Monday, July 25, 2011

Creative use of Production Possibilities Frontier in regards to heathcare outcomes vs cost between the US and Canada. Regardless of how you feel about the issue, this is informative...

I hesitate to call this a Production Possibilities Frontier (the authors of this study do) because it looks different than the one we use in introductory economics. Appears to me to be somewhat of a supply curve with the output ("Health") on the vertical axis and the inputs ("Resources"--which have a price/cost) on the horizontal axis. But they are smarter than me, so lets go with it. It is a nice illustration of Allocative and Productive Efficiency as applied to health care.
Source: David M. Cutler and Dan P. Ly write of  "The (Paper)Work of Medicine: Understanding International Medical Costs." 
The curve is upward sloping indicating that as we add resources (move to the right from the origin on the horizontal axis) we get positive health outcomes (move up from the origin on the vertical axis). The curve is steep at first, indicating that as more resources are added the returns to health outcomes increase faster relative to the added inputs---Increasing Marginal Returns(see definition). It then flattens out, indicating that as more resources are added the returns to health outcomes start to decrease---Decreasing Marginal Returns (see definition).

There are 3 points identified on the graph "Canada", "Ideal US" and "Actual US". The horizontal difference between "Canada" and "Actual US" is labeled "Allocative (in)Efficiency". This means that to get the SAME health outcomes (point of Vertical axis) as Canada, the US uses more resources to do so---identified with the brackets and labeled "Allocative (in) Efficiency". Resources have a dollar cost, hence to get the same health outcomes as Canada we spend more total dollars.  Allocative Efficiency is achieved when the value consumers place on a good or service (reflected in the price they are willing to pay) equals the cost of the resources used up in production. Condition required is that price = marginal cost. When this condition is satisfied, total economic welfare is maximised."".  All things equal, the price of heath care in the US is more expensive than comparable health care in Canada.

Going in the other direction from "Actual US" to "Ideal US", the gap represented by the bracket shows "Productive (in)Efficiency". Given the resources we allocate to health care we SHOULD be getting more/better health care output/outcomes. This is measured by going from "Ideal US" to a point on the vertical axis. We know we are not getting this level of health care outcomes given the resources used, so we are being productively inefficient in the delivery of health care. Productive Efficiency is achieved when the output is produced at minimum average total cost (AC). For example we might consider whether a business is producing close to the low point of its long run average total cost curve. When this happens the firm is exploiting most of the available economies of scale. Productive efficiency exists when producers minimise the wastage of resources in their production processes.

This graph accompanies a very interesting study (link above) on one of the reasons health care costs are high in the US. The focus is on the administrative costs of delivering health care in the US relative to other countries. Regardless of how you feel about the issue, I encourage you to read the whole thing.  We gotta get real if we want to control the cost of health care now and in the future....

HT: The Conversable Economist
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