317_L9, Jan 25, 2008, J. Schaafsma 1 Review of the Last Lecture Have finished our discussion of the Grossman model of the demand for HK (health capital) today begin our discussion of the demand for HC (healthcare)

317_L9, Jan 25, 2008, J. Schaafsma 2 Demand Function & Demand Curve demand curve vs. demand function movement along the demand curve vs. shifts in the demand curve

The Demand for Healthcare is a Derived Demand 317_L9, Jan 25, 2008, J. Schaafsma 3 healthcare does not yield utility directly in fact, at the time of consumption it frequently yields disutility (painful, stressful, embarrassing) healthcare is demanded for its anticipated positive effect on two things that do yield utility directly: 1) our stock of health capital 2) a return to better health when we are sick our demand for HC is driven by our demand for health capital and better HS when we are ill The demand for HC is thus a derived demand

317_L9, Jan 25, 2008, J. Schaafsma 4 The Demand Function for Healthcare Q D = Q(Y, P HC, P NHC, HS, Z) +  where: Q D is the quantity of HC demanded per year Y is nominal annual income P HC is the price of healthcare P NHC is the price of non healthcare goods HS is health status over the year Z is a vector of tastes etc (e.g., belief that a treatment works)  is a random error term NB. Assume for now that there is no health insurance

317_L9, Jan 25, 2008, J. Schaafsma 5 Direct and Indirect Effects on the Demand for HC A variable may affect the quantity of HC demanded directly (health status is assumed to be constant) and indirectly (via its impact on health status). The direct and indirect effects may work in the same direction or in opposite directions only if the two effects work in the same direction can one predict how a change in the variable affects the quantity of HC demanded

317_L9, Jan 25, 2008, J. Schaafsma 6 The Net Effect of a Change in Nominal Income on the Demand for Healthcare Q D = Q(Y, P HC, P NHC, HS, Z) +  The direct effect (HS held constant): as nominal income , ceteris paribus, real income , buy more of all goods, HC is a good, Q of HC demanded  (positive direct effect) (DIAGRAM) The indirect effect: as real income  generally healthier thus need less HC (negative indirect effect) (DIAGRAM) the direct and indirect effects work in opposite directions => net effect of an increase in nominal income (real income  since prices held constant) on Q of HC demanded cannot be predicted

317_L9, Jan 25, 2008, J. Schaafsma 7 An Increase in the Price of HC on Q of HC Demanded The direct effect (HS held constant) is negative (P HC  => Q dem  ) for two reasons ( Q D = Q(Y, P HC, P NHC, HS, Z) +  ): i) income effect (Explain) ii) substitution effect (Explain) The indirect effect: as P HC , use less healthcare and less of all other goods (due to real income down) => not as healthy as before => need more HC (+ve indirect effect) very unlikely that the +ve indirect effect will more than offset the –ve direct effect (DIAGRAM) empirical research indicates that the net effect of P HC on Q of HC demanded is negative

317_L9, Jan 25, 2008, J. Schaafsma 8 A Change in the Price of a Non- Healthcare Good There are many non-healthcare goods and P NHC should really be considered a vector of prices for non-healthcare goods, i.e., P NHC = P NHC1, P NHC2, …,P NHCn The effect of a change in the price of a non-healthcare good on the Q demanded of HC depends on the type of good We will consider the effect on the Q of HC demanded of price changes for two kinds of non-healthcare goods: i) goods that are good for health ii) goods that are bad for health

317_L9, Jan 25, 2008, J. Schaafsma 9 A Decrease in the Price of a Good that is Good for Health The direct effect: as the price of a good that is good for health goes down there is an income effect (P , real income , buy more of all goods, HC is a good) and a substitution effect (P , this good now relatively cheaper, substitute it for some HC) the income and substitution effects work in opposite directions thus can’t predict if the direct effect is positive or negative The indirect effect: P , real income  => HS . There is also a substitution effect: P , substitute this good for other goods, HS . Both effects work in the same direction => HS  => Q of HC demanded  from the indirect effect Theory can’t predict if the net impact of the direct and indirect effects on the Q of HC demanded is posititve or negative

317_L9, Jan 25, 2008, J. Schaafsma 10 An Increase in the Price of a Good that is Bad for Health Some goods are bad for health (tobacco, excessive alcohol consumption, illegal drugs) If the P of a bad  => direct and indirect effects on the Q of HC dem the direct effect combines an income effect (P  => real income , buy less all goods, HC is a good, Q of HC  ) and substitution effect (P , substitute other goods that yield utility for the bad, HC such a good, Q of HC demanded  ) Can’t sign the direct effect. The indirect effect: also consists of the income and substitution effects (explain), both reduce the demand for the bad as P  => HS  => need less HC net impact of the direct and indirect effects unknown, likely Q D 

317_L9, Jan 25, 2008, J. Schaafsma 11 Possible Exception to how Q of HC Demanded Responds to a Change in the Price of a Bad If the person is totally hooked on the bad: The direct effect: no substitution effect (no change in smoking since the P elasticity is 0). There is an income effect. The higher P extracts more purchasing power from the smoker => less left over for other goods including HC => Q of HC demanded  ). The indirect effect: no substitution effect (perfectly price inelastic demand). However, the higher P lowers purchasing power for other goods => HS  => more HC demanded the net impact of the direct and indirect effects could be to increase the demand for HC as the P of the bad  !!

317_L9, Jan 25, 2008, J. Schaafsma 12 Other Variables in the Demand Function for HC Z denotes a set of other variables in the demand function for HC: - illness: +ve effect on Q HC demanded ~> DC shifts right and becomes steeper. Why steeper? - belief about efficacy: e.g. homeopathic products and services, dietary supplements taken for their expected HS benefits. - tastes: (“instant fixes” vs. dietary/lifestyle changes)  random error term e.g. (random incidence of illness).///

317_L9, Jan 25, 2008, J. Schaafsma 13 Own Time Costs and Demand for HC for a salaried worker the unit price of HC is P HC for an hourly paid worker the effective unit price is P HC + the wages lost accessing one unit of HC thus, ceteris paribus, at each P HC a wage labourer will demand less care than a salaried person since the effective price is higher for a wage labourer Also, if the demand curve for healthcare is non-linear with respect to the effective price of HC, the wage labourer’s demand curve with respect to P HC will be steeper than for the salaried person (see diagram) => i.e., a drop in P HC will increase Q of HC demanded by more for a salaried person than for a wage rate labourer.