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Health Economics
Outline
Theoretical derivation of the demand curve for medical services. Economic and noneconomic variables that influence demand. Elasticities. The impact of health insurance on demand.
6
4
2
1 2 3 4
Medical Care
The previous graph illustrates an example of constant marginal utility Because each additional unit of medical care yields the same increase in utility, the relation can be graphed using a straight line.
Because this relation is linear, it can also be represented using the following algebraic equation:
In practice one would never see this relation between utility and medical care, because it violates the assumption of diminishing marginal utility.
8
6 4 2 1 2 3 4 Medical Care
The previous graph illustrates an example of diminishing marginal utility Because each additional unit of medical care yields a smaller increase in utility, the relation cannot be graphed using a straight line.
Medical Care
The graph shows that as the level of medical 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?
tradeoffs
Given the consumers income, she chooses q and z to maximize utility. Utility maximization rule :
MUq MUZ
Pq
Pz
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
Pq
>
MUZ
Pz
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.
Pq
Consumer can
<
MUz
Pz
Pq
q1
q0
When we read graphs, we usually ask how a change in the variable on the horizontal axis affects the variable on the y axis.
However, when economists draw demand curves, price is on the vertical axis, and quantity is on the horizontal axis.
The graph is read in reverse of the usual manner: How does a change along the vertical axis affect the variable on the horizontal axis?
$75
$50
$25
1 2 3 4
Physician Visits
Which of the following equations is more likely to be a demand curve for physician visits?
Q = 8 + 2P Q = 8 2P
Practice Question
Can you come up with an algebraic formula for the demand curve for physician visits that we graphed? (e.g. where 1 visit was demanded at a price of $100) Try this at home, and well look at the answer in the next class.
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.
If income increases, then at any given price, consumer is willing and able to purchase more q.
Price
DO
P0
D1
q0
q1
Physician Visits
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.
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
e.g. Coke and Pepsi e.g. Physicians and Nurse practitioners? e.g. generic and brand name drugs.
e.g. generic and brand name drugs. If generic drugs in price, D for brand name ___.
Price
D1
D0
Brand name drugs
Quantity
D1
D0
Quantity
Deliveries
Knee Surgery Carpal Tunnel
Facelifts
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
We would like a way to quantify the elasticity of a demand curve with respect to price. More generaly, elasticity measures the responsiveness of quantity demanded to a change in an independent factor.
Elasticities (cont.)
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
Relatively elastic
Relatively inelastic
# Visits
Elasticities (cont.)
% QD Q Q P P % P P Q P
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.
Except in special cases, the ED is different on different points of the demand curve. P
ED = -
4
ED = -1 2 ED = 0 4 Demand curve: Q = 8 2P 8
Elasticities (cont.)
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.)
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 Tylenol leads to a 15% increase in the quantity of Advil demanded.
EC
Elasticities
Own price elasticity of demand critical for determining
a health care managers total revenue. TR = PQ D
QD
If demand for physician services is inelastic, and the price is raised, then
I %QD I < I %P I
Although expenditures are rising, we have seen that health status has also improved. The size of the entire economy has grown, so that the % of GDP spent on health care has held steady.
--
10.6%
12.9
10.9
6.7
5.2
8.4
$143
341
1,052
2,690
3,686
4,358
5,043
5.1%
7.1
8.9
12.2
13.3
13.0
13.4
Out-of-pocket payments
Other private payments PUBLIC Medicare Medicaid Oth. Govt TOTAL
199.5
51.8 522.7 216.6 170.6 135.5 1149.1
15.4
6.1 45.3 17.6 15.4 12.2 100
The private and public sources of health expenditure are relatively equal. Private health insurance pays for a substantial amount of health care. The Medicare and Medicaid programs account for a majority of public health care expenditures.