4. DEMAND FOR HEALTH1.ppt, Application of Economic principles in assessing the demand for health care

Demand for health care

1. demand for health care

2. 1. Not medical care per se that consumers want but health
2. The consumer does not passively purchase health but produces it - medical care
demand is a derived demand for an input to produce health itself. People want
health and they demand medical care to produce it (along with lots of other
things)
3.Health last for more than one period. It is a durable good. Thus it is a time
allocation problem.
4. The demand for health has two aspects:
1. Pure consumption aspect - health is desired because it makes people feel
better
2. Pure investment aspect - health is desired because it increases the
number of health days available to work and thus increases income.
5.The Demand for health care is uncertain.
5. The idea is that unlike other goods, we really do not know what our demand will be like in the future.
This adds to the mix, because we need to allow this uncertainty or risk to affect preferences. This gives
rise to the market for health insurance, and also leads to many of the problems in health care markets.
How is health care demand different from other goods?

3. Demand for health services is a function of
•price of health services
•Income
•Type of insurance
•Level of education
•Age
•Lifestyle (do you smoke, do you exercise)
•Quality of care
•Your health status
•Time costs to reach medical care
•Prices of substitutes and complements

4. Quantity of Physician
Services
Price of
Physician
Services
D
Demand of HS is a derived demand, because
what we really want is the demand for good
health not just a visit to the doctor.
Change in prices cause a movement along the
demand curve.
Law of Demand: Inverse relationship between
price and quantity.

5. Relationship between medical care and
health improvement is not exact.
Uncertainty in what type of care needed to
get you better
Consumer does not have medical
knowledge to know what they need to
get better so depends on physician.
Physicians, not consumers choose medical
services and this affects the quantity of
care you may demand.

6. Difficult to accurately delineate
(demarcate bounds of) the
relationship between price and
quantity demanded of medical care.
Prices differ and amount of care for a
given prices differs for difference
people.
Hard to control and measure quality.

7. Demand for Health Services
Fuzzy Demand Curve
Quantity of Physician Services
Price of
Physician
Services
1.For a given price may observe variation in
quantity of medical services.
2.For a given quantity of services, may see
various prices.

8. Demand for Health Services Effect of Price of health care
Own Price Elasticity:
Price HS
Quantity HS
Perfectly Inelastic (E=0);
Large change in price no change in quantity
demanded.
Perfectly Elastic ( E=∞):
Small change in price large change in quantity)
- A good is elastic if E<-1
%
%
d
hs
hs
Q
P



9. Demand for Health Care Empirical Estimates
Own Price Elasticity:
%
%
d
hs
hs
Q
P


 Estimates tend to be between -0.1 and -0.7 for Primary Care and Hospital
Care.
 So a 10% increase in price of primary care leads to a 1 to 7 percent
decrease in quantity demanded – inelastic.
 This is why some argue that you should increase the price. Will not reduce
health care so much, and hopefully people will reduce unnecessary visits.
 In developing countries increasing the price has been meet with a lot of
opposition – not a lot of unneeded visits.

10. Demand for Health Services Effect of Income
Quantity of Physician Services
Price of Physician
Services
D1
D2
Q1



Q2
Increase in income demand
more (health is a normal
good):
Shifts the curve out away from
the origin and would demand
more health care.

11. Demand for Health Services Effect of Health Insurance
How much you demand may depends on type of
insurance
•Co-insurance: consumer pays a fixed percent of the
cost (say 20%) and the insurance company picks up
the rest.
•Indemnity Insurance: Pays a fixed amount for each
type of services (say $150 if you go to the emergency
room).
•Deductibles: consumer must pay out of pocket for all
health care, until reaches a threshold (such as $1000),
then is fully reimbursed (paid back) for expenses
above the threshold.

12. Demand for Health Services Health Insurance:
Coinsurance
Dwo
.5*50
50
5
Consumer Pays with
insurance
Dwo: Demand without insurance
Effective Price: Amount paid out of pocket
Model using DWO curve
Assume: .5 co-insurance
Quantity of Physician Services
Price of
Physician
Services
6
Consumer pays
without insurance
Demand
increased by
one unit

13. Demand for Health Services Health
Insurance: Coinsurance
Dwo
Dwi
.5*50
50
5
Dwo: Demand without insurance
Dwi: Demand with insurance
Model by using market price
-Insurance makes her demand more health care,
-makes demand less elastic: for the same increase in
price will reduce demand less with insurance.
Quantity of Physician Services
Price of
Physician
Services
6
A

14. Demand for Health Services Health Insurance:
Indemnity
Price of
Physician
Services
Quantity of Physician Services
Pay $30 instead of 60 for a
doctors visit.-demand more
health care
-elasticity does not change.
$30
Dwo
Dwi
5
60
6

15. Demand for Health Services Health Insurance:
Deductible
Purpose of deductible is to lower cost for insurance
company
1.Reduce administrative costs because lower number
of small claims.
2.May lower demand for medical care
Depends on cost of the medical episode
Small costs small problem may not demand
health care, big costs you are more likely to
get the health care.

16. Demand for Health Services
Health Insurance: Deductible
Cont.
Time when medical care is demanded
If close to time when deductible is reset, may
wait for care
If just after deductible has started more likely
to have care
Probability of needing additional medical
care in the remainder of the deductible
period.
If know definitely will meet deductible, won’t
wait to go to doctor.

17. Demand for Health Services
Education
Relationship could be positive or negative
Educated take more proactive action to keep
healthy so need less medical care (produce health
care at home)
Want to keep healthy so can work more and earn
more, so demand more health care.
Know when they need to get medical care – so
demand more medical care.
Empirically not sure of direction, do find that those
who have more medical knowledge demand more
medical care.

18. Demand for Health Services
Age, Health Status, Sex, Quality
Very young and the elderly demand more
medical care.
People with lower health status (sicker)
tend to demand more health
Females tend to demand more health
services (child bearing)
If quality of care is higher, tend to demand
more health care.

19. Demand for Health Services
Prices of Substitutes and Complements
Substitute: Herbal and Non-Western
Medicine
Price of substitute rises demand more
medical care.
Complements: Drugs, if can’t afford the
drugs may not bother to go to doctor.
Price of a complement rises demand less
medical care.

20. Demand for Health Services
Travel Time Costs
Demand will depend on how long it
takes to get to the doctor and if there
are waiting times.
•E.G. Kaiser, will no longer be in North
Boulder – those in North Boulder may
go less. – depends on type of illness.
•Important in developing countries

21. GROSS MAN MODEL
To read- becker (1966)
“Investment in health as a form of
human capital the Grossman model”

22. Aims of the session
(what I hope to do)
Provide an insight into the Grossman model
Provide guidance on the technical concepts
and graphical representation of the model
Show the implications of the model – and
highlight some criticisms

23. Objectives
(what I hope you are able to do)
Understand the contribution of the Grossman
model to health economics
Assess the application of consumer theory to the
debate on the demand for health and health care
Be able to discuss the role of variables such as
age, income and education on the demand for
health care

24. General background
Health is determined by many factors among
which medical care is only one
These factors include social class, work
environment, employment status, income, house
heating conditions, education, diet and lifestyle
The relative importance of inequalities in these
types of resources cannot be determined unless
there is an understanding of the links between
resources, behaviour and health

25. Background to Grossman
Grossman (JPE, 1972) was concerned with how
individuals allocate their resources to produce health
The model goes beyond traditional demand analysis
and has been extremely influential in health economics
It utilises the idea of the individual as a producer of
health (not simply a consumer) by removing the
artificial separation of consumption and production
It also introduces the idea of investing in human capital
(health and education) to improve outcomes in both the
market (work) and non-market (household) sectors

26. Key concepts
Demand for health care is derived
from a demand for health (few people want
health care for its own sake)
Demand for health is derived
from the demand for utility (e.g. healthy days in
which to participate in leisure and work)
Individuals are not passive consumers of health
but active producers who spend time and
money on the production of health
Health can be seen as lasting over time periods.
It depreciates (perhaps at a non-constant rate)
and can therefore be analysed as a capital good

27. Key assumptions
Individuals value health but do not value it above
all else (if they did, they would not over-eat,
smoke, drink too much, or drive too fast) 
We have limited incomes with which to finance
health and other activities, and neither is costless 
We exert a relatively high degree of control over
our health by virtue of the fact that we can
influence our health-affecting consumption
patterns, our health care utilisation and our
environment.

28. The demand for health
Health demand consists of two elements:
(1) Consumption effects:
health yields direct utility i.e. you feel better when
you are healthier
(2) Investment effects:
health increases the number of days available to
participate in market and non-market activities –
the novel bit of the model

29. Health as a capital good
H Stock
t
= H Stock
t-1
– dep’n ) + inv. in H (I)
A person is born with initial endowment of H, which
they add to by investment.
The rate of H production will depend on the efficiency
of investment in H.
There will be  in the value of the stock of H through
age, accident, carelessness, sudden disease.
As we are considering U over a life-time we also need
to be aware of the issue of time-preference

30. The human capital model
The individual is a producer of H (amongst other
things): they buy market inputs (medical care, food,
clothing), and combine them with their own time to
produce services that increase their utility
The analysis is based on human capital theory which
shows how individuals invest in themselves e.g.
through training or education, to increase their
productivity
The optimal amount of investment in human capital is
determined by the relative Cs and Bs: usually the Cs
occur in the short-term whilst the Bs accrue in the
future in the form of enhanced job opportunities

31. Investing in health
HEALTH
STOCK
HEALTHY
DAYS
PRODUCTION
PROCESS
Health Care
Diet
Exercise
Environment
Income
OUTPUT
Time
INPUTS

32. And to quote …
“The only way to keep your health is to eat
what you don’t want, drink what you don’t
like and do what you’d rather not.”
Mark Twain (1835-1910)

33. The investment decision
Household production functions:
Health production( health z prod, by time spent improving health…….
I = f(M,T
H)
Consumption goods
Z =f(X,T
C
)
I = investment in health( an increment to capitals stock such as health)
M = market health care inputs
T
H
= time spent on improving health
Z = composite consumption good
X = market produced goods
T
C
= time spent on composite consumption good
So one use money to buy health care inputs(M) and or home guds(X)

34. The investment decision
Analogy with a firm using inputs to produce goods:
decisions made according to production functions –
relationship between inputs and outputs.
Education plays a crucial role in determining the
efficiency of health capital and also in other
production functions, therefore influences
consumption patterns of households
Assume:
individuals want to maximise their lifetime utility
they have perfect knowledge
and able to allocate time between different activities

35. Implied choices
Inter-related time choices:
Labour time (income) vs. leisure time vs. ill time
Within leisure time choice:
health producing time (gym) vs. non-health producing
time
Resource choices:
Health care inputs vs. other consumption
subject to budget constraint

36. Optimal choice of investment
Marginal cost (of investing in H) = Marginal benefits
Marginal cost = r + ,
where
r = rate of interest on other investments
 = rate of depreciation of health
i.e. the opportunity cost
Both r and  are exogenous to the model

37. Optimal choice of investment
Marginal benefit = rate of return = (W*G)/C
where
W = wage rate,
G = marginal product (rate of return) of health
investment which is subject to diminishing MR
C = direct cost of investment in health
This is the ‘marginal efficiency of capital’ (MEC)

38. Demand for Health Capital
Cost of capital
Health Stock
H*
r + ð
MEC
X
At point X marginal cost = marginal benefit
Conventional economics provides a powerful apparatus to
analyse the demand for health capital ( MEI)
= is a demand concept that relates the return to investiment to
the amount of resources invested
Diminishing returns between health investment and health i.e.
the production function is the normal shape - as the level of
health capital increases it is increasingly difficult to generate
health from inputs

39. The Effect of Ageing-SKIP EXAM
Cost of capital
Health Stock
H*
r + ð
MEC
r + ð
1
Part of this is offset by increasing investment in H so health care demand rises.
H
1
Depreciation increases (d to d1) over the life
cycle (not a constant rate), therefore MC
rises, and hence demand for health capital
falls – but demand for health care may rise
due to inelastic demand curve for health.

40. And to quote …
“Biological factors associated with ageing raise the
price of human capital and cause individuals to
substitute away from future health until death is
chosen” (Grossman, 1972)

41. Changes in the Wage Rate
Cost of capital
Health Stock
H
1
r + ð
H
2
An increase in W raises the returns on healthy
days. The optimal level of H is thus higher. But
investment in HC also requires an input of time
which increases the costs of such investment.
MEC
2
MEC
1

42. Changes in Education
MEC
Health CapitalH
1
r + ð
H
2
Education increases the efficiency of non-
market production – it increases the MP of
health inputs thereby raising the optimal
health stock. Also better educated may
enjoy exercise etc. more and may be more
able to follow treatments
MEC
2
MEC
1

43. Implications
Raise education amongst the poorly
educated
Reduce price of health care, especially to
the poor
Increase wages of the low paid
Use policies to affect depreciation

44. Criticisms of the model
Assumes health care is a constant life time
investment
It ignores insurance markets
Assumes perfect information on the part of
consumers about the MEC of health care, interest
rates, depreciation, etc. – for now and the future.
It is deterministic including the choice of when to
die!

45. Summary
Consumers want health not health care per se
Consumers produce health
Health does not depreciate instantly
Demand for health has pure consumption and pure
investment aspects
The cost of holding health is the opportunity costs of
capital plus the depreciation rate
The MEC curve is downward sloping due to MR
Rewards of being healthy are greater for high
income
Health can be generated at less cost by educated

46. Questions
Describe the aspects of health that make it a consumption good
and those aspects that make it an investment good
Give examples of how health might be produced from market and
non-market goods
Discuss some of the factors that might increase an individual’s
marginal efficiency of investment in health capital
Do you think the typical person becomes more or less healthy
upon retirement? What does the Grossman model predict?
Richer people can afford more of all goods (including health care)
yet according to the model will choose a higher health stock. Why?