Transcript price a facelift

Chapter 5:
Demand for Medical Services
and Medical Spending
Health Economics
Outline
Theoretical derivation of the demand
curve for medical services.
 Economic and noneconomic variables
that influence demand.
 Elasticities.
 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
Medical Care and Utility
Example: Do the following values of Medical
Care and Utility imply diminishing marginal
utility of care?
Medical Care
Utility
1
2
2
4
3
6
4
8
MU
Medical Care and Utility
Graph this relation between medical care and
utility.
Utility
8
6
4
2
1
2
3
4
Medical Care
Medical Care and Utility

The previous graph illustrates an
example of constant marginal utility

Because each additional unit of medical
care yields the same increase in utility,
the relation can be graphed using a
straight line.
Medical Care and Utility

Because this relation is linear, it can
also be represented using the following
algebraic equation:
Utility = 2*Medical Care

In practice one would never see this
relation between utility and medical
care, because it violates the assumption
of diminishing marginal utility.
Medical Care and Utility
Example: What about these values? Do they
satisfy the law of diminishing marginal utility?
Medical Care
Utility
1
2
2
6
3
9
4
11
MU
Medical Care and Utility
Graph this relation between medical care and
utility.
Utility
10
8
6
4
2
1
2
3
4
Medical Care
Medical Care and Utility

The previous graph illustrates an
example of diminishing marginal utility

Because each additional unit of medical
care yields a smaller increase in utility,
the relation cannot be graphed using a
straight line.
Medical Care and 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 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?
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
Pq
>
MUZ
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
Pq
 Consumer can

Pq
<
MUz
Pz
U by purchasing less q, and more z.
lower demand for q
Deriving a Demand Curve for
Physician Visits

Downward sloping demand curve for physician
visits.
Price
P1
P0
q1
q0
 Price changes lead to movements along D curve
Demand Curve for Physician Visits
The relation between price and the quantity demanded can be
expressed using a demand schedule:
Price per Visit
$100
Quantity of Visits
Demanded
1
$75
2
$50
3
$25
4
Economists and Reverse
Graph Reading

When we read graphs, we usually ask how a
change in the variable on the horizontal axis
affects the variable on the y axis.

However, when economists draw demand
curves, price is on the vertical axis, and quantity
is on the horizontal axis.

The graph is read in reverse of the usual
manner: How does a change along the vertical
axis affect the variable on the horizontal axis?
Demand Curve for Physician Visits
Graph the previous relation between price and
the quantity of physician visits demanded.
Price
$100
$75
$50
$25
1
2
3
4
Physician Visits
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,…)
Deriving a Demand Curve for
Physician Visits (cont.)
P
4
Demand curves are graphed in the
form P = a – bQ.
8
Q
Deriving a Demand Curve for
Physician Visits (cont.)

Which of the following equations is
more likely to be a demand curve for
physician visits?
Q = 8 + 2P
Q = 8 – 2P
Practice Question

Can you come up with an algebraic
formula for the demand curve for
physician visits that we graphed? (e.g.
where 1 visit was demanded at a price
of $100)

Try this at home, and we’ll look at the
answer in the next class.
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.
Price
D1
DO
P0
q0
q1
Physician Visits
Other Economic Factors
Affecting Demand
2. 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.
Other Economic Factors
Affecting Demand
2. Complements


e.g. contact lenses and optometrist visits.
If contact lenses become cheaper, demand for optometrist
visits ___.
Price
Price of complement
falls
D0
D1
Optometrist Visits
Other Economic Factors
Affecting Demand
3. 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
Demand for generic
drug falls
D1
D0
Brand name drugs
Demand Curve Terminology
Price
A to B: increase in
quantity demanded
A
10
B
8
4
6
Quantity
Demand Curve Terminology (cont.)
Price
D0 to D1: Increase in
demand
D1
D0
Quantity
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Elasticities
Price
A relatively flat demand curve
implies that a small increase in
price leads to a large fall in #
visits demanded.
# Visits
Elasticities
Price
In this case demand is
considered to be relatively
“elastic” with respect to a
change in price.
# Visits
Elasticities
Price
A relatively steep demand curve
implies that a small increase in
price leads to a small fall in #
visits demanded.
# Visits
Elasticities
Price
In this case demand is
considered to be relatively
“inelastic” relative to a change
in price.
# Visits
Elasticities

We would like a way to quantify the
elasticity of a demand curve with respect
to price.

More generaly, elasticity measures the
responsiveness of quantity demanded to a
change in an independent factor.

Elasticities measure this responsiveness
in terms of proportionality.
Elasticities (cont.)

Own-Price Elasticity of Demand:
% QD
% change in quantity demanded
ED 

% P
% change in price

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.
Elasticities (cont.)

ED is expected to be negative. Thus, ownprice 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|<
More price elastic demand leads
to a flatter demand curve.
Price
Relatively elastic
Relatively inelastic
# Visits
Elasticities (cont.)
Q
% QD
Q Q P



P
% P
P Q
P

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.
Except in special cases, the ED is different
on different points of the demand curve.
P
ED = -
4
ED = -1
2
ED = 0
4
Demand curve: Q = 8 – 2P
8
Q
Elasticities (cont.)

Income elasticity of demand:
% QD
% change in quantity demanded
EY 

% Y
% change in income

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.
Elasticities (cont.)

Cross-price elasticity of demand:
% Q X
% change in quantity demanded of good X
EC 

% PZ
% change in price of good Y

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 Tylenol
leads to a 15% increase in the quantity of
Advil demanded.
 EC
is negative for complements.
 EC is positive for substitutes.
Elasticities
 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
 Total revenue will increase if price is raised
when demand is inelastic.
Health Care Expenditures
Expenditure=Price x Quantity

Although expenditures are rising, we
have seen that health status has also
improved.

The size of the entire economy has
grown, so that the % of GDP spent on
health care has held steady.
Health Care Expenditures in the
United States, 1960-2001
1960
1970
1980
1990
1995
1999
2001*
Nominal health expenditures
(billions of dollars)
$26.9
73.2
247.3
699.4
987.0
1210.7
1424.2
Annual rate of growth
(average annual % change
from previous period shown)
Nominal per capita health
expenditures
--
10.6%
12.9
10.9
6.7
5.2
8.4
$143
341
1,052
2,690
3,686
4,358
5,043
Health expenditures as
percentage of GDP
5.1%
7.1
8.9
12.2
13.3
13.0
13.4
*Projected
Source: Health Care Financing Administration Homepage: http://www.hcfa.gov/stats/stats.htm
Health Care Expenditures 1999 (cont.)
Revenue
Source
PRIVATE
$billions
% of Total
626.4
54.7
375
33.1
Out-of-pocket
payments
199.5
15.4
Other private
payments
51.8
6.1
522.7
45.3
Medicare
216.6
17.6
Medicaid
170.6
15.4
Oth. Gov’t
135.5
12.2
1149.1
100
Private
health
insurance
PUBLIC
TOTAL
Health Care Expenditures (cont.)

The private and public sources of health
expenditure are relatively equal.

Private health insurance pays for a
substantial amount of health care.

The Medicare and Medicaid programs
account for a majority of public health
care expenditures.