Lecture 5 FGS - Chapter 4 - finish FGS - Chapter 5 - start

Medical Research? Useless? NO !!! Can provide disease origins Can address specific diseases Moreover, just because marginal impact isn’t big, it doesn’t mean that the total impact isn’t big.

Early contributions. Auster, Leveson, and Sarachek, found. elasticity of medical services expenditures on mortality was about -0.1, and not statistically significant. Is it worth it? ALS found elasticity of education to be -0.2, and significant. So was cigarette smoking.

More Early Contributions Dorothy Rice suggested (1966) that total costs of future earnings loss (then) approx. $50B. Cutting that by 0.1 percent would give benefits of $50M. Increased expenditures would have been $320M. What does this imply?

Age GroupMalesFemales <142%35% %26% %42% %69% %28% %17% % 6% Fuchs -- Utah/Nevada Excess Death Rates (Nevada - Utah)

Hadley, Table 4.3

Neonate Mortality Table 4.4 looks at neonate mortality. Rate is the ratio of infant deaths aged 1 month or less per thousand live births. It fell from 17.9 to 7.7. Corman, Joyce, and Grossman were able to estimate the contributions of specific types of medical care and specific types of neonate-related programs. WIC - Women, Infants and Children (improved nutrition program) is means tested, directed toward the poor. For whites - 25% of the reduction can be explained For blacks - 56% can be explained.

Morbidity Mortality is useful because it is easy to measure. Morbidity refers to illness. What might we expect? If most diseases are either self-limiting, or irreversible, the possibilities for additional medical services to reverse morbidity are small. May work for some services (hypertension, periodontal disease), and not for others. That's about what is found.

Schooling - Two Different Theories Grossman - Educated people produce health more efficiently. Why? If so, it makes sense to transfer resources from medical care to education. Fuchs - Education is an investment with a long time horizon. So is health! Since individuals with low time discount rates, or “long time horizons” will tend to invest both in education and health, the two (health and education) will be correlated. Next (Ch. 5)

Health Capital Your body is like a “car.” Huh ???Huh ??? How do we think of the body as a capital good, and medical care as a health investment ???

Discounting and the Evaluation of Health Care Investments Since the investment aspect to health expenditure is critical to the model of demand for health capital, it is appropriate to discuss the evaluation of investments. Economists are often asked to compare investments that provide different streams of income over a number of periods. Why, for example, should George pay for a physical check-up (Investment H), when instead he can have his car serviced (Investment S) for the same cost.

Evaluating Investments Compare Investment H, which provides $20 at the end of Year 1, and $20 at the end of Year 2, with Investment S, which provides $28 at the end of Year 1, and $11 at the end of Year 2. PDV = R 1 /(1+r) + R 2 /(1+r) 2 a. Interest rate = 5% Health (H)ReturnCar (S)Return Period 1 20Period 1 28 Period 2 20Period 2 11 PDV37.19PDV Health has a higher PDV! What does this mean?

Evaluating Investments Compare Investment H, which provides $20 at the end of Year 1, and $20 at the end of Year 2, with Investment S, which provides $28 at the end of Year 1, and $11 at the end of Year 2. b. Interest rate = 15% HealthReturnCarReturn Period 1 20Period 1 28 Period 2 20Period 2 11 PDV32.51PDV32.66 Car has a higher PDV!

Investment Over Time - (Cost of Capital) Since health is a capital good, it is necessary to understand the cost of capital as well as the capital good demand process. A health clinic, for example, purchases thousands of dollars of X-ray equipment. The return to the X-ray equipment is in the future earnings that ownership of the equipment can provide. Suppose that an X-ray machine costs $50,000, and that its price does not change over time. Suppose that the annual income attributable to the use of the X-ray machine is $10,000. Is this a good investment? Consider the alternative: Instead of purchasing the X-ray machine the clinic could have put the $50,000 in a savings account, at 5 percent interest, yielding:

Cost of Capital 50,000 * 1.05 = 52,500, at the end of Year 1. 52,500 * 1.05 = 55,125, at the end of Year 2. 55,125 * 1.05 = 57,881, at the end of Year 3. 57,881 * 1.05 = 60,775, at the end of Year 4. 60,775 * 1.05 = 63,814, at the end of Year 5. For the investment in an X-ray machine to be desirable by these criteria, it should provide at least $13,810 in incremental revenue over the five years.

Cost of Capital The problem is more complicated, however, because most capital goods depreciate over time. Suppose that the clinic knows that the X-ray machine will wear out (or depreciate), so that after five years, it will be worth only half its original value. The clinic must earn enough not only to cover the opportunity cost from the bank, but also to maintain the value of the machine. For the investment to be worthwhile, then, it must not only earn the competitive 5 percent return each year, but it must also provide enough return to cover depreciation of the machine.

Cost of capital This suggests that the cost of holding this capital good for any one year, as well as over time, will equal the opportunity cost of the capital (interest foregone) plus the depreciation (deterioration of value). Had the price of the asset changed, leading to capital losses or gains, this feature too would have to be considered. How do we consider this? If there is an expected capital gain, we expect a lower cost of holding the capital.