1. 317_L10, Jan 29, 2008, J. Schaafsma 1 Review of the Last Lecture began our discussion of the demand function for healthcare Discussed: derived demand, difference between the demand function and the demand curce specified the demand function for HC: discussed the direct and indirect effects of a variable on the demand for HC Were looking at how an increase in the price of a good that is bad for HS affects the demand for healthcare Q D = Q(Y, P HC, P NHC, HS, Z) + 

2. 317_L10, Jan 29, 2008, J. Schaafsma 2 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: smoke less P  (income and substitution effects) => HS  => need less HC net impact of the direct and indirect effects unknown, likely Q D 

3. 317_L10, Jan 29, 2008, J. Schaafsma 3 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 (P elasticity is 0): 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 left over 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  !!

4. 317_L10, Jan 29, 2008, J. Schaafsma 4 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).///

5. 317_L10, Jan 29, 2008, J. Schaafsma 5 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.

6. 317_L10, Jan 29, 2008, J. Schaafsma 6 Insurance and the Demand for HC: Some Basic Concepts will look at two kinds of insurance: - common kind: insurer pays part or all of the loss - less common kind: indemnity payment ~> insurer pays a fixed amount per unit of HC consumed, regardless of actual unit cost. both kinds could be subject to a deductible (2 kinds of deductibles): annual deductible: insurer only reimburses annual losses in excess of some annual minimum: e.g., insurer may reimburse 70% of annual HC costs above $1000 (here must keep track of losses over the year). per loss deductible: the insurer only reimburses losses in excess of a minimum,.e.g., a $500 deductible per loss for theft insurance. If a $600 bike is stolen, insured only gets $100.///

7. 317_L10, Jan 29, 2008, J. Schaafsma 7 Health Insurance That Pays a Fraction of the Unit Price suppose insurance pays a fraction, ir, of the unit price, e.g., ir = 0.8 (1 – ir) = cir is the co-insurance rate (fraction paid by the patient) Note: two prices: P(1–ir) the effective price paid by the consumer P the price received by the producer thus, if the equation for the demand curve is Q = a - bP without insurance, it is Q = a - b(1-ir)P with insurance. given ir ~> derive new demand curve from the old one (see diagram) insurance rotates the demand curve clockwise ~> more price inelastic. new demand curve is vertical when ir = 1. ///

8. 317_L10, Jan 29, 2008, J. Schaafsma 8 Effect of Insurance on P and Q, and Welfare Loss Insurance coverage drives up P and Q and total expenditure on HC (see diagram) Creates a welfare loss: the cost of the additional HC consumed as a result of insurance exceeds the value placed on the additional benefits (see diagram) Also creates additional producer surplus: a payment to factors of production in excess of what is needed to have them produce HC (see diagram) in this case. The producer surplus is a transfer from the insured to the providers. have ignored the wealth effect of buying insurance, premium reduces income => demand curves for all goods shift left.///

9. 317_L10, Jan 29, 2008, J. Schaafsma 9 The Slope of the Demand and Supply Curves and the Effect of Proportional Insurance on P & Q the size of the welfare loss depends on the slopes of the demand and supply curves the steeper the demand curve the less the increase in P & Q from proportional insurance if the supply curve is vertical insurance only increases P if the supply curve is horizontal insurance only increases Q

10. 317_L10, Jan 29, 2008, J. Schaafsma 10 A User Fee and the Welfare Loss suppose there is 100% insurance coverage ~> P to the consumer = 0 get the maximum welfare loss (see diagram) user fee ~> an amount paid by the patient per unit of HC consumed even a modest user fee can reduce the welfare loss substantially (see diagram) Reason ~> user fee reduces consumption of HC units with the largest per unit welfare loss, i.e. it eliminates the most wasteful spending.///

11. 317_L10, Jan 29, 2008, J. Schaafsma 11 Proportional Insurance and Shifts in Supply As noted earlier: proportional insurance rotates the demand curve clockwise and increases its slope shifts in supply thus have larger P effects and smaller Q effects (explain the economics with a diagram) the steeper the demand curve Implication: with proportional insurance rising costs on the supply side are easier to pass forward through a higher market P (show). ///