very responsive to price changes.
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Price elasticity of demand
• This is summarized below (where PED represents price elasticity of
demand):
• If PED > 1 then demand is price elastic (demand is sensitive to price
changes)
• If PED = 1 then demand is unit elastic
• If PED < 1 then demand is price inelastic (demand is not sensitive to
price changes)

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Formula of PED
• The following formula is used to estimate the price elasticity of
demand:

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Calculating Elasticity
• Figure 4.2 shows one section on the demand curve for paracetamol and
how the quantity demanded responds to a small change in price.
• Initially the price is £5 per pack and 17 packs are sold per week.
• This is shown as the point A in the diagram.
• The price increases to £6 per pack and the quantity demanded decreases
to 15 pack per week (point B in figure 4.2).
• When the price increases by £1 per pack, the quantity demanded
decreases by two packs per week.
• To estimate the elasticity of demand, we express the changes in price and
quantity demanded as percentages of the average price and the average
quantity.
• By using the average price and quantity we are able to calculate elasticity
at a point on the demand curve midway between the original point and the
new point. The original price is £5 and the new price is £6 so the average
price is £5.50.
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Calculations.
• ΔP/Pavg. = (£1/£5.50) = 18% (where Δ denotes ‘change in’) .
• This tells us that the £1 price increase is 18 per cent of the average
price .
• The original quantity demanded is 17 packs per week and the new
quantity demanded is 15 packs per week. So the average quantity
demanded is 16 packs per week.
• The 2 pack per week decrease in the quantity demanded is
approximately 13 per cent of the average quantity.
• This is shown by: ΔQ/Q avg. = (£2/£16) = –13%
• So the price elasticity of demand, which is the percentage change in
the quantity demanded (13 per cent) divided by the percentage
change in price (18 per cent) is –0.72.
• That is shown by: Price elasticity of demand = %ΔQ/%ΔP = –13%/18%
= –0.72 18
What this number represents?
• First, remember that we are concerned with absolute values and
therefore ignore the negative sign.
• We calculated the price elasticity of demand to be 0.72, so our good
is price inelastic (PED < 1) and thus demand is not very sensitive to
price changes.
• Moreover, the value of 0.72 for the price elasticity of paracetamol
tells us that a 1 per cent rise in the price of paracetamol will lead to a
0.72 per cent fall in the quantity demanded.
• Alternatively, a 1 per cent fall in price will lead to a 0.72 per cent rise
in quantity demanded.

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Factors influencing elasticity
1. Availability of substitute goods: the more and closer the substitutes available,
the higher elasticity is likely to be, as people can easily switch from one good to
another if an even minor price change is made. Note that the number of
substitutes depends on how broadly a good is defined.
2. Percentage of income: goods that take a large portion of a consumer’s income
tend to have greater elasticity.
3. Time period: elasticity tends to be greater over the long run as consumers have
more time to adjust their behaviour and to search for substitutes.
4. Necessity: the more necessary a good is, the lower the elasticity, as people will
attempt to buy it no matter the price, such as in the case of insulin for those
that need it.
5. Who pays: where the purchaser does not directly pay for the good they
consume, such as in the case of employer-sponsored health insurance, demand
is likely to be more inelastic.
6. Brand loyalty: an attachment to a certain brand can often make consumers
insensitive to price changes, resulting in more inelastic demand.
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Healthcare elasticity
✓The overall demand for health care services is expected to be
relatively inelastic, in large part because there are few close
substitutes for medical services.
✓If you are sick, you will not be very price sensitive.
✓However, as noted earlier, there are exceptions to this rule (e.g.
elective surgery such as plastic surgery, purchases of glasses).
✓ But most studies find that patients are fairly insensitive to changes in
health care prices.
✓Price, income level, tastes, health status, and other circumstances
influence the consumption of physician services. However, we must
also consider the roles of insurance and of time.

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Other Variables Affecting Demand
1. Ethnicity and Gender : Black people tend to consume less medical care
than the other large, self-identified ethnic groups when other factors are held
constant. Females differ from males most clearly in their time pattern of
medical care usage. During childbearing years, women are relatively heavy
users of health care, but women are healthier in the long run .
2. Urban versus Rural: Studies sometimes find differences in health care usage
due to rural status.
3. Education: to determine whether education improves one’s health, or
whether the income it brings affords a healthier life.

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Example

• An analysis of the demand for physician care in 12 European Union

countries illustrates the universal relevance of demand theory. Jiménez-
Martin, Labeaga, and Martinez-Granado (2004) show that one-third to
one-half the variability in demand across countries is explained by
differences in age, income, and the physician’s role in the health care
system. Other factors include whether the general practitioner (GP) acts as
a gatekeeper and whether physicians are capitated, salaried, or paid on a
fee-for-service basis. In fact, the frequency of GP visits increases and the
probability of contacting specialists as well as the number of visits to
specialists decrease in countries where GPs are gatekeepers. Such results
can help policymakers design reforms that better meet their efficiency and
cost targets.

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Revenue and elasticity
• Price elasticities are also useful
because of their relationship with
revenue.
• Figure 4.3 shows how the revenue to
providers .
• Total revenue is the number of units
• of a good sold (horizontal axis)
multiplied by the price per unit
(vertical axis).
• The quantity sold here is 12 packs and
the market price is £4.
• Therefore total revenue is 12 × 4 =
£48. This is shown by the area of the
rectangular box.

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Revenue and elasticity
• As the price rises some revenue will be gained on each unit sold but some
will be lost because fewer units will be sold.
• We can now put these two concepts of revenue and elasticity together.
• If demand is price elastic then revenue will decrease if the price is
increased.
• If demand is price inelastic then revenue will increase if price goes up.
• We said before that total revenue is equal to price multiplied by quantity
demanded.
• So if price increases then total revenue can only fall if there is a
proportionally larger decrease in the quantity demanded. This is what
happens when the price elasticity of demand is elastic .
• The decrease in revenue due to a reduction in the quantity sold means an
elastic demand .
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Summary of relationship between elasticity and revenues

✓the change in total revenue depends on the elasticity of demand;

✓if demand is elastic, a 1 per cent price rise decreases the quantity
sold by more than 1 per cent and total revenue decreases;
✓ if demand is unit elastic, a 1 per cent price rise decreases the
quantity sold by 1 per cent and so total revenue does not change;
✓ if demand is inelastic, a 1 per cent price rise decreases the quantity
sold by less than 1 per cent and total revenue increases.

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Some other elasticities
• In addition to price elasticity of demand the following elasticities are often
calculated:
1. Cross-price elasticity of demand tells about the change in demand
for one product due to a change in the price of another product. We can
work it out by dividing the % change in the demand for a product by the %
change in the price of another product. Another name for this elasticity is
the cross-price elasticity of demand. When this type of elasticity between
the products is positive, it means that the products are substitutes..
2. Income elasticity of demand It means the change in the demand for
a product or service due to a change in the real income of a user. We can
measure the income elasticity of demand by dividing the % change in the
demand for a product or service by the % change in the income.
Calculating such elasticity also tells if the product is a necessity or inferior.
• If this elasticity is positive, it implies that the product is a normal product.
This means a rise in income would lead to a jump in demand. And, if the
income elasticity is negative, the product is usually an inferior product. It
would mean the demand drops when the income goes up because consumer
switches to better products.
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Implications of elasticity of demand in healthcare
1. Cigarette taxation
Levying of taxes on cigarettes is sometimes used to reduce cigarette
consumption, thus improving health and raising government revenue.
2. Taxes and tariffs on insecticide-treated bed nets :One of the steps
called for in the fight against malaria is the removal of tariffs and
taxes on insecticide treated bed-nets (ITNs), netting materials, and
insecticides, with a view to reducing the retail prices of ITNs and
thus increasing utilization.

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Summary
• In this chapter you have learned what is meant by price elasticity of
demand (PED) and how to calculate it.
• You also learned about the relationship between elasticity and total
revenue
• and the factors that influence elasticity of demand – closeness of
substitutes, the price of complements and the proportion of income
spent on the good.
• Finally, you looked at some practical applications of the concept of
elasticity and its usefulness in decision-making

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Videos
• https://www.youtube.com/watch?v=J82_xd5XxXg elasticity

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Activity
• For the following pairs of services, which of the two services would
you expect to be more income elastic? More price elastic?Explain
1. Surgical services versus allergist services
2. Heart surgery versus cosmetic surgery

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