Measuring Efficiency and Cost-Effectiveness in the Health Care Sector

Size: px
Start display at page:

Download "Measuring Efficiency and Cost-Effectiveness in the Health Care Sector"

Transcription

1 Measuring Efficiency and Cost-Effectiveness in the Health Care Sector Kam Yu Department of Economics Lakehead University Thunder Bay, Ontario Canada P7B 5E1 Phone: January 14, 2011 The author acknowledges funding from Health Canada for this project. This paper is published as Chapter 5 in Kam Yu (2010) Essays on the Theory and Practice of Index Numbers: The Making of Macroeconomics Data, VDM Verkag.

2 Abstract The health care sector has become a large part of the national economy. Its expenditure share in the gross domestic product has been increasing over the years. An important piece of information for the current policy debate is the effectiveness and efficiency of our health care system. The objective of this study is to review and critique approaches in measuring the effectiveness and efficiency of health care production at the sub-sector level. For the market economy, economists identify three main type of efficiencies, namely, technical efficiency, cost efficiency, and allocative efficiency. A measure of efficiency, often called productivity, is the amount of output produced by a unit of input. For reasons of social equity and the market structure and incentives, most developed countries choose a publicly funded health care system. The output quantity of health care services is a key component in productivity measurement. There are, however, conceptual difficulties in pinpointing a precise definition in health care output. Current practices include factor inputs, service activities, course of treatment, health status of patients, and monetary metric of overall well-being. Lack of observed output prices further adds to the challenge of aggregating different services into a higher level index number. There are two general approaches in measuring productivity change over time. The statistical approach is more flexible and versatile but technically more challenging. The index number approach requires more assumptions on the production technology. The benefits are simplicity, ease of use, and consistency of the results. For efficiency comparison across regions or production units, analysts have developed the data envelopment technique in addition to statistical and index number approaches. All three methods are based on a concept called the Malmquist productivity index. Data envelopment analysis is also a flexible and versatile technique, with minimal assumption on the production technology. The method is popular among health care analysts and managers. There are, however, a few technical deficiencies and shortcomings. Other practical challenges facing health care analysts are consistent in output definitions, the treatment of quality changes in the services, and the lack of appropriate input data for productivity calculation. JEL: C43, I12 1

3 Contents Abstract 1 1 Introduction 4 2 Economic Efficiency and Effectiveness Competitive Production Economy Private Versus Public Sectors Output Measurement in Health Care Measuring Costs Measuring Activities Measuring Cases Measuring Consequences Measuring Welfare Measuring Efficiency Change Over Time Relative Efficiency Productivity and Growth Accounting Index Number Approach Cost Weighted Productivity Index for the Health Care Sector Econometrics Versus Index Numbers Comparing Efficiency Across Production Units Deflation (Distance) Function Malmquist Productivity Index Data Envelopment Analysis The Basic CCR Model Simple Examples Extensions of the Basic Model Applications to Health Care Sector Limitations of DEA Measurement Problems of Health Care Sectors in Canada 31 7 Conclusion 34 References 35 A Appendix Technical Details of Cost Weighted Productivity Indices 41 A.1 Fixed Coefficient Technologies A.2 Separable Production Functions A.3 General Cost Functions

4 List of Figures 1 Williamson s Contractual Schema Measuring Efficiency Deflation Functions Technical and Cost Efficiencies Data Envelopment Analysis Health Care Spending Laspeyres Output Index of the Canadian Hospital Sector, List of Tables 1 Hours of Operation and Patient Visits in Family Clinics Health Care Expenditures in G7 Countries in

5 1 Introduction In Canada and other industrialized countries, the share of the health care sector in the overall economy has been increasing over recent years. Total health care spending in Canada is forecast to reach 160 billion dollars in 2007 and the ratio of health expenditures to GDP to hit 10.6 percent (CIHI, 2007a). In most OECD countries, health expenditures per capita are growing faster than per capita income and the widening gap in these growth rates creates the potential of an enormous unfunded future liability (Kotlikoff, 2007). There is an ongoing policy debate on the implications of the rising costs of health care. To facilitate a rational debate, it is essential for policy makers and citizens to be informed about the basic trends and characteristics of the health care sector. This information includes the determinants of health care expenditure (Di Matteo and Di Matteo, 1998; Di Matteo, 2004), a proper measure of inputs and outputs, and the outcomes or general health status of the citizens. This allows policy analysts to monitor productivity and cost efficiency of the sector over time and compare performance with other countries. There are, however, a number of methodological problems in the measurement and analysis of the health care sector. While essentially having many of the characteristics of marketed goods and services, health care services in Canada and most industrialized countries are funded by the government and sometimes also provided by the public sector. In Canada, approximately 70 percent of health care is publicaly funded while 30 percent is private. Apart from equity issues, there are economic justifications for this arrangement. Williamson (2000) argues that under various forms of contractual hazard and bounded rationality, direct government provision of a good or service can be the optimal choice in order to reduce transaction costs. Under this arrangement, health spending determinants are hard to pin point even in theory. For example, doctors play a double role as patients agents and providers. When medical costs are not out-of-pocket expenses, the services are not evaluated by the consumers on a willingness to pay basis. Often the provision of some services are rationed. All these make it difficult to separate the demand side from the supply side. As well, there are irreversibilities in production, asymmetric information and issues of moral hazard that also complicate health care service provision and measurement. There are three definitions of efficiency that are considered by economists. First, technical efficiency addresses the question of whether the producer maximizes outputs with given inputs and technology. Second, cost efficiency involves minimizing total cost of production for a given output level. Finally, allocative efficiency ensures that the product mix attains maximum social welfare. All three efficiencies are satisfied under the assumption of a competitive economy. With the mixed market and public sector structure of the health care sector there is no reason to believe that any of these conditions for a competitive economy are satisfied. A number of techniques have been developed in recent years to measure various aspects of efficiency for the health care sector. Cost-effectiveness analysis (CEA) uses 4

6 the idea of the change of cost with respect to the change of outcome for a particular disease. It can be used to compare cost efficiency across hospitals for the same treatments or procedures. Cost-utility analysis (CUA), on the other hand, measures the change of cost with respect to an utility-based measure such as the quality-adjusted life year (QALY). CUA can be used to compare benefits of treatments across diseases and so it has the potential of addressing the problem of allocative efficiency. There are, however, controversies in using outcome-based measure in efficiency studies. Fuchs (1998) argues that health status of citizens primarily relates to genetic and environmental factors and personal behaviours. Also, outcome measures such as a QALY are life expectancy adjusted with a utility score. The scale of adjustment is subject to the interpretation of the analysts. Another approach in measuring efficiency over time is the index number method. By assuming that production is cost-efficient, a productivity index can be calculated to reflect the change of technological improvement in different time periods. In fact, the measure requires the break down of the total expenditure change into two components, namely a price change and an output change. The challenge in this approach is to take into account of the quality change in each treatment of disease and adjust the price or quantity index. An index number approach creates the possibility of an standardized and consistent approach to measurement of health care outputs and outcomes. In addition to measuring efficiency change over time, policy analysts and health care managers are interested in how it varies across regions or production units. along side with the index number approach, other techniques such as data envelopment analysis are popular among analysts. The objectives of this research project are to review and critique current approaches to measuring efficiency and/or costeffectiveness of the health care sector at the sub-sector (e.g. primary care and hospitals) level, to review advances in other countries in the measurement of efficiency and cost-effectiveness of public spending on health care, and to identify the means and mechanisms by which we can develop better measures in Canada. The structure of the paper is as follows. Section 2 introduces the concept of efficiency in a market economy and discuss the rationale of a publicly funded health care system. Section 3 discusses the difficulty of defining the output of a service sector such as health care, and suggests the best compromise in doing so. Statistical methods and the index number approach in measuring productivity over time are explained in section 4. A cost weighted productivity index is introduced to overcome the absence of output prices. Section 5 introduces the deflation function and its use in the Malmquist productivity index and its relation to data envelopment analysis. Techniques involving DEA and its applications to the health care sector 5

7 are explained in detail. In section 6 we discuss the practical problems facing health care analysts in measuring efficiency and productivity. Finally section 7 concludes. 2 Economic Efficiency and Effectiveness In this section we first define various types of economic efficiencies in a competitive market economy and their meaning in a publicly funded health care system. 2.1 Competitive Production Economy In a competitive production economy with free exchanges, market prices play the vital roles of allocation of resources, production, and distribution of outputs to achieve efficiency. Under the neoclassical paradigm, Pareto efficiency is the commonly used criterion in evaluating the performance of an economy. An allocation of goods and services is defined as Pareto efficient if the welfare of any consumer cannot be improved without making the welfare of another consumer worse off. The First Welfare Theorem of Economics asserts that, under the competitive assumptions with no externality, the free market solution, known as the Walrasian equilibrium condition, is Pareto efficient. First, consumption efficiency is achieved since every consumer s welfare is maximized given the budget constraint. Second, production efficiency is achieved since every producer maximizes its profit. Third, consumption and production of all goods and services are in a state of optimal balance, which economists call production-mix or market efficiency. Market prices in this competitive economy play the central role of connecting the consumers and the producers. Agents observe the prices as a common signal and make buying and selling decisions to achieve their own objectives. The idea of production efficiency can be further broken down into several concepts: Technical efficiency This refers to a producer achieving the maximum output level given all the input resources under the prevailing technology. In other words, the producer utilizes the resources in the most efficiency way. Economists use the idea of a production function to represent technology. For example, suppose a producer uses capital K, labour L, and other intermediate inputs M to produce a single output Y, technology is represented by the production function F as follows: Y F (K, L, M). (1) Technical efficiency is achieved when the inequality in (1) turns into an equality. In general, a producer can be inefficient due to obsolete technology or poor management. Cost efficiency Technology allows a producer to choose different combination of input factors to produce a required output level. The choice of the 6

8 combination depends the market prices of the input factors. The objective of the producer is to choose an input bundle that minimizes total cost. For example, suppose r is the rental rate of capital services, w is the market wage rate, and w M is the price of intermediate input M, the producer chooses an input combination (K, L, M) to minimize total cost rk + wl + w M M to achieve an output level Y. Both technical efficiency and cost efficiency are necessary conditions for the overall production efficiency. Given the market price p of the output, production efficiency is achieved when the producer chooses output level Y and input bundle (K, L, M) to maximize profit, which is py (rk + wl + w M M). (2) It can be seen from (2) that this cannot be achieved unless the producer produces the best possible amount of output with the lowest possible total cost. On the consumer side, efficiency is achieved when the consumers have the full information to make a rational decision on their consumption choice. Since a consumer s preferences is private information, economists normally assume that the consumer s actual choice is optimal. 1 Conceptually, the value of consuming an economic good or service is the sum of the market value and the consumer surplus. For a produced good, market demand is the total of all individual consumer s demand for the good, market supply is the total amount supplied by all producers. Both consumers and producers make their decision by observing the market price. The idea of a Walrasian equilibrium is a set of prices such that total demand for each good and services is equal to its total supply. If such an equilibrium exists, no consumer or producer want to change their decisions. Under this ideal situation the economy s resources are put into their best uses and market efficiency is achieved. 2.2 Private Versus Public Sectors From an efficiency viewpoint, the above discussions provide the rationale for an market economy. That is, the provision of goods and services relies on producers in the private sector, and consumers are free to choose the combination and quantities of goods and services they buy. The economic role of the government is to define and maintain the property rights of its citizens and to serve as an arbitrator in contract enforcement. In reality, however, conditions for such a laissez faire economy are rarely satisfied. On the whole, the economy operates under a variety of additional constraints. These constraints can be cultural, historical, social, political, psychological, or technical. The presence of these constraints gives rise to our formal and informal institutions (North, 1990). In this section we focus our discussion on technical nature of markets which result in government intervention or public provision of the goods and services. 1 Reveal preference theory can be used to test whether the consumer s observed behaviours conform with rationality assumptions. 7

9 Economists use the term market failure when a market fails to achieve Pareto efficiency. There are many reasons for the inefficiency. Here we discuss a number of key concepts. Externality This occurs when consumption or production of a good or service affect the welfare of other consumers or the profit of other producers. The effect can be positive (R&D) or negative (pollution). In either case efficiency cannot be achieved in a market in the presence of externality. Coase (1960) famously asserts that externality arises in situations which property rights are not well-defined. Non-rivalry A good or service is non-rivalous when it can be consumed by many users without extra cost. Non-exclusiveness In this case the usage rights of a property is not welldefined. 2 That is, the owner of a good cannot exclude other people from using it. The term public goods is often used for goods and services that are nonrivalous and non-exclusive. Under provision of such goods by the private sector due to the free-rider problem usually leads to public provision. Examples are national defence, foreign affairs, and diplomatic services. Asymmetric information The neoclassical model assumes that agents have full information for economic transactions. In many situation either the buyer or the seller has difficulty or no incentive to reveal the full information about the transaction to the other party. This so called signalling problem causes the market to be inefficient. Important consequences are adverse selection, moral hazard, and statistical discrimination. High transaction costs Economic transactions always involve measurement costs and enforcement costs. Measurement costs include the costs of revealing the physical and legal characteristics of a good or services, whereas enforcement costs consist of the costs of defining and enforcing the contract. Transaction costs generally depend on the institutional environment. High transaction costs often cause contractual hazard and market inefficiency. Although health care services are generally not non-rivalrous and non-exclusive, the presence of externality, asymmetric information, and transaction costs may causes certain degree of market failure and justify public provision of at least part of the services. Figure 1 illustrates a contractual schema taken from Williamson (1985, 2000), where h denotes contractual hazards and s denotes safeguards. The nodes from A to D represent different choice of market structures. We now apply the schema to the market of health insurance. It is well-known that contractual hazards exist 2 Property rights can be divided into ownership, usage, income, and transfer rights. See Furubotn and Richter (2005, ) 8

10 A (Unassisted market) h = 0 B (Unrelieved hazard) s = 0 h > 0 C (Credible commitment) s > 0 market safeguard administrative Figure 1: Williamson s Contractual Schema D (Integration) both on the demand side and the supply side (Pauly, 1968; Zweifel and Manning, 2000; and Krugman, 2006). Therefore node A, the neoclassical unassisted market does not exist. Node B, the market structure of unrelieved hazard, represent what Williamson calls fly-by-night transactions, where no safeguard is employed to mitigate the contractual hazard. In fact, studies have shown that a private system like that in the U.S. results in high transaction cost on safeguards (Woolhandler et al., 2003). Node C is where the private health insurance companies operate, with a mixture of government regulations and reputation effects. Most health care systems in industrialized countries, however, opt for node D. It represent the case that the government chooses to manage the transaction itself. (Williamson, 2000, p. 604) Therefore, in the presence of contractual hazard, the most efficient market solution with the lowest transaction costs on safeguards may be a government administered health care system. Indeed there are evidences that in the U.S. the public systems of Medicare and Medicaid have lower average costs than that of the private system (Woolhandler et al., 2003). 3 Output Measurement in Health Care The first step in measuring efficiency and effectiveness of any sector is to define the inputs and outputs. Input factors in the health care sector is relatively well-defined, depending on the scope of the analysis. Outputs in the sector, however, is a different story. The problem is common in the service sector in general. The lack of market prices for most of the services in health care adds another layer of complication. The production and consumption of goods and services can be roughly divided 9

11 into five stages, namely, inputs, activities, products, consequences, and welfare. The followings are examples in the health care sector: 1. Inputs nurses, doctors, technicians, administration staffs, drugs, medical tools and equipment, clinics and hospitals, catering, etc. 2. Activities clinic and hospital visits, physical examinations, diagnostic tests, surgeries performed, sessions of therapy, etc. 3. Products courses (episodes) of treatment, number of cases adjusted for severity, lengths of treatment, quality of care, etc. 4. Consequences health status of patients adjusted for environmental and socioeconomic factors. 5. Welfare The overall welfare of consumers combining health status with consumption of other goods and services. 3.1 Measuring Costs Most countries, including Canada, traditionally measure the total costs of inputs as total expenditures in publicly provided services such as hospital care. Since price information is unavailable, changes in total expenditure are treated as pure price changes. In other words, Q is assumed to be 1 in every period, forcing the price index P equal to the expenditure ratio. Sharpe et al. (2007) report that the average annual real output growth of the hospital sector in Canada is 1.02 percent from 1984 to From the theoretical standpoint, the cost-based approach can be justified by considering the government as a provider of health care services with cost function C(w, q) where w is the input price vector. Assuming zero economic profit, the output prices are the elements of the vector of marginal costs, p = q C(w, q). If we further assume that technology exhibits constant return to scale, then q q C(w, q) = C(w, q) and so cost will be the correct value for government outputs (Yu, 2008). Marginal costs, however, are not easily observable. Additional difficulties arise in the definitions of quantity. 3.2 Measuring Activities Instead of aggregating input factors as output, activities carried out by medical personnel can be counted. For example, starting from 1998, the U.K. has switched from an input-based measurement to an activity-based one. In the health care sector there are 16 activity series such as inpatient and day cases, outpatient and community health treatments, general practitioner services, dental services, etc. 3 In any series, 3 See Pritchard (2003), Mai (2004), and HMSO (2005). 10

12 activities such as surgeries performed or number of consultations are aggregated using a Laspeyres quantity index: Q L = N i=1 p0 i a 1 i, N i=1 p0 i a0 i where a t i is the number of activities i in period t and p 0 i is its average cost in period 0. These cost-weight activity indices was implemented until 2004, when the series were expanded and the definitions of activities were more refined. From the patients perspectives, the number or level of activities such as number of diagnostic tests conducted, surgeries performed, or length of hospital stay is not the main concern. It is, instead, whether or not an acute disease or injury can be cured as quick as possible, or a chronic illness can be under control with minimum impacts on their quality of life. Therefore, if a cancerous tumour can be removed with less amount of hospital stay and fewer number of intrusive surgical procedures or chemotherapy treatments, it should be considered as a quality improvement. Although there is a decrease in activities, output measures should be adjusted upward. Therefore activities can be an inappropriate measure as a proxy for output. 3.3 Measuring Cases There are an increasing number of economists suggesting that health care measurement, particularly for hospital services, should move towards an episode based approach. 4 The idea is close to the concept of a product in a market economy, which is the object of measurement in the system of national accounts. Hospital services, for example, can be classified according to a well-defined system of taxonomy such as the International Classification of Diseases (ICD) published by the World Health Organization (WHO). 5 In the latest version, ICD-10, each type of disease is coded by an alphabet with a two digit number. For example, J60 represents anthracosilicosis, a lung disease suffered mostly by coal mine workers. The Canadian version is called ICD-10-CA. The number of cases in each type of disease can be compared and an elementary quantity index calculated. These indices can in principle be adjusted for severity and quality of care. Aggregation can be achieved by weighing the elementary indices with their relative costs. 3.4 Measuring Consequences There has been a large volume of research on cost effectiveness in health care services. 6 One of the objectives of these analyses is to study the technical efficiency 4 See Triplett (1999), Bernt et al. (2000), National Academy of Science (2002), Mai (2004). 5 Details are available at 6 For reviews see Gold et al. (1996), Brazier et al. (1999) and Garber (2000). For the theoretical foundation see Grossman (1972). 11

13 of two or more treatment methods for a particular disease. For example, the costeffectiveness ratio between two treatment methods A and B for the same disease is defined as CE AB = p A p B e A e B, (3) where p A, p B, e A, and e B are respectively their costs and measures of effectiveness. In comparing two treatments, the ratio is compared with a bench mark number. A relatively low ratio means that treatment A is more cost-effective than B. Note that the costs of the treatments should include both direct cost and indirect costs, which may be time of treatments, income loss, etc. The effectiveness measure can be simple mortality rates, success rate of curing an appropriate physiologic measure such as blood pressure, hormone level, etc., or a combination of several desirable characteristics. Cost-effectiveness ratios can also be used to study allocative efficiency across diseases. The effectiveness e in this case must be a general outcome measure of the well-being of the patients. Commonly used measures are money metric evaluations of the patients utility values on the treatment. For example, the quality-adjusted life years (QALY) of a patient can be defined as the present value of the weighted sum of all future life years. For a patient with age A, QALY A = i=a δ i A w i π i, (4) where w i is a weight between 0 and 1, π i is the probability of the patient being alive at age i, and δ is a time discount factor. The weight factor w i is equal to 1 when the patient is in perfect health and 0 if dead. 7 The interpretation of δ is ambiguous. It incorporates both the intertemporal time preference structure of the patient and his/her attitude towards risk and uncertainty. This ambiguity, however, is common in cost-benefit analysis. Conceptually QALY can be viewed as a quality-adjusted life expectancy. That is, if we assume δ = w i = 1 for all i, the result is life expectancy of the patient at age A. For this reason QALY is sometimes called health-adjusted life expectancy. If QALY is multiplied by the dollar value of a statistical life year, the cost-effectiveness ratio in (3) becomes dimensionless, which is useful in cross-disease analysis and international comparison of the same treatments. Another utility-based outcome measure directly models the patients preferences on health status under risk. Suppose a patient has a von Neumann-Morgenstein utility function U(Q, t) on health status Q and life year t. Then the health-year equivalent, H is implicitly defined as U(Q H, H) = U(Q T, T ). (5) Here Q H is a perfect health status or profile for H year and Q T is the patient s actual health profile for T years. That is, the patient is indifferent between living H years 7 Some analysts allow w i to have negative values, meaning the suffering from an illness is worse than being dead from the patient s perspective. 12

14 under perfect health and T years under the condition Q T. Conceptually healthyear equivalent is similar to the certainty equivalent in expected utility theory. The conversion of any health profile is converted to a standard measure so that health years can be aggregated across patients and diseases. 3.5 Measuring Welfare The ultimate objective of health care intervention is for the consumers to combine their improved health status with consumption of other goods and services to achieve a higher quality of life. This means the health status of a consumer (Q T in (5)) is intrinsically interwound with other consumption in the utility function. This poses a challenge in separating the net value of health status with other goods and services. A widely used tool for this purpose is cost-benefit analysis. For marketed goods and services, the benefit of consumption can be inferred from the observed price and quantity data. For non-marketed goods, there are tools available such as the contingent valuation method (CVM). The procedure involves interviews, questionnaires, or experimental techniques to ask the respondents directly about their willingness-topay (WTP) for the goods, or infer the values indirectly from the experiments. CVM has become acceptable after some studies show that the results yield WTP similar to results using other direct approaches such as the hedonic method and the travelling cost method. For example, Pauly (1999) suggests that the price of a quality change of a particular treatment is the difference in premiums charged by the insurance company for including the new treatment in the package. This price difference provides a lower bound estimate for the consumers WTP for the quality change. For publicly funded system with universal coverage, however, he recommends using a general effectiveness measure such as QALY since inclusion of more costly new treatment methods is a collective choice which involves altruistic externalities. 4 Measuring Efficiency Change Over Time It is clear from section 3 that efficiency in the health care sector depends critically on the definition of output. The first two measures, direct costs and activities, are more associated with technical efficiency. The case measure, on the other hand, is close to the concept of output of a marketed product and therefore related to the concept of overall production efficiency. Finally, consequences and welfare involve the consumption side and can be put in the broader scope of consumption efficiency and market efficiency. In this section we shall review the theory and practice of efficiency measurement over time. In Section 5 we shall discuss comparing efficiencies across production units. 13

15 4.1 Relative Efficiency In the ideal world of the neoclassical model, decision makers are perfectly rational and information is costless to obtain. In this frictionless economy institutions are unnecessary. In the real world, agents face additional constraints and therefore it is impossible to define an absolute state of efficiency. In practice, the measurement of efficiency is relative. Often there are two types of comparison we can make. The first type is intertemporal productivity studies, which involves comparing efficiency of the same economy over time. 8 The second type is spatial productivity studies, which compare the relative efficiency of two or more economies or firms in the same time period. The basic idea of efficiency is quite simple. It is a measure of how much output a firm or an economy can produce using a certain amount of input. Consider the simplest case of one output (Y ) and one input (L). Technology in period t is represented by the production function Y = F t (L). If F exhibits constant returns to scale, then Y is a linear function of L. For example, doubling the input L will produce exact doubt the output Y. Suppose in period 0 a firm uses input l 0 to produce output y 0, which is depicted as point A in Figure 2(a). In period 1 the same input produces output y 1, at point B. The efficiency change from period 0 to 1 can be expressed by a productivity index P r = y 1/l 0 y 0 /l 0 = y 1/y 0 l 0 /l 0 = y 1 y 0. Since point A is on the production function F 0 in period 0 and point B is on F 1 in period 1, the firm is technically efficient. In the case P r is a measure of the technological change between the two periods. On the other hand, suppose that in period 1 the firm uses input l 2 to produce output y 2, which is point C in Figure 2(a). Then the firm is technically inefficient in period 1 if we maintain the assumption of constant returns to scale. With input equal to l 2, the firm has to be at point D to be technically efficient. The productivity index P r = y 2/y 0 l 2 /l 0 now include technical efficiency and technological change. It is, however, possible that our assumption of constant returns to scale is incorrect. Figure 2(b) shows the production functions in the two periods with decreasing returns to scale. In this case point C is on the production function F 1 and so the firm is technically efficient in both periods. We shall show later in this paper that revealing the scale of the production function can be challenging. 8 The term productivity traditionally means the unit of overall output that can be produced from one unit of aggregate input for a particular economy. Recently productivity studies have extended to firm and even plant levels. In this paper we use the terms relative efficiency and productivity interchangeably. 14

16 Y Y y 2 y 1 y 0 Y = F 1 (L) D Y = F 0 (L) C B A L l 0 l 2 B A C Y = F 1 (L) Y = F 0 (L) L (a) Constant Returns to Scale (b) Decreasing Returns to Scale Figure 2: Measuring Efficiency 4.2 Productivity and Growth Accounting Let us now consider intertemporal productivity measurement using the Solow-Swan Model. The model has been successful applied to growth accounting, the study of total factor productivity growth over time. 9 Consider the production in (1) again with the superscript t representing the time period: Y t = A t F (K t, L t ). (6) The new variable A t is often called the Hicksian shift parameter. Also, we have dropped the intermediate input factor M for notational convenience. Denote the time derivative of any variable X by Ẋ = X/ t, the production function can be written in the following time derivative form: Ẏ t Y t = Kt Y t Y t K t K t K + Lt Y t t Y t L t Lt L + A t (7) t A t The term (K t /Y t )( Y t / K t ) is the output elasticity of capital and similarly for the labour input L t. These elasticities are not directly observable but if we assume that each input factor is paid the value of its marginal product, then The elasticities become Y t K t = rt p t and Y t L t = wt p t. K t Y t Y t K t = rt K t p t Y t = st K and l t Y t Y t L t = wt L t p t Y t = st L 9 See Barro and Sala-i-Martin (1995) for an extensive review on growth theory. 15

17 where s t K and st L are the income shares of capital and labour respectively. Using these assumptions, (7) can be written as R t = Ȧt A = Ẏ t t Y t st K K t L t K t st L (8) L t The Solow residual, R t is the growth rate of the Hicksian parameter A t and a measure of the productivity growth rate of the economy in growth accounting. The concept, however, is the same if we use it as a measure of productivity growth on the industry level. 10 By using continuous time analysis, the Solow residual is a form of Divisia index (Hulten, 1973). In practice data are available only in discrete time periods. There are two general approaches to implement discrete productivity measurement. In the first approach, a functional form is assumed for the production function F. Parameters in the functional form are then estimated by econometric method. 11 The residual R t can be derived from (8) using the estimated parameters. Notice that since market prices for most medical services are not available, the output quantity index Ẏ t /Y t has to be estimated using some direct method (Yu and Ariste, 2008). 4.3 Index Number Approach The second approach in measuring productivity growth is the index number approach. A productivity index from a base period 0 to a comparison period 1 can be defined as P r = Q(p0, p 1, y 0, y 1 ) (9) Q (w 0, w 1, x 0, x 1 ) where p t and y t are the price and quantity vectors of the output, and w t and x t are the price and quantity vectors of the input factors in period t, t = 0, 1. Q and Q are the output and input quantity indices respectively. Diewert (1992a) recommends that the Fisher quantity index to be used for Q and Q. The Fisher input quantity index, for example, is defined as ( ) Q F (w 0, w 1, x 0, x 1 w0 x 1 w 1 x 1 1/2 ) =. (10) w 0 x 0 w 1 x 0 There are two advantages in using the Fisher formula. First, it possesses the largest number of axiomatic properties that are desirable for an index number. Second, the Fisher index can be derived from a production function that has the functional form F (x) = (x T Ax) 1/2, (11) where x is the input quantity vector and A is a symmetric matrix of parameters. F in (11) is known as a normalized quadratic function and is capable of approximating 10 See Prucha and Nadiri (1981) for the productivity study of the U.S. electrical machinery industry. 11 See, for example, Diewert (1992b) for details. 16

18 an arbitrary continuous production function to the second degree. Diewert (1976) defines an index number formula that satisfies this criterion as a superlative index. 12 It can be shown that most superlative indices approximate each other at equal prices and equal quantities to the second degree. Therefore unless the price and quantity vectors change dramatically over two periods, the choice of superlative index formulae is not important. Another commonly used superlative index is the Törnqvist (1936) index. For example, the Törnqvist input quantity index is defined as Q T (w 0, w 1, x 0, x 1 ) = N ( ) x 1 (s 0 n +s 1 n )/2 n, (12) where s t n is the value share of input factor n in period t. Diewert (1976) shows that the Törnqvist quantity index can be derived from a translog production function, which is a popular choice of functional form used in productivity analysis as in (8). The productivity index defined in (9) is often called a nonparametric approach. What Diewert has shown is that the index formulae are not quite nonparametric. Behind each of the commonly used index is a particular form of production function. In addition to the Fisher and Törnqvist indices defined above, for example, the Laspeyres and the Paasche quantity indices are exact for the Leontief production function F (x) = min{x n /a n : a n > 0, n = 1,..., N}. (13) n The Laspeyres and the Paasche indices, however, are not superlative as defined by Diewert because the Leontief function is not flexible, that is, it cannot provide a second order approximation to an arbitrary function. As a consequence, the use of the Laspeyres or the Paasche quantity indices may result in biases in the productivity index. Details of the economic approach in index numbers can be found in Diewert (1993a). In practice, productivity indices such as P r defined in (9) are called multi-factor productivity (MFP) as opposed to indices using one input only, such as labour productivity. Input factors are grouped into major categories, which are themselves quantity indices. In recent years statistical agencies around the world have generally agreed to use a standardized system called KLEMS, which stands for capital, labour, energy, materials, and purchased services (Baldwin et al., 2007; Statistics Canada, 2008). 4.4 Cost Weighted Productivity Index for the Health Care Sector Since the output prices in the government provided health care sector is unobservable, the traditional method in calculating the outputs in the system of national account is based on the cost approach. Yu (2009) points out that by assuming the providers 12 The Fisher index is also said to be exact for the normalized quadratic function. n=1 x 0 n 17

19 such as hospitals as non-profit organization, the social optimal prices should be the marginal costs. For example, let C(w, y) be the cost function of a hospital where w is the input price vector and y is the output quantity vector. Then the output price vector is p = y C(w, y). Furthermore, if we assume that technology exhibits constant returns to scale, then the total cost is given by C(w, y) = p y = y C(w, y) y. Therefore under these assumptions the value of total outputs is indeed equal to the total value of the inputs. Assuming marginal cost pricing and constant returns to scale, Diewert (2008) has developed cost weight productivity indices under various functional forms for the production function. Diewert s approach is a step forward in the theoretical foundation of productivity index when output prices are not observable. We summarize Diewert s results in the section. Details can be found in Appendix A. In the first model, the production function is assumed to be the Leontief function defined in (13). In particular, a production unit or hospital provides treatments for M diseases according to the ICD classification using N input factors. Denote the M- vector y = (y 1,..., y n ) as the cases or episodes of treatment. For each disease type i, i = 1,..., M, denote the N i -vector x = (x i1,..., x ini ) as the quantities of input factors, with price vector w i = (w i1,..., w ini ). Each treatment i uses a fixed amount of each of the N i input factors, expressed as a vector of unit factor requirement a i = (a i1, a i2,..., a ini ). The marginal cost pricing assumption implies that the price of treatment i is p i = w i a i. The Fisher productivity index can be shown to be P rf = Q F Q F = ( M i=1 (w0 i a 0 i )y 1 i i=1 (w0 i a1 i )y1 i i=1 (w1 i a 1 i )y 0 i i=1 (w1 i a0 i )y0 i ) 1/2. In the second model, each treatment i is assumed to have an independent production function. The constant returns to scale assumption implies that the cost function is separable, that is, for treatment of disease i, the total cost is C i (w i, y i ) = c i (w i )y i = w i x i. (14) The marginal cost pricing assumption implies that output price of treatment of disease i is p i = c i (w i ) = w i x i y i. (15) The cost ratio from period from period 0 to period 1 can be decomposed into three indices, C 1 (w 1, y 1 ) = αβγ, (16) C 0 (w 0, y 0 ) where α is an output quantity index, β is an input price index, and γ is a reciprocal index of technical progress. Intuitively, the change in total cost of treating all M diseases from period 0 to period 1, C 1 (w 1, y 1 )/C 0 (w 0, y 0 ) can be explained by the three factors: 18

20 1. Real change in the provision of health care services: the quantity index α aggregates the number of cases in across diseases using the marginal costs given in (15) as weights. 2. Pure price changes of the input factors such as salaries and cost of drugs, etc., captured by the index β; 3. A residual factor measured by γ: the index captures the technological change of the underlying production function through the cost function. Conceptually this measure of productivity change is similar to the Solow residual defined in (8). Using (45) and (15), α and β can be calculated using the Fisher formulae. Then γ can be inferred by (16). It can be shown that the Fisher productivity index P rf is the reciprocal of γ (see Appendix A.2 for details). Therefore, under the above assumptions, the Fisher productivity index can be calculated using observed output quantities, input quantities, and input prices. The theory behind this index may be involving but the implementation is simple and straight forward. Next we compare the pros and cons of the statistical approach and the index number approach. 4.5 Econometrics Versus Index Numbers Productivity in the health care sector can be studied using the growth accounting technique described in Section 4.2. A flexible functional form such as a translog function is employed as the production function. The parameters are then estimated using econometric methods. On the other hand, the index number approach calculate a productivity index directly using observed price and quantity data. Under the right assumptions, however, the use of a particular index number formula is equivalent to some underlying production or cost function. For example, the Törnqvist quantity index defined in (12) is exact for the translog production function. A question naturally arisen is, which approach should we use, and what are the trade-offs between the two methods? The distinction is not as clear cut as we think due to the following reasons. 13 First, with a general production function the assumptions of cost minimization, marginal cost pricing and constant returns to scale can be relaxed. On the other hand, as most applied econometricians are aware of, the analyst faces the possibility of violation of curvature condition, forcing the imposition of parameter restrictions. Multicollinearity sometimes requires the subjective removal of independent variables, which leads to the question of robustness. The implementation of the index number is non-parametric, using observed price and quantity data, thus avoid many subjective decisions to be made by the analyst. 13 See Hulten (2001) for more detailed discussions. 19

Market Power and Efficiency in Card Payment Systems: A Comment on Rochet and Tirole

Market Power and Efficiency in Card Payment Systems: A Comment on Rochet and Tirole Market Power and Efficiency in Card Payment Systems: A Comment on Rochet and Tirole Luís M. B. Cabral New York University and CEPR November 2005 1 Introduction Beginning with their seminal 2002 paper,

More information

Inflation. Chapter 8. 8.1 Money Supply and Demand

Inflation. Chapter 8. 8.1 Money Supply and Demand Chapter 8 Inflation This chapter examines the causes and consequences of inflation. Sections 8.1 and 8.2 relate inflation to money supply and demand. Although the presentation differs somewhat from that

More information

PUBLIC HEALTH OPTOMETRY ECONOMICS. Kevin D. Frick, PhD

PUBLIC HEALTH OPTOMETRY ECONOMICS. Kevin D. Frick, PhD Chapter Overview PUBLIC HEALTH OPTOMETRY ECONOMICS Kevin D. Frick, PhD This chapter on public health optometry economics describes the positive and normative uses of economic science. The terms positive

More information

Macroeconomics Lecture 1: The Solow Growth Model

Macroeconomics Lecture 1: The Solow Growth Model Macroeconomics Lecture 1: The Solow Growth Model Richard G. Pierse 1 Introduction One of the most important long-run issues in macroeconomics is understanding growth. Why do economies grow and what determines

More information

Midterm exam, Health economics, Spring 2007 Answer key

Midterm exam, Health economics, Spring 2007 Answer key Midterm exam, Health economics, Spring 2007 Answer key Instructions: All points on true/false and multiple choice questions will be given for the explanation. Note that you can choose which questions to

More information

Second Hour Exam Public Finance - 180.365 Fall, 2007. Answers

Second Hour Exam Public Finance - 180.365 Fall, 2007. Answers Second Hour Exam Public Finance - 180.365 Fall, 2007 Answers HourExam2-Fall07, November 20, 2007 1 Multiple Choice (4 pts each) Correct answer indicated by 1. The portion of income received by the middle

More information

Equilibrium in Competitive Insurance Markets: An Essay on the Economic of Imperfect Information

Equilibrium in Competitive Insurance Markets: An Essay on the Economic of Imperfect Information Equilibrium in Competitive Insurance Markets: An Essay on the Economic of Imperfect Information By: Michael Rothschild and Joseph Stiglitz Presented by Benjamin S. Barber IV, Xiaoshu Bei, Zhi Chen, Shaiobi

More information

2. Information Economics

2. Information Economics 2. Information Economics In General Equilibrium Theory all agents had full information regarding any variable of interest (prices, commodities, state of nature, cost function, preferences, etc.) In many

More information

Why is Insurance Good? An Example Jon Bakija, Williams College (Revised October 2013)

Why is Insurance Good? An Example Jon Bakija, Williams College (Revised October 2013) Why is Insurance Good? An Example Jon Bakija, Williams College (Revised October 2013) Introduction The United States government is, to a rough approximation, an insurance company with an army. 1 That is

More information

ECON20310 LECTURE SYNOPSIS REAL BUSINESS CYCLE

ECON20310 LECTURE SYNOPSIS REAL BUSINESS CYCLE ECON20310 LECTURE SYNOPSIS REAL BUSINESS CYCLE YUAN TIAN This synopsis is designed merely for keep a record of the materials covered in lectures. Please refer to your own lecture notes for all proofs.

More information

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Chapter 8 Capital Budgeting Concept Check 8.1 1. What is the difference between independent and mutually

More information

Measurement of Economic Costs in School Programs for Children and Youth Introduction Opportunity Cost and Resource Use

Measurement of Economic Costs in School Programs for Children and Youth Introduction Opportunity Cost and Resource Use Measurement of Economic Costs in School Programs for Children and Youth Eric Slade, Ph.D. Center for School Mental Health Analysis and Action Division of Child and Adolescent Psychiatry University of Maryland

More information

Problem Set #3 Answer Key

Problem Set #3 Answer Key Problem Set #3 Answer Key Economics 305: Macroeconomic Theory Spring 2007 1 Chapter 4, Problem #2 a) To specify an indifference curve, we hold utility constant at ū. Next, rearrange in the form: C = ū

More information

The National Accounts and the Public Sector by Casey B. Mulligan Fall 2010

The National Accounts and the Public Sector by Casey B. Mulligan Fall 2010 The National Accounts and the Public Sector by Casey B. Mulligan Fall 2010 Factors of production help interpret the national accounts. The factors are broadly classified as labor or (real) capital. The

More information

A.2 The Prevalence of Transfer Pricing in International Trade

A.2 The Prevalence of Transfer Pricing in International Trade 19. Transfer Prices A. The Transfer Price Problem A.1 What is a Transfer Price? 19.1 When there is a international transaction between say two divisions of a multinational enterprise that has establishments

More information

. In this case the leakage effect of tax increases is mitigated because some of the reduction in disposable income would have otherwise been saved.

. In this case the leakage effect of tax increases is mitigated because some of the reduction in disposable income would have otherwise been saved. Chapter 4 Review Questions. Explain how an increase in government spending and an equal increase in lump sum taxes can generate an increase in equilibrium output. Under what conditions will a balanced

More information

Chapter 1. Introduction

Chapter 1. Introduction Chapter 1 Introduction What is productivity, how is it measured and why is it important? These questions are a useful starting point from which we can define and explain the range of productivity measures

More information

Comparing the Consumer Price Index and the Personal Consumption Expenditures Price Index

Comparing the Consumer Price Index and the Personal Consumption Expenditures Price Index 26 November 2007 Comparing the Consumer Price Index and the Personal Consumption Expenditures Price Index By Clinton P. McCully, Brian C. Moyer, and Kenneth J. Stewart I N THE United States, there are

More information

Moral Hazard. Itay Goldstein. Wharton School, University of Pennsylvania

Moral Hazard. Itay Goldstein. Wharton School, University of Pennsylvania Moral Hazard Itay Goldstein Wharton School, University of Pennsylvania 1 Principal-Agent Problem Basic problem in corporate finance: separation of ownership and control: o The owners of the firm are typically

More information

Well-being and the value of health

Well-being and the value of health Well-being and the value of health Happiness and Public Policy Conference Bangkok, Thailand 8-9 July 2007 Bernard van den Berg Department of Health Economics & Health Technology Assessment, Institute of

More information

Lecture 2 Dynamic Equilibrium Models : Finite Periods

Lecture 2 Dynamic Equilibrium Models : Finite Periods Lecture 2 Dynamic Equilibrium Models : Finite Periods 1. Introduction In macroeconomics, we study the behavior of economy-wide aggregates e.g. GDP, savings, investment, employment and so on - and their

More information

HEALTH INSURANCE COVERAGE AND ADVERSE SELECTION

HEALTH INSURANCE COVERAGE AND ADVERSE SELECTION HEALTH INSURANCE COVERAGE AND ADVERSE SELECTION Philippe Lambert, Sergio Perelman, Pierre Pestieau, Jérôme Schoenmaeckers 229-2010 20 Health Insurance Coverage and Adverse Selection Philippe Lambert, Sergio

More information

Imperfect information Up to now, consider only firms and consumers who are perfectly informed about market conditions: 1. prices, range of products

Imperfect information Up to now, consider only firms and consumers who are perfectly informed about market conditions: 1. prices, range of products Imperfect information Up to now, consider only firms and consumers who are perfectly informed about market conditions: 1. prices, range of products available 2. characteristics or relative qualities of

More information

Lecture 6: Price discrimination II (Nonlinear Pricing)

Lecture 6: Price discrimination II (Nonlinear Pricing) Lecture 6: Price discrimination II (Nonlinear Pricing) EC 105. Industrial Organization. Fall 2011 Matt Shum HSS, California Institute of Technology November 14, 2012 EC 105. Industrial Organization. Fall

More information

1 Uncertainty and Preferences

1 Uncertainty and Preferences In this chapter, we present the theory of consumer preferences on risky outcomes. The theory is then applied to study the demand for insurance. Consider the following story. John wants to mail a package

More information

Rafal Borkowski, Hipoteczna 18/22 m. 8, 91-337 Lodz, POLAND, E-mail: r-borkowski@go2.pl

Rafal Borkowski, Hipoteczna 18/22 m. 8, 91-337 Lodz, POLAND, E-mail: r-borkowski@go2.pl Rafal Borkowski, Hipoteczna 18/22 m. 8, 91-337 Lodz, POLAND, E-mail: r-borkowski@go2.pl Krzysztof M. Ostaszewski, Actuarial Program Director, Illinois State University, Normal, IL 61790-4520, U.S.A., e-mail:

More information

Economics and Economic Evaluation

Economics and Economic Evaluation This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License. Your use of this material constitutes acceptance of that license and the conditions of use of materials on this

More information

These are some practice questions for CHAPTER 23. Each question should have a single answer. But be careful. There may be errors in the answer key!

These are some practice questions for CHAPTER 23. Each question should have a single answer. But be careful. There may be errors in the answer key! These are some practice questions for CHAPTER 23. Each question should have a single answer. But be careful. There may be errors in the answer key! 67. Public saving is equal to a. net tax revenues minus

More information

MEASURING ECONOMIC IMPACTS OF PROJECTS AND PROGRAMS

MEASURING ECONOMIC IMPACTS OF PROJECTS AND PROGRAMS Economic Development Research Group April 1997 MEASURING ECONOMIC IMPACTS OF PROJECTS AND PROGRAMS GLEN WEISBROD, ECONOMIC DEVELOPMENT RESEARCH GROUP BURTON WEISBROD, ECONOMICS DEPT., NORTHWESTERN UNIV.

More information

Universidad de Montevideo Macroeconomia II. The Ramsey-Cass-Koopmans Model

Universidad de Montevideo Macroeconomia II. The Ramsey-Cass-Koopmans Model Universidad de Montevideo Macroeconomia II Danilo R. Trupkin Class Notes (very preliminar) The Ramsey-Cass-Koopmans Model 1 Introduction One shortcoming of the Solow model is that the saving rate is exogenous

More information

Efficiency in the Canadian Life Insurance Industry: Some Preliminary Results Using DEA

Efficiency in the Canadian Life Insurance Industry: Some Preliminary Results Using DEA Efficiency in the Canadian Life Insurance Industry: Some Preliminary Results Using DEA Gilles Bernier, Ph.D., Industrial-Alliance Insurance Chair, Laval University, Québec City Komlan Sedzro, Ph.D., University

More information

Chapter 7. Sealed-bid Auctions

Chapter 7. Sealed-bid Auctions Chapter 7 Sealed-bid Auctions An auction is a procedure used for selling and buying items by offering them up for bid. Auctions are often used to sell objects that have a variable price (for example oil)

More information

A PRIMAL-DUAL APPROACH TO NONPARAMETRIC PRODUCTIVITY ANALYSIS: THE CASE OF U.S. AGRICULTURE. Jean-Paul Chavas and Thomas L. Cox *

A PRIMAL-DUAL APPROACH TO NONPARAMETRIC PRODUCTIVITY ANALYSIS: THE CASE OF U.S. AGRICULTURE. Jean-Paul Chavas and Thomas L. Cox * Copyright 1994 by Jean-Paul Chavas and homas L. Cox. All rights reserved. Readers may make verbatim copies of this document for noncommercial purposes by any means, provided that this copyright notice

More information

ECONOMIC QUESTIONS FOR THE MASTER'S EXAM

ECONOMIC QUESTIONS FOR THE MASTER'S EXAM ECONOMIC QUESTIONS FOR THE MASTER'S EXAM Introduction 1. What is economics? Discuss the purpose and method of work of economists. Consider observation, induction, deduction and scientific criticism. 2.

More information

Lecture 2. Marginal Functions, Average Functions, Elasticity, the Marginal Principle, and Constrained Optimization

Lecture 2. Marginal Functions, Average Functions, Elasticity, the Marginal Principle, and Constrained Optimization Lecture 2. Marginal Functions, Average Functions, Elasticity, the Marginal Principle, and Constrained Optimization 2.1. Introduction Suppose that an economic relationship can be described by a real-valued

More information

Chapter 12. Aggregate Expenditure and Output in the Short Run

Chapter 12. Aggregate Expenditure and Output in the Short Run Chapter 12. Aggregate Expenditure and Output in the Short Run Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 203 502 Principles of Macroeconomics Aggregate Expenditure (AE)

More information

Markups and Firm-Level Export Status: Appendix

Markups and Firm-Level Export Status: Appendix Markups and Firm-Level Export Status: Appendix De Loecker Jan - Warzynski Frederic Princeton University, NBER and CEPR - Aarhus School of Business Forthcoming American Economic Review Abstract This is

More information

Price Discrimination: Part 2. Sotiris Georganas

Price Discrimination: Part 2. Sotiris Georganas Price Discrimination: Part 2 Sotiris Georganas 1 More pricing techniques We will look at some further pricing techniques... 1. Non-linear pricing (2nd degree price discrimination) 2. Bundling 2 Non-linear

More information

Evaluating Costs anti Benefits in Health Care

Evaluating Costs anti Benefits in Health Care 2 Evaluating Costs anti Benefits in Health Care Contents Introduction...................................................... Definition of CEA/CBA............................................. Importance

More information

Chapter 6 Economic Growth

Chapter 6 Economic Growth Chapter 6 Economic Growth 1 The Basics of Economic Growth 1) The best definition for economic growth is A) a sustained expansion of production possibilities measured as the increase in real GDP over a

More information

An Economic Evaluation of the Japanese Telehealth System. by CVM: Comparison of Four Regions

An Economic Evaluation of the Japanese Telehealth System. by CVM: Comparison of Four Regions An Economic Evaluation of the Japanese Telehealth System by CVM: Comparison of Four Regions Masatsugu Tsuji OSIPP (Osaka School of International Public Policy), Osaka University 1-31, Machikaneyama-cho,

More information

Chap 3 CAPM, Arbitrage, and Linear Factor Models

Chap 3 CAPM, Arbitrage, and Linear Factor Models Chap 3 CAPM, Arbitrage, and Linear Factor Models 1 Asset Pricing Model a logical extension of portfolio selection theory is to consider the equilibrium asset pricing consequences of investors individually

More information

Choice under Uncertainty

Choice under Uncertainty Choice under Uncertainty Part 1: Expected Utility Function, Attitudes towards Risk, Demand for Insurance Slide 1 Choice under Uncertainty We ll analyze the underlying assumptions of expected utility theory

More information

HANDBOOK ON PRICE AND VOLUME MEASURES IN NATIONAL ACCOUNTS

HANDBOOK ON PRICE AND VOLUME MEASURES IN NATIONAL ACCOUNTS HANDBOOK ON PRICE AND VOLUME MEASURES IN NATIONAL ACCOUNTS Version prepared for the seminar on Price and Volume Measures, 14-16 March 2001, Statistics Netherlands, Voorburg Handbook on Price and Volume

More information

Priority Areas of Australian Clinical Health R&D

Priority Areas of Australian Clinical Health R&D Priority Areas of Australian Clinical Health R&D Nick Pappas* CSES Working Paper No. 16 ISSN: 1322 5138 ISBN: 1-86272-552-7 December 1999 *Nick Pappas is a Henderson Research Fellow at the Centre for Strategic

More information

Theories of Exchange rate determination

Theories of Exchange rate determination Theories of Exchange rate determination INTRODUCTION By definition, the Foreign Exchange Market is a market 1 in which different currencies can be exchanged at a specific rate called the foreign exchange

More information

The Real Business Cycle model

The Real Business Cycle model The Real Business Cycle model Spring 2013 1 Historical introduction Modern business cycle theory really got started with Great Depression Keynes: The General Theory of Employment, Interest and Money Keynesian

More information

Unit 2: Theory of Externalities: Pareto optimality and market failure in the presence of externalities; property rights and the Coase theorem

Unit 2: Theory of Externalities: Pareto optimality and market failure in the presence of externalities; property rights and the Coase theorem Unit 2: Theory of Externalities: Pareto optimality and market failure in the presence of externalities; property rights and the Coase theorem Public Goods and Externalities (from chapter five, Kolstad,

More information

Unraveling versus Unraveling: A Memo on Competitive Equilibriums and Trade in Insurance Markets

Unraveling versus Unraveling: A Memo on Competitive Equilibriums and Trade in Insurance Markets Unraveling versus Unraveling: A Memo on Competitive Equilibriums and Trade in Insurance Markets Nathaniel Hendren January, 2014 Abstract Both Akerlof (1970) and Rothschild and Stiglitz (1976) show that

More information

chapter >> Externalities Section 2: Policies Toward Pollution

chapter >> Externalities Section 2: Policies Toward Pollution chapter 19 >> Externalities Section 2: Policies Toward Pollution Before 1970, there were no rules governing the amount of sulfur dioxide power plants in the United States could emit which is why acid rain

More information

MSc Finance and Economics detailed module information

MSc Finance and Economics detailed module information MSc Finance and Economics detailed module information Example timetable Please note that information regarding modules is subject to change. TERM 1 TERM 2 TERM 3 INDUCTION WEEK EXAM PERIOD Week 1 EXAM

More information

Discounting in Economic Evaluation

Discounting in Economic Evaluation Discounting in Economic Evaluation Henry Glick Epi 550 March 30, 2012 Which Lottery? Suppose you decided to buy a single lottery ticket You have a choice between equally priced tickets for 2 tax free lotteries

More information

Quality adjustment of public service health output: current method

Quality adjustment of public service health output: current method Information note Quality adjustment of public service health output: current method April 2012 Introduction When measuring health productivity in the Healthcare Productivity articles ONS explicitly adjusts

More information

ECONOMIC GROWTH* Chapter. Key Concepts

ECONOMIC GROWTH* Chapter. Key Concepts Chapter 5 MEASURING GDP AND ECONOMIC GROWTH* Key Concepts Gross Domestic Product Gross domestic product, GDP, is the market value of all the final goods and services produced within in a country in a given

More information

Demand for Health Insurance

Demand for Health Insurance Demand for Health Insurance Demand for Health Insurance is principally derived from the uncertainty or randomness with which illnesses befall individuals. Consequently, the derived demand for health insurance

More information

Perman et al.: Ch. 4. Welfare economics and the environment

Perman et al.: Ch. 4. Welfare economics and the environment Perman et al.: Ch. 4 Welfare economics and the environment Objectives of lecture Derive the conditions for allocative efficiency of resources Show that a perfect market provides efficient allocation of

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Suvey of Macroeconomics, MBA 641 Fall 2006, Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Modern macroeconomics emerged from

More information

Week 7 - Game Theory and Industrial Organisation

Week 7 - Game Theory and Industrial Organisation Week 7 - Game Theory and Industrial Organisation The Cournot and Bertrand models are the two basic templates for models of oligopoly; industry structures with a small number of firms. There are a number

More information

The Case for a Tax Cut

The Case for a Tax Cut The Case for a Tax Cut Alan C. Stockman University of Rochester, and NBER Shadow Open Market Committee April 29-30, 2001 1. Tax Increases Have Created the Surplus Any discussion of tax policy should begin

More information

Chapter 21: The Discounted Utility Model

Chapter 21: The Discounted Utility Model Chapter 21: The Discounted Utility Model 21.1: Introduction This is an important chapter in that it introduces, and explores the implications of, an empirically relevant utility function representing intertemporal

More information

The Multiplier Effect of Fiscal Policy

The Multiplier Effect of Fiscal Policy We analyze the multiplier effect of fiscal policy changes in government expenditure and taxation. The key result is that an increase in the government budget deficit causes a proportional increase in consumption.

More information

Labor Economics, 14.661. Lecture 3: Education, Selection, and Signaling

Labor Economics, 14.661. Lecture 3: Education, Selection, and Signaling Labor Economics, 14.661. Lecture 3: Education, Selection, and Signaling Daron Acemoglu MIT November 3, 2011. Daron Acemoglu (MIT) Education, Selection, and Signaling November 3, 2011. 1 / 31 Introduction

More information

Moral Hazard. Question for this section. Quick review of demand curves. ECON 40447 Fall 2009

Moral Hazard. Question for this section. Quick review of demand curves. ECON 40447 Fall 2009 Moral Hazard ECON 40447 Fall 2009 First day of class, listed five unique characteristics of the health care sector Uncertainty Large role for federal govt Agency problem Non-profit sector Medical care

More information

CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM)

CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM) 1 CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM) This model is the main tool in the suite of models employed by the staff and the Monetary Policy Committee (MPC) in the construction

More information

ECONOMIC CONSIDERATIONS FOR COMMUNITY RESILIENCE

ECONOMIC CONSIDERATIONS FOR COMMUNITY RESILIENCE ECONOMIC CONSIDERATIONS FOR COMMUNITY RESILIENCE 1. Introduction a. Purpose To identify and briefly describe the ways in which disasters affect the local economy and the way the economy influences the

More information

B.A. PROGRAMME DISCIPLINE COURSE ECONOMICS. COURSE CONTENTS (Effective from the Academic Year 2011-2012 onwards)

B.A. PROGRAMME DISCIPLINE COURSE ECONOMICS. COURSE CONTENTS (Effective from the Academic Year 2011-2012 onwards) B.A. PROGRAMME DISCIPLINE COURSE ECONOMICS COURSE CONTENTS (Effective from the Academic Year 2011-2012 onwards) DEPARTMENT OF ECONOMICS UNIVERSITY OF DELHI DELHI 1 Syllabus for B.A. Programme - Economics

More information

13 EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL* Chapter. Key Concepts

13 EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL* Chapter. Key Concepts Chapter 3 EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL* Key Concepts Fixed Prices and Expenditure Plans In the very short run, firms do not change their prices and they sell the amount that is demanded.

More information

This paper is not to be removed from the Examination Halls

This paper is not to be removed from the Examination Halls This paper is not to be removed from the Examination Halls UNIVERSITY OF LONDON EC2065 ZA BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas

More information

On Compulsory Per-Claim Deductibles in Automobile Insurance

On Compulsory Per-Claim Deductibles in Automobile Insurance The Geneva Papers on Risk and Insurance Theory, 28: 25 32, 2003 c 2003 The Geneva Association On Compulsory Per-Claim Deductibles in Automobile Insurance CHU-SHIU LI Department of Economics, Feng Chia

More information

Optimal Paternalism: Sin Taxes and Health Subsidies

Optimal Paternalism: Sin Taxes and Health Subsidies Optimal Paternalism: Sin Taxes and Health Subsidies Thomas Aronsson and Linda Thunström Department of Economics, Umeå University SE - 901 87 Umeå, Sweden April 2005 Abstract The starting point for this

More information

Chapter 4 Specific Factors and Income Distribution

Chapter 4 Specific Factors and Income Distribution Chapter 4 Specific Factors and Income Distribution Chapter Organization Introduction The Specific Factors Model International Trade in the Specific Factors Model Income Distribution and the Gains from

More information

Working Paper Series

Working Paper Series RGEA Universidade de Vigo http://webs.uvigo.es/rgea Working Paper Series A Market Game Approach to Differential Information Economies Guadalupe Fugarolas, Carlos Hervés-Beloso, Emma Moreno- García and

More information

UNIVERSITY OF VIENNA

UNIVERSITY OF VIENNA WORKING PAPERS Egbert Dierker Hildegard Dierker Birgit Grodal Nonexistence of Constrained Efficient Equilibria when Markets are Incomplete August 2001 Working Paper No: 0111 DEPARTMENT OF ECONOMICS UNIVERSITY

More information

Economic and Financial Considerations in Health Policy. Gerard F. Anderson, PhD Johns Hopkins University

Economic and Financial Considerations in Health Policy. Gerard F. Anderson, PhD Johns Hopkins University This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License. Your use of this material constitutes acceptance of that license and the conditions of use of materials on this

More information

Why the government should do cost-effectiveness analysis in a health insurance market

Why the government should do cost-effectiveness analysis in a health insurance market Government Why the government should do cost-effectiveness analysis in a health insurance market TILEC, Tilburg University April 17, 2012 Government Outline 1 Motivation 2 3 4 Government 5 6 Government

More information

Research Summary Saltuk Ozerturk

Research Summary Saltuk Ozerturk Research Summary Saltuk Ozerturk A. Research on Information Acquisition in Markets and Agency Issues Between Investors and Financial Intermediaries An important dimension of the workings of financial markets

More information

PREFERENCE ELICITATION METHODS. Lecture 9. Kevin Frick

PREFERENCE ELICITATION METHODS. Lecture 9. Kevin Frick This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License. Your use of this material constitutes acceptance of that license and the conditions of use of materials on this

More information

Income and the demand for complementary health insurance in France. Bidénam Kambia-Chopin, Michel Grignon (McMaster University, Hamilton, Ontario)

Income and the demand for complementary health insurance in France. Bidénam Kambia-Chopin, Michel Grignon (McMaster University, Hamilton, Ontario) Income and the demand for complementary health insurance in France Bidénam Kambia-Chopin, Michel Grignon (McMaster University, Hamilton, Ontario) Presentation Workshop IRDES, June 24-25 2010 The 2010 IRDES

More information

Optimal Health Insurance for Prevention and Treatment

Optimal Health Insurance for Prevention and Treatment Optimal Health Insurance for Prevention and Treatment Randall P. Ellis Department of Economics Boston University Willard G. Manning Harris School of Public Policy Studies The University of Chicago We thank

More information

The level of price and inflation Real GDP: the values of goods and services measured using a constant set of prices

The level of price and inflation Real GDP: the values of goods and services measured using a constant set of prices Chapter 2: Key Macroeconomics Variables ECON2 (Spring 20) 2 & 4.3.20 (Tutorial ) National income accounting Gross domestic product (GDP): The market value of all final goods and services produced within

More information

Determinants of Social Discount Rate, general case

Determinants of Social Discount Rate, general case Determinants of Social Discount Rate, general case The resulting equation r = ρ + θ g is known as the Ramsey equation after Frank Ramsey (928) The equation states tt that t in an optimal intertemporal

More information

Asymmetry and the Cost of Capital

Asymmetry and the Cost of Capital Asymmetry and the Cost of Capital Javier García Sánchez, IAE Business School Lorenzo Preve, IAE Business School Virginia Sarria Allende, IAE Business School Abstract The expected cost of capital is a crucial

More information

Using Discount Rate for Water Sector Planning in Bangladesh under Climatic Changes

Using Discount Rate for Water Sector Planning in Bangladesh under Climatic Changes Using Discount Rate for Water Sector Planning in Bangladesh under Climatic Changes Dr. Mohammad Ismail Khan Associate professor, Department of Agricultural Economics Bangabndhu Sheikh Mujibur Rahman Agricultural

More information

Conditions for Efficiency in Package Pricing

Conditions for Efficiency in Package Pricing Conditions for Efficiency in Package Pricing Babu Nahata Department of Economics University of Louisville Louisville, Kentucky 40292, USA. e-mail: nahata@louisville.edu and Serguei Kokovin and Evgeny Zhelobodko

More information

PART I: A STANDARD ANALYSIS OF FACTOR MOBILITY

PART I: A STANDARD ANALYSIS OF FACTOR MOBILITY 1 PART I: A STANDARD ANALYSIS OF FACTOR MOBILITY CHAPTER 1: BENEFICIAL vs. DISTORTIONARY MOBILITY OF FACTORS OF PRODUCTION Introduction Classical economic setups suggest that factors of production move,

More information

In recent years, Federal Reserve (Fed) policymakers have come to rely

In recent years, Federal Reserve (Fed) policymakers have come to rely Long-Term Interest Rates and Inflation: A Fisherian Approach Peter N. Ireland In recent years, Federal Reserve (Fed) policymakers have come to rely on long-term bond yields to measure the public s long-term

More information

AN ASSESSMENT OF FINANCIAL RATIO ANALYSIS AND DATA ENVELOPMENT ANALYSIS IN COMPARING THE RELATIVE PROFITABILITY OF BANKS

AN ASSESSMENT OF FINANCIAL RATIO ANALYSIS AND DATA ENVELOPMENT ANALYSIS IN COMPARING THE RELATIVE PROFITABILITY OF BANKS AN ASSESSMENT OF FINANCIAL RATIO ANALYSIS AND DATA ENVELOPMENT ANALYSIS IN COMPARING THE RELATIVE PROFITABILITY OF BANKS JJL Cronje Curtin University of Technology, Perth WA Presented by PH Potgieter :

More information

THE COST OF ROAD TRAFFIC ACCIDENT IN VIETNAM

THE COST OF ROAD TRAFFIC ACCIDENT IN VIETNAM THE COST OF ROAD TRAFFIC ACCIDENT IN VIETNAM Trinh Thuy ANH Lecturer. University of Transport and Communication. Department of Transport - Economics Address: Caugiay, Ha Noi, Vietnam Tel: 84 4 8674702

More information

Terms of Trade Effects: Theory and Measurement

Terms of Trade Effects: Theory and Measurement Terms of Trade Effects: Theory and Measurement Marshall B. Reinsdorf* Marshall.Reinsdorf@BEA.gov Revised version of WP2009-01 October 2009 Foreign trade enables a nation to consume a different mix of goods

More information

Calibration of Normalised CES Production Functions in Dynamic Models

Calibration of Normalised CES Production Functions in Dynamic Models Discussion Paper No. 06-078 Calibration of Normalised CES Production Functions in Dynamic Models Rainer Klump and Marianne Saam Discussion Paper No. 06-078 Calibration of Normalised CES Production Functions

More information

Why do merchants accept payment cards?

Why do merchants accept payment cards? Why do merchants accept payment cards? Julian Wright National University of Singapore Abstract This note explains why merchants accept expensive payment cards when merchants are Cournot competitors. The

More information

BOOK REVIEWS. The Healthcare Fix: Universal Insurance for All Americans Laurence J. Kotlikoff Cambridge: The MIT Press, 2007, 96 pp.

BOOK REVIEWS. The Healthcare Fix: Universal Insurance for All Americans Laurence J. Kotlikoff Cambridge: The MIT Press, 2007, 96 pp. BOOK REVIEWS The Healthcare Fix: Universal Insurance for All Americans Laurence J. Kotlikoff Cambridge: The MIT Press, 2007, 96 pp. This book is about how and why a severe economic and financial crisis

More information

Lectures, 2 ECONOMIES OF SCALE

Lectures, 2 ECONOMIES OF SCALE Lectures, 2 ECONOMIES OF SCALE I. Alternatives to Comparative Advantage Economies of Scale The fact that the largest share of world trade consists of the exchange of similar (manufactured) goods between

More information

Lecture notes for Choice Under Uncertainty

Lecture notes for Choice Under Uncertainty Lecture notes for Choice Under Uncertainty 1. Introduction In this lecture we examine the theory of decision-making under uncertainty and its application to the demand for insurance. The undergraduate

More information

A public good is often defined to be a good that is both nonrivalrous and nonexcludable in consumption.

A public good is often defined to be a good that is both nonrivalrous and nonexcludable in consumption. Theory of Public Goods A public good is often defined to be a good that is both nonrivalrous and nonexcludable in consumption. The nonrivalrous property holds when use of a unit of the good by one consumer

More information

Market Failure. EC4004 Lecture 9

Market Failure. EC4004 Lecture 9 Market Failure EC4004 Lecture 9 Today. Online Exam. Quantity Demanded, Quantity Supplied at each price 10 9 8 7 6 5 4 3 2 1 Supply at each Price, S(p) t Demand at each Price, D(p) 1 2 3 4 5 6 7 8 9 10

More information

What is costeffectiveness?

What is costeffectiveness? ...? series Second edition Health economics Supported by sanofi-aventis What is costeffectiveness? Ceri Phillips BSc(Econ) MSc(Econ) PhD Health Economist, Swansea University Cost-effectiveness analysis

More information

Chapter 20. The Measurement of National Income. In this chapter you will learn to. National Output and Value Added

Chapter 20. The Measurement of National Income. In this chapter you will learn to. National Output and Value Added Chapter 20 The Measurement of National Income In this chapter you will learn to 1. Use the concept of value added to solve the problem of double counting when measuring national income. 2. Describe the

More information

Insurance. Michael Peters. December 27, 2013

Insurance. Michael Peters. December 27, 2013 Insurance Michael Peters December 27, 2013 1 Introduction In this chapter, we study a very simple model of insurance using the ideas and concepts developed in the chapter on risk aversion. You may recall

More information

Efficiency Analysis of Life Insurance Companies in Thailand

Efficiency Analysis of Life Insurance Companies in Thailand Efficiency Analysis of Life Insurance Companies in Thailand Li Li School of Business, University of the Thai Chamber of Commerce 126/1 Vibhavadee_Rangsit Rd., Dindaeng, Bangkok 10400, Thailand Tel: (662)

More information