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Basic Economic Principles
N287E Spring 2006Joanne Spetz29 March 2006
Course web page and contact
My office is at Laurel Heights Suite 410 2-4443 Cell phone: 415-271-6496
Nursing school office: N505Web page: www.saidin.com/joanne
Class time & assignments
Class time is divided 11am-2pm, generally in classroom
U506 15 minute break to get lunch
Readings Finkler & Kovner book Reading listed in syllabus, most are
on line
Class time & assignments
Assignments 2 problem sets Final project Be prepared to discuss readings in class
Grading 30% each problem set 10% proposal for final project 30% final project +up to 10 extra points for class participation
Final projectBusiness planPolicy topics
Earthquake retrofit Universal health insurance proposals Health of academic medical centers
Workforce analysis Solutions to the shortage Mandatory overtime
Cost effectiveness analysisFinancial analysis
Financially troubled hospital or health care provider Proposed hospital merger
What is “health economics”?
The study of health and health care from the economic perspective
Economics: The study of the allocation of scarce
resources
Principles of economics
Resources are limited You must make choices
Substitutability Resources can be dedicated to many uses What is the value of alternate uses of a
resource?
Heterogeneous preferences One person’s pleasure is another’s poison
Trade occurs because…
People have different productivity Specialized skills Access to capital (land, equipment)
People have different preferences Preferences vary with amount already
consumed
Where did health economics start?
Kenneth Arrow, 1963 “Uncertainty and the welfare
economics of medical care” American Economic Review
Some people focus on nursing economics Donald Yett Peter Buerhaus
Utility
Economic analysis begins with the concept of utility
product
utility“diminishing marginal benefit”
Indifference curves
better
wine
cheese
How do we decide how much to consume?
Prices of trade determine consumption
Wine: $3/glass
Cheese:$1/ounce
Slope = -3
Tangent point is optimal
What if prices change?
New prices are wine=$2, cheese=$1
Wine
Cheese
Slope = -2
New optimal point
Why marginal instead of average values?
The value of a tradeoff may vary based on the quantity of the unitAverage values does not reflect the actual change of a particular unit
Calculating Marginal Values
Marginal=(change in output)/(change in nurses)
Average=(total output)/(total nurses)
Number of Nurses
Total Pt care hours
Average product
Marginal product
0 0 - -
1 100 100/1=100 (100-0)/(1-0)=100
2 250 250/2=125 (250-100)/(2-1)=150
Volume discounts
Wine
Cheese
Optimal point
From the indifference curves, we can derive a demand curve
Wine
$
Demand for wine
What about production?
# pills
CostPerpill Economy of scale =
“diminishing marginal cost”
MC=marginal cost
How much do you choose to produce?
Marginal revenue = marginal cost
MC
MR=marginal revenue=demand
quantity
$
P*=price
Q*=quantity
Sum of individualdemand curves
There is a logic to this
If you are a producer: The marginal cost of making one
more pill is $0.50 The marginal revenue of that pill is
$1.00
you will produce one more pill
Normally, there is a point where the margins balance
To sell more pills you have to drop the priceTo increase production you might have to increase marginal cost of production Build a new plant or pay overtime
Marginal costs can have many shapes
MC
quantity
$
MC
quantity
$
We also care about average costs
quantity
$ MC
AC=average cost
“decreasing returnsto scale”
What do firms do?
Firms maximize profit Profit = revenue – cost
Revenue = price * quantity Cost = AC * quantity
Profit will maximize at MR=MC If MR=$16 and MC=$12, producing one
more unit increases profit $4
Equilibrium: where supply and demand intersect
quantity
demand
supplyprice
Neither buyers nor sellershas any incentive to change the price they are bidding or asking.
This is the price and quantitywe will observe in the market.
Changes in equilibrium
Shifting of the supply or demand curve can change the equilibrium market price and quantityUnderstanding these changes are important because they reflect what we observe in the market place
How will this change the demand or supply for a drug?
cheaper generic medicines available in the market
quantity
demand
$supply
How will this change the demand or supply for a drug?
successful advertisement
quantity
demand
$supply
How will this change the demand or supply for a drug?
new technology and a more efficient production line
quantity
demand
$supply
How will this change the demand or supply for a drug?
rising costs of resources used to produce drug X
quantity
demand
$supply
In perfect competition…
Many buyers and sellersProduct is homogeneousCan enter & exit marketPerfect information
In a perfect market…
Firms are “price-takers”S
D
There is zero “profit” in the long run – this means all firms earn the same economywide profit
Elasticity
Elasticity refers to the degree to which supply or demand changes with the price “Inelastic” demand doesn’t change
with prices (e.g., perfectly competitive market)
“Elastic” demand changes a lot with prices
A chart to explain elasticity
$
Quantity
Inelastic: price changes don’t affect quantity much
Elastic: price changes affect quantity a lot
How do supply and demand lead to price changes?
$
Q
S
D
P1
S1 D1
Excess demand
Firms will bid up the price
Economic theory applies to health care, to some extent
Production of health: H = h(m,X)
m=medical care X=other stuff (genetics, behavior, etc.)
We assume more medical care increases health
This is not always so…
m=medical care
H=health
Diminishing marginal returns
Why can we have diminishing marginal returns to med care?
Nosocomial infectionsHigher morbidity from some treatments E.g., chemotherapy
What is “m”?
Medicare care is not a single, homogeneous thing Some treatments don’t have
decreasing returns Some “treatments” have no effect on
health
Improving “health” may not be the same as “curing” the patient
What about “X”
SmokingFatty foodsMotorcycling
ExerciseVeggiesVolvos
GeneticsAging
In most industrialized nations, X is more important than m
“Perfect competition” might not exist
No free entry/exitImperfect informationUncertainty/riskNon-homogeneous goodsPeople don’t see prices of products
Does this sound like health care?
Break Time!
Demand for nursing personnel
# nurses
wage
Supply (perfect competition)
Demand for nurses
Why do we see nursing shortages?
Limited number of employersDelays in wage increasesDelays in producing new nursesLicensing regulationsMinimum staffing requirements for hospitals, LTC facilities, other providersMinimum wages
Limited number of employers
Supply slopes up
# nurses
wage Supply
D1
D2
Shock to demand: D1 to D2
Wage responds slowlyTemporary shortage
Slow production of new RNs
# nurses
wage S1
D1
D2
Shock to demand: D1 to D2
S responds slowlyTemporary shortageCan overshoot supply!
S2
w1
w2
Monopsony from limited number of employers
Nurses
wage
S
MC
D
N*
w*
Reported shortage
Research on monopsony
Donald Yett Survey Data analysis Urban vs. rural markets
Sullivan – monopsony “inverse elasticity”
Hansen – no monopsonySpetz et al. – some market power
Is This Shortage Different?
Severity of current shortage is greater than in the pastDemand won’t adjust even when wages rise Focus on staffing due to recent research Minimum nurse-to-patient ratios
Aging nursing workforce will lead to massive retirements There cannot be enough new graduates to keep
up
Delving more deeply into the nursing shortage…
Forecasts predict worsening shortage Bureau of Health Professions report,
2002 Buerhaus, Staiger, & Auerbach, 2000
Age distribution of California RNs, 2004
05,000
10,00015,00020,00025,00030,00035,00040,00045,000
Source: California Board of Registered Nursing 2004 Survey
Percent of RNs Working in Nursing, by Age
0%10%20%30%40%50%60%70%80%90%
100%
Source: California Board of Registered Nursing 2004 Survey
Source: California Board of Registered Nursing Surveys
Change in the Age Distribution
Changes in income for RNs
Any forecasting exercise is open to critique!
Typical forecasts assume:
Wages do not changeChanges in numbers of graduates follow a time trendDemand does not fundamentally change RN demand is based on health care
demand
The BHPr Projections
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
Year
Num
ber
of R
Ns
Supply
Demand
What if we create a model…
Allow wages to increase as a result of shortageHow much do wages need to increase to end the shortage?Can wages increase too much, so a surplus results?
Forecasting with National Data
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
Wages 1999$
NLN graduates
Forecasting Strategy
How much growth in graduations do we need per year to meet BHPr demand forecasts? 2,810,414 needed in 2020
Use a regression to get relationship between wage growth and graduation growthCalculate wage growth needed to get required number of graduates
Assumptions
Demand does not respond to wage increasesWages can increase as needed in response to shortageNursing schools can expand to produce needed numbers of graduatesOutflows of nurses due to retirement/other factors match BHPr’s projections
Regression models: change in graduations
3-year lag
3-year lag 4-year lag
4-year lag
Change in wage
2.509(0.687)
2.477(0.727)
2.285(1.117)
2.252(1.168)
Change in unemploymt. rate
0.053(0.137)
-0.097(0.168)
Intercept -0.026(0.019)
-0.023(0.021)
-0.022(0.031)
-0.024(0.033)
R-squared 0.60 0.60 0.34 0.37
Wage growth scenarios
Regression model used for forecast 3-year lag 3-year lag
with unemployme
nt
4-year lag 4-year lag with
unemployment
Required yearly real
wage growth,
2005-2016
3.2% 3.5% 3.7% 3.8%
Cumulative real wage growth,
2002-2016
55.4% 61.9% 66.3% 68.6%
Real wage in 2016
$37.12 $38.77 $39.92 $40.50
3.2 – 3.8% Wage Growth Meets Demand
This is comparable to current wage growth ratesCumulative wage growth of up to 69% between now and 2016Total RN expenditures would double by 2016
What About Cycles?
Nursing shortages are historically cyclicalReal wage growth may be greater than 3.8% as shortage widens in short-termProblem: cannot estimate effect of degree of shortage on wage changes No historical data on degree of shortage Measurements of shortage are suspect
Creating a Cycle
Cal Nurses Assoc contracts give approximately 4% real wage growth Assume this is the national rate through 2004 This produces 6.9% annual growth in
graduations through 2008
Assume wage growth is about 2 percentage points less than shortage Measure shortage by (BHPr demand – supply)
Cyclical forecasts:
-10%
-5%
0%
5%
10%
15%
20%
Shortage/surplus of RNs
Wage change
Change in # of RN grads
This Shortage Is Different!
Most RN shortages have lasted 3-8 years10 more years of shortage appear likelySubstantial wage growth from the shortage could create a surplus by 2016 Assuming nursing schools can increase
graduations by that much!
Does this have policy implications?
