In the previous chapter you were told that health service use is determined by supply as well as demand. The following extract by Martin Green (1995) starts by describing the influence of supply, using the example of osteopathy.
The free market approach to health care
Supply – analysing sellers’ behaviourWe assume that osteopaths want to maximise their profits. What are profits and how can they be maximised? Osteopaths earn money (revenue) by selling their services e.g. by massaging away muscular strains. Out of this revenue they need to pay for the factors they use to produce the treatment (costs) e.g. pay their receptionist, pay the rent or pay for a new ultrasound machine. Profit is the excess of revenue over costs.
Seeking to maximise profits leads each osteopath to want to sell more care at higher prices. There is a reliable and predictable positive relationship between price and quantity supplied. Formally, supply is defined as the quantity of a good or service that sellers are willing and able to sell at every conceivable price. This positive relationship is shown graphically by the supply curve. If the price changes there is a movement along the supply curve (Figure 4.1).
If the level of factor costs change (e.g. nurses wages go up or rent becomes less expensive) then the supply curve will shift (Figures 4.2 and 4.3).
Figure 4.1 The supply curve for osteopathy treatments
SS is the supply curve for treatments. At price P′ osteopaths are prepared to sell Q′ treatments.
When the price rises to P″ osteopaths are prepared to sell Q″ treatments.
Source: Green (1995)
The market
We can now put the demand and supply together to get a picture of the market for osteopathy. This is shown by Figure 4.4. Notice that there is only one price at which the quantity of treatments people want to buy is the same as the quantity the osteopaths want to sell. This is called the equilibrium price (P′ on Figure 4.4). Equilibrium means a state of rest where there is no pressure for change.
Figure 4.2 Nurses’ wages rise
SS is the initial supply curve for treatments. Now nurses’ wages rise, pushing up osteopaths’
costs. Osteopaths react by being prepared to supply less treatments at each price. The supply curve shifts inwards to S″S″. At a price such as P″ osteopaths are now only prepared to sell Q′ treatments rather than Q″.
Source: Green (1995)
Figure 4.3 Rent falls
SS is the initial supply curve for treatments. Now rents fall and osteopaths react by being prepared to supply more treatments at each price. The supply curve shifts outwards to S′S′. At a price such as P′ osteopaths are now prepared to sell Q″ treatments rather than Q′.
Source: Green (1995)
At any other price either buyers or sellers are dissatisfied and act to change the price.
Figures 4.5 and 4.6 illustrate this. If there is excess demand consumers bid up the price while if there is excess supply sellers cut the price. Both these processes continue until equilibrium is reached. So the free interaction of buyers and sellers in the market auto- matically leads to a single price at which the quantity traded ‘clears’ the market i.e. the quantity supplied equals the quantity demanded.
Figure 4.4 The market for osteopathy treatments
DD shows how many treatments consumers wish to purchase at each price while SS shows how many osteopaths are prepared to sell. Q′, P′ are the equilibrium quantity and price.
Source: Green (1995)
Figure 4.5 Excess demand
At P′ consumers demand Q but osteopaths are only prepared to supply Q′. Excess demand leads to the price being bid up to P″.
Source: Green (1995)
How the market responds to a shock
A shock is anything which moves a market out of equilibrium. Suppose people’s incomes rise: how will the osteopathy market react? Figure 4.7 illustrates this situation. This process will occur whenever there is a shock leading to either a shift in demand or supply.
Figure 4.6 Excess supply
At P osteopaths wish to sell Q but consumers only wish to buy Q′. Excess supply leads to prices being cut to P″.
Source: Green (1995)
Figure 4.7 Impact of increase in income on market for osteopathy
DD and SS are the initial demand and supply curves and P′/Q′ is the initial equilibrium. The increase in income shifts the demand curve outwards (DD to D′D′) reflecting the fact that osteopathy is a normal good. This shift in demand throws the market out of equilibrium. Now people want to buy Q treatments at price P′ but the osteopaths are still only prepared to sell Q′. The result is excess demand and unsatisfied buyers who react by ‘bidding up’ the price. The market regains equilibrium at price and quantity P″/Q″.
Source: Green (1995)
The market will move out of equilibrium with either excess demand or excess supply appearing. Price will adjust until equilibrium is regained.
Now, suppose you want to increase the quantity of dental services provided in your country. In the short term this will require dentists and their staff to work longer hours. Because they value their leisure time they might insist on a higher wage to work these longer, less sociable hours. The wage paid must reflect the opportunity cost of the lost leisure time. In the long term, you might be able to increase the number of dentists. To do this, you would have to raise dentists’ wages to tempt people away from other career paths and into dental school. So in both the short term and long term the implication is that to increase output requires making use of more expensive resources. Therefore larger quantities can only be supplied at higher prices.
Activity 4.1
Figure 4.8 shows the supply curve for dental check-ups in a hypothetical city.
1 Suppose that there is an increase in the number of qualified dentists. What do you think would be the effect on quantity supplied, ceteris paribus? Mark and label this effect on Figure 4.8.
2 Now, suppose that the price charged for a dental check-up falls from p1 to p3, ceteris paribus. Mark the effect on Figure 4.8.
Feedback
1 The increase in dentistry graduates is an increase in the number of providers of dental services, including dental check-ups. Other things remaining equal, this means that quantity supplied increases at each price level – that is, the supply curve shifts to the right (a shift from S1 to S2 on Figure 4.9, resulting in an increase in quantity supplied at that price from q1 to q2).
Figure 4.8 The supply of dental health checks
2 This fall in price can be represented by a downward movement on the supply curve.
Dentists are willing to provide fewer check-ups at the lower price. This is shown in Figure 4.9 by the decrease in quantity supplied from q1 to q3.
Activity 4.2
Considering the dental practice described in Activity 4.1, what would be the effect on the supply curve in the following circumstances?
1 Suppose that there is a movement of dental clinics to an area that is outside the city.
This means that dentists no longer have to pay the high rents of the city centre.
Mark this effect on Figure 4.10, ceteris paribus.
Figure 4.9 Changes in the supply of dental health checks
Figure 4.10 The supply of dental health checks
2 If receptionists’ salaries increase, what would be the effect on supply of dental check-ups, ceteris paribus? Again mark the change on Figure 4.10.
Feedback
1 The lower rent charge implies lower costs for all dental activities including check- ups. This means that the dentists will be prepared to supply more dental check-ups at each price level – that is, the supply curve shifts to the right (from S1 to S2 on Figure 4.11).
2 The higher wage of receptionists implies higher costs for all dental activity, including check-ups. This means that the dentists will be able to supply fewer dental check-ups at each price level – that is, the supply curve shifts to the left (from S1 to S3 on Figure 4.11).