Chapter 3Demand for Health Care

Services

Outline

Theoretical derivation of the demand curve for medical services

Economic and noneconomic variables that influence demand

Elasticity The impact of health insurance on

demand

Medical Care and Utility

Medical care is an input in producing health Subject to law of diminishing marginal

productivity

Health yields utility to the consumer Subject to law of diminishing marginal utility

We can generally graph the relation between medical care and utility as follows:

Utility

Medical Care

Medical Care and Utility

The graph shows that as the level of medical care rises, each additional unit of medical care yields a smaller increase in utility

Given this fact, how does the consumer decide how much health care to purchase?

Medical Care and Utility

Consumer’s Optimal Choice of Health

Define : MU = marginal utility of medical care

P = price q = quantity of medical services z = quantity of all other goods

tradeoffs

Given the consumer’s income, she chooses q and z to maximize utility.

Utility maximization rule :

MUq MUZ

Pq Pz

Consumer’s Optimal Choice of Health

Total utility reaches its peak when the marginal utility gained from the last $ spent on each product is equalized

i.e. The consumer equalizes “the bang for the buck” across all goods

Proof Suppose that instead :

MUq MUZ

Pq Pz

Last $ spent on medical care generates more U than

last $ spent on other goods Consumer could U by purchasing more medical

care (q), and less other goods (z) Then MUq would fall, MUz would rise, until the 2

ratios are equalized

>

Deriving a Demand Curve for Physician Visits

Note : Now let q represent physician visits

Suppose Pq rises. This will lead to :

MUq Muz

Pq Pz

Consumer can U by purchasing less q, and more z

Pq lower demand for q

<

Downward sloping demand curve for physician visits

Price changes lead to movements along D curve

Deriving a Demand Curve for Physician Visits

Price

P1

P0

q0q1

Deriving a Demand Curve for Physician Visits (cont.)

Consumer’s purchase of medical care is a “derived demand”

i.e., “no direct” utility from visiting the doctor

U derived from health resulting from dr. visit:

U = U(h,z) h = h(q,…)

Other Economic Factors Affecting Demand The demand curve illustrates the effect of

changes in the price of the good on quantity demanded holding all other factors (income, prices of other goods) constant

Changes in factors other than the price of the good itself lead to shifts in the demand curve

Other Economic Factors Affecting Demand

1. Income If income increases, then at any given

price, consumer is willing and able to purchase more q

q0 q1

Price

P0

DOD1

Physician Visits

Other Economic Factors Affecting Demand Complements - 2 or more goods which are

consumed together e.g. left shoes and right shoes e.g. laser printers and toner cartridges e.g. alcohol and cigarettes? e.g. contact lenses and optometrist visits

2. Complements e.g. contact lenses and optometrist visits If contact lenses become cheaper, demand for

optometrist visits ___

Other Economic Factors Affecting Demand

Price

D0

D1

Optometrist Visits

Price of complement falls

Other Economic Factors Affecting Demand

Substitutes - other goods which satisfy the same wants, or provide same characteristics

e.g. Coke and Pepsi e.g. Physicians and Nurse practitioners? e.g. generic and brand name drugs

Other Economic Factors Affecting Demand

3. Substitutes - other goods which satisfy the same wants, or provide same characteristics

e.g. generic and brand name drugs If generic drugs in price, D for brand name ___

Price

D1

D0

Brand name drugs

Demand for brand name drug falls

Elasticities

A relatively flat demand curve implies that a small increase in price leads to a large fall in # visits demanded

Price

# Visits

In this case demand is considered to be relatively “elastic” with respect to a change in price

Price

# Visits

Elasticities

A relatively steep demand curve implies that a small increase in price leads to a small fall in # visits demanded

Price

# Visits

Elasticities

Price

# Visits

In this case demand is considered to be relatively “inelastic” relative to a change in price

Elasticities

Elasticities (cont.) Own-Price Elasticity of Demand:

Example: If the elasticity of demand for physician visits is -.6, a 10% increase in price leads to a 6% decrease in the number of visits demanded

Elasticities are scale-free We can compare the ED for physician visits vs.

nursing home days, even though they are consumed in different units

priceinchange

demandedquantityinchange

P

QE DD %

%

%

%

ED is expected to be negative. Thus, own-price elasticities of demand are often quoted in terms of absolute value

The demand curve is inelastic if 0<|ED|<1

The demand curve is elastic if

1<|ED|<

Elasticities (cont.)Elasticities (cont.)

Elasticities (cont.)

If you are given a formula for a demand curve, you can compute the elasticity of demand for any combination of price and quantity along that demand curve

Q

P

P

Q

PPQ

Q

P

QD *%

%

Except in special cases, the ED is different on different points of the demand curve

P

Q

4

8

Demand curve: Q = 8 – 2P

4

2

ED = -1

ED = -

ED = 0

Elasticities (cont.)

Income elasticity of demand:

Example: If the elasticity of demand for physician visits is .1, a 10% increase in income leads to a 1% increase in the number of visits demanded

For most types of medical care, EY should be positive

incomeinchange

demandedquantityinchange

Y

QE DY %

%

%

%

Elasticities (cont.)

Cross-price elasticity of demand:

Example: If the elasticity of demand for Tylenol with respect to the price of Advil is 1.5, a 10% increase in the price of Advil leads to a 15% increase in the quantity of Tylenol demanded EC is negative for complements

EC is positive for substitutes

Ygoodofpriceinchange

Xgoodofdemandedquantityinchange

P

QE

Y

XC %

%

%

%

Total revenue will increase if price is raised when demand is inelastic

• Own price elasticity of demand critical for determining a health care manager’s total revenue

TR = PQ D

• Demand theory tells us that P QD

If demand for physician services is inelastic, and

the price is raised, then I %QD I < I %P I

ElasticitiesElasticities

QUIZ

A 1991 study by Frank Chaloupka estimated the price elasticity demand for cigarettes to be:

A. .48B. .83C. 1.02D. 1.33

Insurance

The above demand analysis assumed that the patient pays for care out-of-pocket

How does insurance affect the demand for care?

Coinsurance - Patient pays only a fixed % of the cost of each visit (often C = .20)e.g. If the visit costs $100 : patient pays $20, insurance pays $80

Insurance

No insurance : consumer faces price P, makes q visits

W/coinsurance : consumer faces price cP, wants to make qc visits

Price

P

cP

qcq # Visits

Insurance (cont.)Insurance (cont.)

Coinsurance leads to a demand of qc visits at price P, shared by consumer and insurance company

Price

P

cP

qcq # Visits

Demand curve rotates clock wise

What if the consumer has full coverage?

i.e., copayment = 0

Price

# Visits

• Indemnity Insurance Insurer pays a fixed amount for each

purchased service Insurer pays $150 for each overnight

hospital stay, and patient pays the restPrice

Visits

D0

D1

$150

• Fixed $ copayment Patient pays up to $20 per visit, and insurer

pays the rest

Price

Visits

D0

$20

D1

• Deductibles - Consumer must pay a fixed amount out of pocket per year before coverage begins e.g. The initial $100 per year in health care

expenditures must be paid by the customer Lowers administrative costs, because fewer

small claims are filed each year Lowers demand for relatively inexpensive

medical services near start of the year Has much less impact on demand if relatively

expensive medical services are required