Health Care Economics: Supply, Demand, and Equity Explained

Supply and Demand in Health Care

Health care economics can be understood through a number of fundamental economic concepts, the most basic of which is supply and demand. Supply refers to how much of something is available in a market, while demand refers to how much people want it. The concept reflects the idea that, without constraints, supply and demand will be roughly equal. In the real world, of course, constraints always exist.

Demand has a number of drivers, and health care providers need to be aware of them. Older people require more health care, so demand increases as the population ages. Sick people similarly require more health care, meaning that rising rates of disease or illness also increase demand. As people approach the end of life—especially at an advanced age—they become prolific consumers of health care services. While the aging baby boomer generation will result in increased demand for health care in the near term, the biggest impact will come as more of this generation enters its eighties and begins consuming health care at a much more rapid rate.

Policy changes also affect demand. Something like the Affordable Care Act (ACA) increases demand because more people have health insurance and are therefore able to pay for health care services. For health care providers, increased demand must be met with increased supply. It is not necessarily easy to increase supply—training doctors and nurses and building infrastructure all take considerable time and investment. Thus, when supply is short, prices rise as those who demand health care compete to attract the attention of suppliers. For those in the health care industry, it is important to understand the different drivers of demand and then assess how the existing supply will match up against them.

Scarcity and the Price Mechanism

Scarcity is a concept closely related to supply and demand. It describes a situation in which supply is less than demand. Normally, scarcity is reflected in a higher price, as those who demand a good bid up the price in order to acquire it at the expense of others who want it as well. The price of a good is therefore determined by the relative balance of its supply and demand. When the price rises, scarcity tends to dissipate as demand exits the market.

Need Versus Demand in Health Care Markets

Scarcity also provides a useful lens for understanding the difference between need and demand. Demand is essentially the aggregate of need and want. As the price of a scarce good rises, the "want" component typically exits the market, leaving only genuine need. In health care terms, elective surgery can be seen as part of demand but not of need, whereas cancer treatment represents both a need and a component of demand.

However, when analyzing health care economics, it is important to recognize that an excess supply of one type of health care service cannot simply substitute for a shortage in another. If there is excess demand in the health care system overall, that imbalance cannot be resolved merely by eliminating supply that caters to wants. A surgeon specializing in cosmetic rhinoplasty cannot simply begin treating dementia in the elderly. Health care may often be discussed in aggregate terms, but it is actually a collection of similar yet distinctly different individual markets, each with its own supply and demand conditions.

Marginal Analysis and Opportunity Cost

Several other economic concepts help illuminate health care economics. One important tool is marginal analysis, which health care providers use to make decisions about the provision of supply. Marginal analysis seeks to weigh the additional benefits of a decision against its additional costs. An action is typically undertaken when the marginal benefit exceeds the marginal cost.

This is closely related to the concept of opportunity cost—the cost of one choice as measured by the value of the next-best alternative forgone. A straightforward example is a hospital that has $20 million available for a new wing. It can invest that sum in a children's medicine wing, but doing so means it cannot spend the same money on a new cancer wing. The opportunity cost of pursuing children's medicine is therefore the foregone cancer wing. In economic terms, the hospital would compare the marginal value of each option and select the one that delivers the greater return.