1. Chapter 3 Demand for Health Care Services

2. 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

3. 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

4. Medical Care and Utility
We can generally graph the relation between medical care and utility as follows:
Utility
Medical Care

5. 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?

6. 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

7. 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

8. Last $ spent on medical care generates more U than
Proof
Suppose that instead :
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
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9. 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
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10. Deriving a Demand Curve for Physician Visits
Downward sloping demand curve for physician visits
Price changes lead to movements along D curve
Price P1 P0 q0 q1

11. 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,…)

12. 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

13. Other Economic Factors Affecting Demand
1. Income
If income increases, then at any given price, consumer is willing and able to purchase more q q0 q1
Price P0 DO D1
Physician Visits

14. Other Economic Factors Affecting Demand
Complements 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

15. Other Economic Factors Affecting Demand
2. Complements
e.g. contact lenses and optometrist visits
If contact lenses become cheaper, demand for optometrist visits ___
Price D0 D1
Optometrist Visits
Price of complement falls

16. 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

17. 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 D1 D0
Brand name drugs
Demand for brand name drug falls

18. Elasticities
A relatively flat demand curve implies that a small increase in price leads to a large fall in # visits demanded
Price
# Visits

19. Elasticities
In this case demand is considered to be relatively “elastic” with respect to a change in price
Price
# Visits

20. Elasticities
A relatively steep demand curve implies that a small increase in price leads to a small fall in # visits demanded
Price
# Visits

21. Elasticities
Price
In this case demand is considered to be relatively “inelastic” relative to a change in price
# Visits

22. Elasticities (cont.) Own-Price Elasticity of Demand:
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

23. Elasticities (cont.)
ED is expected to be negative. Thus, own-price 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|<

24. 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

25. Except in special cases, the ED is different on different points of the demand curveQ 4 8
Demand curve: Q = 8 – 2P 2
ED = -1
ED = -
ED = 0

26. Elasticities (cont.) Income elasticity of demand:
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

27. Elasticities (cont.) Cross-price elasticity of demand:
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 Advil leads to a 15% increase in the quantity of Tylenol demanded
EC is negative for complements
EC is positive for substitutes

28. 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 %DQD I < I %DP I
Total revenue will increase if price is raised when demand is inelastic

29. QUIZ
A 1991 study by Frank Chaloupka estimated the price elasticity demand for cigarettes to be:
.48
.83
1.02
1.33

30. 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

31. Insurance No insurance : consumer faces price P, makes q visits
W/coinsurance : consumer faces price cP, wants to make qc visits
Price P cP qc q
# Visits

32. Insurance (cont.)
Price P cP qc q
# Visits
Coinsurance leads to a demand of qc visits at price P,
shared by consumer and insurance company
Demand curve rotates clock wise

33. What if the consumer has full coverage?
i.e., copayment = 0
Price
# Visits

34. 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
Visits D0 D1
$150

35. Fixed $ copayment
Patient pays up to $20 per visit, and insurer pays the rest
Price D1
$20 D0
Visits

36. 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