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World health expenditure as share of global GDP.[1]
World health expenditure as share of global GDP.[1]
How much did the UK spend on healthcare in 2012?
How much did the UK spend on healthcare in 2012?

Health economics is a branch of economics concerned with issues related to efficiency, effectiveness, value and behavior in the production and consumption of health and healthcare. Health economics is important in determining how to improve health outcomes and lifestyle patterns through interactions between individuals, healthcare providers and clinical settings.[2] In broad terms, health economists study the functioning of healthcare systems and health-affecting behaviors such as smoking, diabetes, and obesity.

A seminal 1963 article by Kenneth Arrow is often credited with giving rise to health economics as a discipline. His theory drew conceptual distinctions between health and other goods.[3] Factors that distinguish health economics from other areas include extensive government intervention, intractable uncertainty in several dimensions, asymmetric information, barriers to entry, externality and the presence of a third-party agent.[4] In healthcare, the third-party agent is the patient's health insurer, who is financially responsible for the healthcare goods and services consumed by the insured patient.

Health economists evaluate multiple types of financial information: costs, charges and expenditures.

Uncertainty is intrinsic to health, both in patient outcomes and financial concerns. The knowledge gap that exists between a physician and a patient creates a situation of distinct advantage for the physician, which is called asymmetric information.

Externalities arise frequently when considering health and health care, notably in the context of the health impacts as with infectious disease or opioid abuse . For example, making an effort to avoid catching the common cold affects people other than the decision maker[5][6][7]:vii–xi[8] or finding sustainable, humane and effective solutions to the opioid epidemic.


The scope of health economics is neatly encapsulated by Alan Williams' "plumbing diagram"[9] dividing the discipline into eight distinct topics:

Healthcare demand

The demand for healthcare is a derived demand from the demand for health. Healthcare is demanded as a means for consumers to achieve a larger stock of "health capital." The demand for health is unlike most other goods because individuals allocate resources in order to both consume and produce health.

The above description gives three roles of persons in health economics. The World Health Report (p. 52) states that people take four roles in the healthcare:

  1. Contributors
  2. Citizens
  3. Provider
  4. Consumers

Michael Grossman's 1972 model of health production[10] has been extremely influential in this field of study and has several unique elements that make it notable. Grossman's model views each individual as both a producer and a consumer of health. Health is treated as a stock which degrades over time in the absence of "investments" in health, so that health is viewed as a sort of capital. The model acknowledges that health is both a consumption good that yields direct satisfaction and utility, and an investment good, which yields satisfaction to consumers indirectly through fewer sick days. Investment in health is costly as consumers must trade off time and resources devoted to health, such as exercising at a local gym, against other goals. These factors are used to determine the optimal level of health that an individual will demand. The model makes predictions over the effects of changes in prices of healthcare and other goods, labour market outcomes such as employment and wages, and technological changes. These predictions and other predictions from models extending Grossman's 1972 paper form the basis of much of the econometric research conducted by health economists.

In Grossman's model, the optimal level of investment in health occurs where the marginal cost of health capital is equal to the marginal benefit. With the passing of time, health depreciates at some rate . The interest rate faced by the consumer is denoted by . The marginal cost of health capital can be found by adding these variables: . The marginal benefit of health capital is the rate of return from this capital in both market and non-market sectors. In this model, the optimal health stock can be impacted by factors like age, wages and education. As an example, increases with age, so it becomes more and more costly to attain the same level of health capital or health stock as one ages. Age also decreases the marginal benefit of health stock. The optimal health stock will therefore decrease as one ages.

Beyond issues of the fundamental, "real" demand for medical care derived from the desire to have good health (and thus influenced by the production function for health) is the important distinction between the "marginal benefit" of medical care (which is always associated with this "real demand" curve based on derived demand), and a separate "effective demand" curve, which summarizes the amount of medical care demanded at particular market prices. Because most medical care is not purchased from providers directly, but is rather obtained at subsidized prices due to insurance, the out-of-pocket prices faced by consumers are typically much lower than the market price. The consumer sets out of pocket, and so the "effective demand" will have a separate relationship between price and quantity than will the "marginal benefit curve" or real demand relationship. This distinction is often described under the rubric of "ex-post moral hazard" (which is again distinct from ex-ante moral hazard, which is found in any type of market with insurance).

Health technology assessment

Main article: Health technology assessment

Economic evaluation, and in particular cost-effectiveness analysis, has become a fundamental part of technology appraisal processes for agencies in a number of countries. The Institute for Quality and Economy in Health Services (Institut für Qualität und Wirtschaftlichkeit im Gesundheitswesen – IQWiG) in Germany and the National Institute for Health and Care Excellence (NICE) in the United Kingdom, for example, both consider the cost-effectiveness of new pharmaceuticals entering the market.

Some agencies, including NICE, recommend the use of cost–utility analysis (CUA). This approach measures outcomes in a composite metric of both length and quality of life, the Quality-adjusted life year (QALY).

Healthcare markets

The five health markets typically analyzed are:

Although assumptions of textbook models of economic markets apply reasonably well to healthcare markets, there are important deviations. Many states have created risk pools in which relatively healthy enrollees subsidise the care of the rest. Insurers must cope with adverse selection which occurs when they are unable to fully predict the medical expenses of enrollees; adverse selection can destroy the risk pool. Features of insurance market risk pools, such as group purchases, preferential selection ("cherry-picking"), and preexisting condition exclusions are meant to cope with adverse selection.

Insured patients are naturally less concerned about healthcare costs than they would if they paid the full price of care. The resulting moral hazard drives up costs, as shown by the famous RAND Health Insurance Experiment. Insurers use several techniques to limit the costs of moral hazard, including imposing copayments on patients and limiting physician incentives to provide costly care. Insurers often compete by their choice of service offerings, cost-sharing requirements, and limitations on physicians.

Consumers in healthcare markets often suffer from a lack of adequate information about what services they need to buy and which providers offer the best value proposition. Health economists have documented a problem with supplier induced demand, whereby providers base treatment recommendations on economic, rather than medical criteria. Researchers have also documented substantial "practice variations", whereby the treatment also on service availability to rein in inducement and practice variations.

Some economists argue that requiring doctors to have a medical license constrains inputs, inhibits innovation, and increases cost to consumers while largely only benefiting the doctors themselves.[11]

Economic Rationale for Government Intervention in the Healthcare Markets

Folland, Godman, and Stino the authors of the book, The Economics of Health and Health Care[12] lists several separate and independent reasons for governments intervening in health-care systems rather than leaving it to the private market forces.

1. The first is to ensure that the optimum level of production and consumption of public goods (hospitals, vaccines) and goods with a partially public character are available.

2. Secondly, the rationale is to increase the quality and equity of insurance for those services that can be produced in the private sector but require risk-sharing due to the expense and uncertainties about needs. For example; investing in research and development for new cures and health care equipment. Governments usually subsidize for those who cannot afford insurance or, in certain situations, those low-cost activities and facilities that non-poor citizens can afford on their own. For example; the largest health insurance scheme in the world was launched in India by the name Ayushman Bharat in 2018.[13]

3. The third reason for which the government might want to intervene is to prevent market failure.[14] A classic example of market failure is Monopoly Power. Several health-care markets tend to have the potential for monopoly control to be exercised. Medical care in markets with few hospitals, patent-protected prescription products, and some health insurance markets is the major reason for higher costs and especially in cases where the providers are private companies.[15]

4. Knowledge can be perceived as a public good with a strong economic value. The information provided by one user does not restrict the information available to another. While those who do not pay are often denied access to information and the marginal cost of providing information to another person is frequently low. As a result, one might argue that private markets would under-produce knowledge, necessitating government intervention to increase its availability. Government intervention, in this case, can be seen as assisting in the public distribution of established information, either directly or by subsidizing private sector operations.

5. The last point in this section is related to incomplete markets. Incomplete markets may arise when private markets struggle to satisfy existing demand. This situation can arise when the cure of disease is very expensive, such as cancer or a wide spread of new diseases such as HIV-AIDS or Covid-19. In such cases either private insurers require a high premium as the risk factor and costs are high or they may not insure the people for a particular case. This leads to a void in the market where a certain section of the population will not be able to afford healthcare. Certain insurance markets, such as those for patients with HIV/AIDS, cancer, or other pre-existing conditions who are searching for new coverage, may be incomplete in the sense that those patients may be unable to afford coverage at any price. In such cases, the government usually intervenes and provides health care for such cases. For example; during the Covid-19 pandemic no private insurance company predicted that such disease would hit, as a result, state intervention became necessary to treat people.

Other issues

Medical economics

Often used synonymously with health economics, medical economics, according to Culyer,[16] is the branch of economics concerned with the application of economic theory to phenomena and problems associated typically with the second and third health market outlined above: physician and institutional service providers. Typically, however, it pertains to cost–benefit analysis of pharmaceutical products and cost-effectiveness of various medical treatments. Medical economics often uses mathematical models to synthesise data from biostatistics and epidemiology for support of medical decision-making, both for individuals and for wider health policy.

Mental health economics

Mental health economics incorporates a vast array of subject matters, ranging from pharmacoeconomics to labor economics and welfare economics. Mental health can be directly related to economics by the potential of affected individuals to contribute as human capital. In 2009 Currie and Stabile published "Mental Health in Childhood and Human Capital" in which they assessed how common childhood mental health problems may alter the human capital accumulation of affected children.[17] Externalities may include the influence that affected individuals have on surrounding human capital, such as at the workplace or in the home.[18] In turn, the economy also affects the individual, particularly in light of globalization. For example, studies in India, where there is an increasingly high occurrence of western outsourcing, have demonstrated a growing hybrid identity in young professionals who face very different sociocultural expectations at the workplace and in at home.[19]

Mental health economics presents a unique set of challenges to researchers. Individuals with cognitive disabilities may not be able to communicate preferences. These factors represent challenges in terms of placing value on the mental health status of an individual, especially in relation to the individual's potential as human capital. Further, employment statistics are often used in mental health economic studies as a means of evaluating individual productivity; however, these statistics do not capture "presenteeism", when an individual is at work with a lowered productivity level, quantify the loss of non-paid working time, or capture externalities such as having an affected family member. Also, considering the variation in global wage rates or in societal values, statistics used may be contextually, geographically confined, and study results may not be internationally applicable.[18]

Though studies have demonstrated mental healthcare to reduce overall healthcare costs, demonstrate efficacy, and reduce employee absenteeism while improving employee functioning, the availability of comprehensive mental health services is in decline. Petrasek and Rapin (2002) cite the three main reasons for this decline as (1) stigma and privacy concerns, (2) the difficulty of quantifying medical savings and (3) physician incentive to medicate without specialist referral.[20] Evers et al. (2009) have suggested that improvements could be made by promoting more active dissemination of mental health economic analysis, building partnerships through policy-makers and researchers, and employing greater use of knowledge brokers.[18]

Health and utility

Generally, economists assume that individuals act rationally with the aim of maximising their lifetime utility, while all are subject to the fact that they cannot buy more than their resources allow. In an inter-temporal setting, the model gets very complex. It gets even more so, when you introduce the uncertainty concerning the horizon, in other words how long will they live. We can split the issue: 1. How does health produce utility and 2. What affects health (e.g., medical care and life-style choices).[21]

Probably the most fundamental thing in consumer demand theory is that the good increases an individual’s utility. Health is not really a good in the traditional sense, but health in itself produces happiness. We can think of health as a durable good, much like for instance a car, a house or an education. We all come into the world with some inherent “stock” of health, and a healthy baby has a fairly high stock of health. Basically, every decision we take during our lifetime will affect our stock of health.[21]

Think of X as a bundle of other goods, and H as a stock of health. With this in mind we can get the formula for an individual’s utility as: Utility = U(X, H). For simplicity, we continue to think the stock of health produces utility, but technically, it is the flow of services created by the stock of health that produces utility. As the traditional fashion for goods, we say that more is better, in other words an increase in health leads to an increase in utility. With this in mind it seems logical that X grows with health, for instance it is more enjoyable to visit the zoo when you do not suffer from a headache.[21]

Like other durable goods, the stock of health wears out over time, much like other durable goods. This process can be called aging. When our stock of health has dropped low enough, we will lose our ability to function. We can say, in economic terminology that the stock of health depreciates. Since life expectancy has risen a lot during this century, it implies that e.g., the depreciation rate has decreased during this time. Public-health care efforts and individual medical care are in place to restore the stock of health or to decrease the depreciation rate on the stock of health. If we were to plot an individual’s stock of health throughout its lifetime in a graph, it would steadily increase in the beginning during its childhood, and after that gradually decline because of aging, meanwhile sudden drops created by random events, such as injury or illness.[21]

There are many other things than “random” health care events, which individuals consume or do during their lives that affect the speed of aging and the severity and frequency of the drops. Lifestyle choices can deeply better or worse our health. If we go back to X, the bundle of goods and services, can undertake numerous characteristics, some add value while others noticeably decrease our stock of health. Outstanding among such lifestyle choices are the decision to consume alcohol, smoke tobacco, use drugs, composition of diet, amount of exercise and so on. Not only can X and H work as substitutes for one another in producing utility, but X can also affect H in a production sense as well. X can then be split into different categories depending on which effect it has on H, for instance “good” types (e.g., moderate exercise), “bad” types (e.g., food with high cholesterol) and “neutral” types (e.g., concerts and books). Neutral goods do not have an apparent effect on individuals’ health.[21]

See also



  1. ^ "World Health Expenditure as Share of Global GDP". Our World in Data. Retrieved 5 March 2020.
  2. ^ Howard, Brandon; Health, JH Bloomberg School of Public. "What Is Health Economics?". Johns Hopkins Bloomberg School of Public Health. Retrieved 25 February 2020.
  3. ^ Arrow, Kenneth (1963). "Uncertainty and the Welfare Economics of Medical Care". The American Economic Review. 53 (5): 941–973.
  4. ^ Phelps, Charles E. (2003), Health Economics (3rd ed.), Boston: Addison Wesley, ISBN 978-0-321-06898-9 Description and 2nd ed. preview.
  5. ^ Fuchs, Victor R. (1987). "health economics". The New Palgrave: A Dictionary of Economics. 2. pp. 614–19.
  6. ^ Fuchs, Victor R. (1996). "Economics, Values, and Health Care Reform" (PDF). American Economic Review. 86 (1). Archived from the original (PDF) on 14 July 2007.
  7. ^ Fuchs, Victor R. (1998) [1974]. Who Shall Live? Health, Economics, and Social Choice.
  8. ^ Wolfe, Barbara (2008). "health economics." The New Palgrave Dictionary of Economics', 2nd Edition. Abstract & TOC.
  9. ^ Williams, A. (1987), "Health economics: the cheerful face of a dismal science", in Williams, A. (ed.), Health and Economics, London: Macmillan
  10. ^ Grossman, Michael (1972), "On the Concept of Health Capital and the Demand for Health", Journal of Political Economy, 80 (2): 223–55, CiteSeerX, doi:10.1086/259880
  11. ^ Svorny, Shirley (2004), "Licensing Doctors: Do Economists Agree?", Econ Journal Watch, 1 (2): 279–305
  12. ^ Folland, S., Goodman, A. C., & Stano, M. (2012). The Economics of Health and Health Care. Routledge.
  13. ^ National Health Policy. (2019, January 7). Ayushman Bharat. Retrieved from National Health Policy:
  14. ^ "Why government intervention in health care is necessary". Erasmus University Rotterdam. nd.
  15. ^ Roy, A. (22 August 2011). "Hospital Monopolies: The Biggest Driver of Health Costs That Nobody Talks About". Forbes.
  16. ^ A.J. Culyer (1989) "A Glossary of the more common terms encountered in health economics" in MS Hersh-Cochran and KP Cochran (Eds.) Compendium of English Language Course Syllabi and Textbooks in Health Economics, Copenhagen, WHO, 215–34
  17. ^ Currie, Janet and Mark Stabile. "Mental Health in Childhood and Human Capital". The Problems of Disadvantaged Youth: An Economic Perspective ed. J. Gruber. Chicago: University of Chicago Press, 2009.
  18. ^ a b c Evers, S.; Salvador–Carulla, L.; Halsteinli, V.; McDaid, D.; MHEEN Group (April 2007), "Implementing mental health economic evaluation evidence: Building a Bridge between theory and practice", Journal of Mental Health, 16 (2): 223–41, doi:10.1080/09638230701279881, S2CID 56590693
  19. ^ Bhavsar, V.; Bhugra, D. (December 2008), "Globalization: Mental health and social economic factors" (PDF), Global Social Policy, 8 (3): 378–96, doi:10.1177/1468018108095634, S2CID 53418285
  20. ^ Petrasek M, Rapin L; Rapin (2002), "The mental health paradox", Benefits Q, 18 (2): 73–77, PMID 12004583
  21. ^ a b c d e Phelps, C.E. (2017). Health economics. Routledge. pp. 27–43.

Further reading