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HEALTH ECONOMICS Supply Supply is the amount of some product which will be available to customers or the willingness of the

seller to sell. Factors affecting supply Innumerable factors and circumstances could affect a sellers willingness or ability to produce and sell a good. Some of the more common factors are: Goods own price: The basic supply relationship is between the price of a good and the quantity supplied. Althought there is no "Law of supply" generally the relationship is positive or direct meaning that an increase in price will induce and increase in the quantity supplied. Price of related goods: For purposes of supply analysis related goods refer to goods from which inputs are derived to be used in the production of the primary good Technology. Technology is the way inputs are combined to produce a final good. A technological advance would cause the average cost of production to fall which would be reflected in an outward shift of the supply curve. Expectations: Sellers expectations concerning future market condition can directly affect supply. If the seller believes that the demand for his product will sharply increase in the foreseeable future the firm owner may immediately increase production in anticipation of future price increases. The supply curve would shift out. Note that the outward shift of the supply curve may create the exact condition the seller anticipated, excess demand. Price of inputs: Inputs include land, labor, energy and raw materials. If the price of inputs increases the supply curve will shift in as sellers are less willing or able to sell goods at existing prices. For example, if the price of electricity increased a seller may reduce his supply because of the increased costs of production. The seller is likely to raise the price the seller charges for each unit of output. Government policies and regulations: Government intervention can have a significant effect on supply. Government intervention can take many forms including environmental and health regulations, hour and wage laws, taxes, electrical and natural gas rates and zoning and land use regulations. Time and Supply Unlike the demand relationship, however, the supply relationship is a factor of time. Time is important to supply because suppliers must, but cannot always, react quickly to a change in demand or price. So it is important to try and determine whether a price change that is caused by demand will be temporary or permanent.

The Law of Supply Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue. Shifts in the Supply Curve While changes in price result in movement along the supply curve, changes in other relevant factors cause a shift in supply, that is, a shift of the supply curve to the left or right. Such a shift results in a change in quantity supplied for a given price level. If the change causes an increase in the quantity supplied at each price, the supply curve would shift to the right: Seeking to maximise profits leads sellers to want to sell more quantity 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 a population of sellers is willing and able to sell at every conceivable price. This positive relationship is shown graphically by the supply curve on the left - SS. If the price changes there is a movement along the supply curve (see Figure A).

Figure B

Figure C

Figure E

Figure F

Figure G

Figure H

Equilibrium When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding.

As you can see on the chart, equilibrium occurs at the intersection of the demand and supply curve, which indicates no allocative inefficiency. At this point, the price of the goods will be P* and the quantity will be Q*. These figures are referred to as equilibrium price and quantity. In the real market place equilibrium can only ever be reached in theory, so the prices of goods and services are constantly changing in relation to fluctuations in demand and supply. Disequilibrium Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*. 1. Excess Supply If the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency.

At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1, however, the quantity that the consumers want to consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much is being produced and too little is being consumed. The suppliers are trying to produce more goods, which they hope to sell to increase profits, but those consuming the goods will find the product less attractive and purchase less because the price is too high. Excess Supply is where Quantity supplied > Quantity demanded, and results in surpluses at the current price.

2. Excess Demand Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it.

In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2. Conversely, the quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of the consumers. However, as consumers have to compete with one other to buy the good at this price, the demand will push the price up, making suppliers want to supply more and bringing the price closer to its equilibrium. Excess Demand occurs when Quantity demanded > Quantity supplied, and results in shortages at current prices. In free markets, surpluses and/or shortages tend to be temporary and obey the law of supply and demand, since actions of buyers and sellers tend to match prices back toward their equilibrium levels.

Supply and Demand The market price of a good is determined by both the supply and demand for it. In 1890, English economist Alfred Marshall published his work, Principles of Economics, which was one of the earlier writings on how both supply and demand interacted to determine price. Today, the supply-demand model is one of the fundamental concepts of economics. The price level of a good essentially is determined by the point at which quantity supplied equals quantity demanded. To illustrate, consider the following case in which the supply and demand curves are plotted on the same graph. Supply and Demand

On this graph, there is only one price level at which quantity demanded is in balance with the quantity supplied, and that price is the point at which the supply and demand curves cross. The law of supply and demand predicts that the price level will move toward the point that equalizes quantities supplied and demanded. To understand why this must be the equilibrium point, consider the situation in which the price is higher than the price at which the curves cross. In such a case, the quantity supplied would be greater than the quantity demanded and there would be a surplus of the good on the market. Specifically, from the graph we see that if the unit price is $3 (assuming relative pricing in dollars), the quantities supplied and demanded would be: Quantity Supplied = 42 units Quantity Demanded = 26 units Therefore there would be a surplus of 42 - 26 = 16 units. The sellers then would lower their price in order to sell the surplus. Suppose the sellers lowered their prices below the equilibrium point. In this case, the quantity demanded would increase beyond what was supplied, and there would be a shortage. If the price is held at $2, the quantity supplied then would be: Quantity Supplied = 28 units Quantity Demanded = 38 units Therefore, there would be a shortage of 38 - 28 = 10 units. The sellers then would increase their prices to earn more money. The equilibrium point must be the point at which quantity supplied and quantity demanded are in balance, which is where the supply and demand curves cross. From the graph above, one sees that this is at a price of approximately $2.40 and a quantity of 34 units. To understand how the law of supply and demand functions when there is a shift in demand, consider the case in which there is a shift in demand:

Shift in Demand

In this example, the positive shift in demand results in a new supply-demand equilibrium point that in higher in both quantity and price. For each possible shift in the supply or demand curve, a similar graph can be constructed showing the effect on equilibrium price and quantity.

Result of Shifts in Supply and Demand


Demand Supply + + + + Equilibrium Equilibrium Price Quantity + + + + ? + ? + ? ?

+ + -

1. Draw a supply and demand diagram of the market for health care in the late 1980s and early 1990s. Show the initial equilibrium price and quantity. a)In this period, employers increasingly adopted managed care plans. What happened to the supply curve as a result? Why? b)Illustrate this on your diagram and show the implications for the equilibrium price and quantity of health care. 2. Now draw a similar diagram for health care in 1999-2000. Show the initial equilibrium. a)As drug prices have risen and doctors have charged more as they have consolidated, what has happened to supply and/or demand? Explain your response. b)Illustrate the changes on your diagram and show the implications for the equilibrium price and quantity of health care. 3. Draw a diagram showing the demand for, and the supply of, managed care. Mark the initial equilibrium price and quantity. a)Many consumers are complaining about the service provided by managed care plans. If employers were to take their feelings into account, what would happen to the demand and/or supply curves? Explain which determinant of supply or demand has changed. b)Illustrate the effect of this on the equilibrium price and quantity of managed care. c)If both changes in Questions 2 and 3 were to occur in the market for managed care, what would happen to the equilibrium price and quantity of managed care?