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?