As one of the largest industries in any country, health care plays an important role in the economy. It also carries important psychological and social significance. People with chronic diseases often require long-term care, which can include physical therapy and psychotherapy. In addition, access to health services is vital for people with less serious ailments. The cost of health care in most countries ranges from 3 to nearly 18 percent of GDP.
The economics of health care is complex and varied. In general, it is different from most other industries in several respects: the product is ill-defined; there is uncertainty in demand, as well as uncertainty about the effectiveness of treatment; and large segments of the industry are dominated by nonprofit providers and payments made by third parties. Nevertheless, health care is like other industries in that it responds to incentives just as other industries do.
In the past, much health economics work focused on the classic concept of positive externalities and market failures. Such externalities occur when the consumption of a good or service generates benefits for others that are not captured by market exchanges. In particular, the consumption of a service may impose costs on non-consumers or the environment that are not reflected in its market price (e.g., environmental costs associated with production and disposal of drugs).
Another common problem in health care is the information asymmetry between consumers and providers. This leads to market failures in which patients fail to purchase the amount of care that they would if they were fully informed, they purchase care of differing quality, and so on. Health care has additional problems resulting from the fact that its delivery is time-consuming and requires substantial personal commitment on the part of physicians and other providers. For example, tight physician fee schedules give doctors incentives to reduce their own time and other resources during patient visits, so that patients must make multiple visits in order to receive the same total care that they would have received if the physicians were unconstrained by these restrictions. This hidden patient time cost does not appear in standard measures of health care spending.
The final reason for market failures in health care is the negative effect that a change in medical technology can have on consumer welfare. This effect depends on two factors: the marginal contribution of improvements in health status to utility, U/HS, which is subjective and known only by the individual; and the marginal productivity of a service in producing health, HS/HC, which is a technical relationship that can be established by scientific research.
The economics of health care are challenging because the quality of the industry is a matter of life and death for individuals as well as for societies as a whole. It is a unique service industry that is critical to the economic survival of most economies, and is especially crucial to a sense of community well-being. As a result, it is important to understand its dynamics in order to manage it effectively.