#### Transcript Health Economics ch3

```Chapter 3
Demand 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
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 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?
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
Given the consumer’s income, she chooses q and z
to maximize utility.
 Utility maximization rule :

MUq
Pq
MUZ
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

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
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
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

Price
D1
DO
P0
q0
q1
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
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




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 brand
name drug falls
D1
D0
Brand name drugs
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 (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|<
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
% Q D
Q Q P


*
P
% P
P Q
P
Except in special cases, the ED is different on different
points of the demand curve
P
4

ED = -
ED = -1
2
ED = 0
4
Demand curve: Q = 8 – 2P
8
Q
Elasticities (cont.)

Income elasticity of demand:
EY 
% QD % change in quantity demanded

% 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:
EC 

% Q X % change in quantity demanded of good X

% PY
% 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
quantity of Tylenol 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
QUIZ

A 1991 study by Frank Chaloupka estimated the price
elasticity demand for cigarettes to be:
A.
.48
.83
1.02
1.33
B.
C.
D.
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
Price
P
cP
q
qc
# Visits
No insurance : consumer faces price P, makes q visits
 W/coinsurance : consumer faces price cP, wants to
make qc visits

Insurance (cont.)
Price
P
cP
q
qc
# Visits
 Coinsurance leads to a demand of qc visits at price P,
shared by consumer and insurance company
 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 rest
Price
\$150
D1
D
0
Visits
•
Fixed \$ copayment

Patient pays up to \$20 per visit, and insurer pays the rest
Price
D1
\$20
D0
Visits
•
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
```