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Issue 28/13 October 2010

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Today’s Issue Includes:


What do we need? A new AS Data Response Question and Answer by Brian Ellis, former Chief Examiner for Edexcel, Economics and Business, and currently Chair of Examiners.

Evidence A - What is normal?

Our concept of poverty has two variations. Absolute poverty means not having essentials such as adequate food and shelter. Relative poverty means not having enough income to participate actively in society. One definition of relative poverty is anything below 60% of median income. The Joseph Rowntree Foundation offers another approach to relative poverty.

The Foundation commissions research into a ‘minimum income standard’, based on what people need for a socially acceptable standard of living. In 2010, researchers said a single person needs to earn at least £14,400 a year before tax to reach this standard. A couple with two children needs £29,200. These totals are above 60% of median income so above the alternative thresholds for relative poverty.

The members of the public who were involved in the research believe that people need more than physical essentials like food, warmth and shelter, but also things which allow them to participate in society. A computer and home Internet connection are now considered essential for non-pensioner households. Fridge-freezers, DVD players and mobile phones are considered an integral part of modern life that everyone should be able to afford. A certain budget for going out is required, people need to be able to buy birthday presents and everyone needs at least a week's holiday away from home each year.

Benefits for people who are out of work provide substantially less than the minimum income standards suggested above. The pay required to meet the minimum income standard is well above the national minimum wage (£5.80 per hour at the time of writing). The majority of UK workers are paid more than the minimum wage, so the majority of households where at least one person works have incomes above the minimum income standard.

Evidence B - Who needs Omalizumab?

Asthma and related problems have become increasingly common in developed countries. Over 1 million children in the UK have asthma. An allergic reaction is often involved. Many patients have relatively mild symptoms and can limit problems they have by the use of inhalers or other straightforward treatments. For a small minority of patients asthma presents a severe threat to their quality of life, and can even be a cause of death. Omalizumab is a relatively new drug treatment for severe asthma symptoms. Up to 80% of patients in trials had improved lung function and quality of life when treated. The UK National Institute for Clinical Excellence (NICE) has approved National Health Service (NHS) use of Omalizumab, under the brand name Xolair, for patients aged 12 and above with severe persistent allergic asthma. The drug is taken by injection, the makers charge the NHS over £6000 per typical patient for a year's treatment.

Questions

1.What is meant by ‘national minimum wage’?(4)

2. Explain two negative consequences of raising the national minimum wage to £8 per hour in order to help low paid workers to reach minimum income standards.(8)

3. How necessary are fridge-freezers?(8)

4. Examine the opportunity cost of Omalizumab use.(10)

5. Makers of newly approved drugs are protected from competition for a number of years, copying of such products is not allowed. Explain a strength and a weakness of this system.(8)

6. Expensive new treatments, the ageing population and rising expectations are all adding to pressures on NHS budgets. Assess the case for more use of the price mechanism (e.g. charging for visits to doctors) in the NHS.(12)

Suggested Answers

1.What is meant by ‘national minimum wage’?

The national minimum wage is the lowest hourly wage which an employer can pay to an adult in the UK. In other words, in 2010 employers are required to pay at least £5.80 per hour to adult employees. This has no effect on people paid more than the minimum but sets a floor level and makes it illegal to pay people any less than this rate.

2. Explain two negative consequences of raising the national minimum wage to £8 per hour in order to help low paid workers to reach minimum income standards.

Labour is a derived demand. Employers are interested in how much workers add to revenue. It only makes sense to employ someone if they add more to revenue than it costs to employ them. If someone adds say £7 to revenue per hour worked and is paid £5.80, employing that person makes sense. If the wage rate is forced up to £8, this is more than the gain from employing the person. The employer might sack them rather than lose money.

Because £8 is substantially more than £5.80, there are likely to be thousands of people who could lose their jobs if the national minimum wage went up to such an amount. The intention might be to help low paid workers. This could be achieved for workers who kept their jobs. However, it is likely that thousands of people would become unemployed. As a result, these people would probably become worse off rather than better off.

There are many low-paid workers in the public sector, including many cleaners, teaching assistants and clerical workers. Public sector activity is not guided by profits in the same way as the private sector, but public sector employers would also see big increases in their wage bills. If they chose not to sack workers the bigger wage bills would need to be funded. Ultimately, public sector spending is largely financed by taxation. It could well become necessary to raise taxes in order to meet the wage bills.

Extra taxes such as income tax or national insurance would reduce the amount people are able to spend and so their standard of living. Extra indirect taxes would raise prices and so would also reduce the amounts of goods and services people could afford to buy from their incomes.

3. How necessary are fridge-freezers?

One interpretation of necessity would be to identify things which are needed for survival. In that sense, fridge-freezers are not a necessity. If we look at people around the threshold for absolute poverty, they will not have fridge-freezers. In less developed countries many people don’t even have electricity supplies so such appliances are exceptional. At the same time, fridge-freezers are useful and are one of the many appliances which are now regarded as normal for most UK households.

Although fridge-freezers are not absolutely necessary, they do make a contribution to the quality-of-life by extending the period for which many products from milk to frozen meals can be stored and the majority of UK citizens now expect to have the use of at least a fridge. DVD players, mobile phones and computers are perhaps even less ‘necessary’, but they are also useful for the way that most of us live in the UK.

Evidence A talks about a socially acceptable standard of living. We can say that fridge-freezers are seen as necessary for a socially acceptable standard of living by the members of the public consulted in the Rowntree Foundation research. This is a common sense point of view as most of us expect to have to use the least a fridge and probably a fridge-freezer. They are not necessary for survival but they are a necessary part of the typical UK lifestyle in the 21st century.

4. Examine the opportunity cost of Omalizumab use.

Opportunity cost refers to the best alternative forgone when a particular choice is made. Evidence B says that the typical cost of Omalizumab is over £6000 per patient per year. If we confine ourselves to looking at a fixed NHS budget, every patient given this drug means £6000 less for the NHS to spend on something else.

With a fixed budget, NHS managers must choose between competing priorities as it is not possible to provide all of the treatments that anybody might want. Thus, for example, cosmetic surgery which is entirely for reasons of vanity is not normally funded by the NHS. Only in exceptional circumstances of particular need does the NHS fund cosmetic surgery. Something must give from within the range of treatments and services that the NHS provides whenever a new treatment becomes available with no corresponding extra funding. Savings could be made by scrapping a particular service or by limiting the number of treatments given and making some patients wait for a future funding period.

If we allow the possibility of extra funding for the NHS, the opportunity cost of this is either a reduction in some other area of public spending or an increase in taxation or public borrowing. Everyone is entitled to their own view on public spending priorities. Some people believe that universities should charge more fees and so cost the taxpayer less, others see aspects of defence such as Trident submarines as a low priority. There has to be a political judgement between competing claims on spending, giving more to the NHS could mean spending less on something else.

The alternative of raising taxation would transfer the opportunity cost to taxpayers. The NHS would be able to afford more but at least some taxpayers would become less well off. If the government borrows more money, this will increase future interest and repayments and so have an impact on future taxpayers. Health services take up around 10% of total spending and this could be increased if less is spent on something else. Once again, political judgements are required on how much tax should be paid and by whom.

Any use of resources reduces the resources available for other purposes and so has an opportunity cost. Omalizumab is no exception to this. One could argue that successfully treated patients become more productive so reduce the real net cost. Some other recently introduced drug treatments cost more than £30,000 per patient per year and so have an even greater opportunity cost.

5. Makers of newly approved drugs are protected from competition for a number of years, copying of such products is not allowed. Explain a strength and a weakness of this system.

Protection from competition (which is legally called patent protection) means that the makers of new drug treatments can charge whatever they like for their products. The big advantage of this system is that it gives pharmaceutical companies a strong incentive to research and develop new treatments. Inevitably, some products will not be successful so money spent on their research and development will be lost. The ability to recover such losses and make substantial profits on successful treatments explains why the pharmaceutical companies are heavily involved in research and development.

When this leads to successful drug treatments, it brings a benefit to patients and society. For example, a range of powerful new drugs has significantly improved survival and recovery rates from many cancers. Improved medical understanding and treatments are part of the explanation for increasing life expectation around the world.

The weakness in this system is that patents allow pharmaceutical companies to set very high prices for up to 20 years. New and better drugs come onto the market but their high prices place a major strain on the finances of the NHS and other health systems. Where patients pay privately for treatment, the most expensive drugs can be beyond the means of all but a small minority of rich people. Thus, although new and improved treatments are introduced, they are often not accessible to some of the patients who could benefit from them.

As explained earlier, there is also a heavy opportunity cost imposed on health services when they decided to use and pay for such treatments. Once patents expire, copying of drugs becomes legal and prices generally tumble. This means that the benefits of new treatments are eventually more widely available. However, the pharmaceutical companies have an incentive to research and introduce even better treatments, perhaps at higher prices, before their patents expire.

6. Expensive new treatments, the ageing population and rising expectations are all adding to pressures on NHS budgets. Assess the case for more use of the price mechanism (e.g. charging for visits to doctors) in the NHS.

If consultations and treatments are available at price zero (or with a relatively small charge for prescriptions), people are free to make as much use of the NHS as they wish. If we think in terms of a downward sloping demand curve, people might use the NHS even when the benefit they gain is very small. Even a tiny benefit is worthwhile to the individual if there is no cost involved.

Charges might make people think a little more carefully about the resource cost that their NHS treatments involve. This could slightly reduce the pressure on NHS budgets by marginally reducing the demands made on the service. For the price signals to accurately reflect resource costs, prices would have to be set at realistic levels.

This goes against one of the principles of the National Health Service, which is that access to treatment should not depend on income or payment. Omalizumab gives us an example of a treatment which some people could simply not afford. If means testing were introduced, so that just those who could afford to were asked to pay for their treatment, this would entail complex administration and raise issues around fairness.

A second reason for introducing charging is that it would generate an income stream which could add to or partly replace government funding. With growing demands on the NHS, this could make it possible to offer more and better treatments without taking more taxpayer funding. With all of the other demands on government spending, charges would give the NHS a little more independence and perhaps make it more able to anticipate future funding.

People do not enjoy paying taxes so any alternative means of meeting some of the costs of the NHS will have an appeal. Such a development might also lead to better integration between the NHS and private medicine. At the moment, those who can afford to choose can opt for free NHS treatment or the full cost of private treatment. If the choice was between part payment for NHS treatment or full payment for private treatment, more people might choose private treatment and so reduce the demands made on the NHS.

A key issue here would be whether charges made reflected the full cost of treatment or a token amount. If the full cost is charged then the difference between NHS treatment and private medicine almost disappears. If only a token charge is made, then the price mechanism is not being used to fully signal the cost of services. Medical care is expensive and becoming more expensive over time. A service which is free at the point of use risks overconsumption. Introducing charging and therefore price mechanism signals has an appeal but is an option which also brings many problems.


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