Demand for Health Care

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 Outline
• Demand & purpose of demand analysis
• Need, want & demand
• Michel Grossman model of demand for health
• Factors affecting demand for health
• Distinctive characteristics of health sector
• Law of demand, demand schedule & curve
• Economic factors that affect demand for health
• Equilibrium of demand & supply
• Elasticity of demand
• Factors affecting elasticity of demand
• Elastic & inelastic demand curves 2
 Demand
• Demand describes the behavior of consumers. It
does not mean the desire to obtain something
(Health care)

• The hungry man who can not pay for food has no
demand for it

• An individual’s demand for a good is the various

quantities of goods & services that the consumer
is willing and able to buy at each specific price

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 Demand for health care
• The major purpose of demand analysis for
medical care is to determine those factors
which on the average, most affect a
persons utilization of medical services

• Demand analysis seeks to identify which

factors are most influential in determining
how much care people are willing to
purchase
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 Need Vs. want
• A need is something that is necessary for humans
to live a healthy life.
• Needs are distinguished from wants because a
deficiency would cause a clear negative outcome,
such as dysfunction or death.
• In economics, a want is something that is desired.
• It is said that people have unlimited wants, but
limited resources.
• Thus, people cannot have everything they want and
must look for the best alternatives which they can
afford.
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 Need versus demand
Need
Someone's subjective
idea
(may be based on a
formula applied
objectively, but the choice
to use the formula was
someone's subjective
idea.
Money is not a factor.
Demand
Objectively observable as
behavior in the market.
Money is a key factor.
"Demand" is also called
"effective demand,"
because it's expressed
only by spending money.
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 Need versus demand…
• Health plans that focus on need and
ignore demand will face under- or over-
utilization of service capacity

• If one believes quantity demanded is too

little or too much (e.g. under-use or over-
use of emergency room) relative to need,
then quantity demanded must be
manipulated by changing,
– price or other costs to buyer, or
– demand through marketing or de-marketing
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 A model of demand for
medical care
• Consumer purchase goods and services for the
utility

• If the commodity demanded by consumers is good

health, then health can be produced by goods and
services purchased in the market as well as by the
time devoted to preventive measures

• Demand for medical care is derived from the more

basic demand for health
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 A model of demand for medical
care…
• According to Michel Grossman, consumers
have a demand for health for two reasons:

– Health is a consumption commodity—it makes

the consumer feel better

– Health is an investment commodity—a state of

health will determine the amount of time
available to the consumer for productivity
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 Grossman’s demand model

Individual/client factors
[age, sex, education, occupation]

Health care resources

Environmental factors factors
(physical, economic, Demand
E.g. supply, access,
social, cultural) acceptability

Prepayment factors
E.g. private insurance, tax based health
Insurance, national health system,
Out of pocket payment
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 Grossman’s demand model…
 According to this model every one inherits a
stock of health when born

• Health depreciated overtime, however an

investment is required to sustain health

• As peoples’ age advances there is an increase

in rate of illness and in the utilization of health
services.

• The stock of health can be sustained by

investment to maintain health., such as use of
health services and health promoting activities
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 Grossman’s demand model…

• A view of medical care demand being

derived from the demand for health
implies the following:
– increase in age result in an increase in the
rate at which the person’s stock of health
depreciates

– Over the life cycle people will attempt to offset

part of the increased rate of depreciation in
their stock of health by increasing their
expenditure on health
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Grossman’s demand model…

– the demand for medical care will

increase with increases in person’s
income

– education may have a negative effect

on the demand for health care, because
more highly educated people are
presumed to be more efficient in
producing health
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Distinctive characteristics of health
sector
– Consumer ignorance

– Non-profit motive

– Large components of personal service

– Restrictions on competition

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Distinctive characteristics of health
sector…

– The uneven and unpredictable

incidence of illness

– External effects e.g. Herd immunity

– Mixture of consumption and investment

elements
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 Deriving a Demand Curve for
institutional Visits
• Downward sloping demand curve for the visits

Price

P1

P0

q1 q0
• Price changes lead to movements along D curve 16
 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.

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 Other Economic Factors
Affecting Demand…
1. Income
• If income increases, then at any given price,
consumer is willing and able to purchase more q
Price

DO D1

P0

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q0 q1 Physician Visits
 Other Economic Factors
Affecting Demand…
2. Complements - 2 or more goods which
are consumed together

• e.g. laser printers and toner cartridges

• e.g. sugar and milk?
• e.g. contact lenses and optometrist visits

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 Other Economic Factors
Affecting Demand…
2. Complements
• e.g. contact lenses and optometrist visits
• If contact lenses become cheaper, demand for
optometrist visits will increase

Price
Price of complement
falls

D1
D0
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Optometrist Visits
 Other Economic Factors
Affecting Demand…
3. Substitutes - other goods which satisfy the
same wants, or provide same characteristics

• e.g. Doctor and Health Officer?

• Generic and brand name drugs
• Private and public hospitals

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 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 will decrease

Price
Demand for brand name
drug falls

D0
D1
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Brand name drugs
 Elasticity
• In economics elasticity refers to the ratio of the
relative change in a dependent variable to the
relative change in an independent variable.

• A change in any of the demand factors will

cause a change in quantity purchased of a
good per time period.

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 Factors affecting elasticity of
demand
• Price change
• Availability & price of substitutes
• Availability & price of complements
• Income change
• Nature of commodity
• Multiple uses
• Deferred consumption
• Position of the commodity in consumers budget
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 Elasticity of demand in heath care
• Demand may be affected by factors determined
by the consumer, the provider, the supply or
location of services

• Elasticity of demand relates quantity demanded

to the price of the goods or services

• Cost to the consumer is a factor in choosing to

purchase goods or services
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 Elasticity
Price A relatively flat demand curve
implies that a small increase in
price leads to a large fall in #
visits demanded

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

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

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

# Visits
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 Elasticity…
Price Elasticity of Demand:

%QD % change in quantity demanded

ED  
%P % change in price
• 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

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 Elasticity…
• ED is expected to be negative. Thus, 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|<
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 Elasticity...
Q
% 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
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 Elasticity…
• Income elasticity of demand:
%QD % change in quantity demanded
EY  
%Y % change in income
• 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
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 Elasticity…
•Price elasticity of demand is 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
if the price is raised, then I %QD I < I %P I
 Total revenue will increase if price is raised
when demand is inelastic
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 Insurance
 The above demand analysis assumed that the
patient pays for care out-of-pocket
How does insurance affect the demand for care?

1. 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

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 Insurance…

Price

cP

q qc # Visits

• No insurance : consumer faces price P, makes q visits

• With coinsurance : consumer faces price cP, wants to
make qc visits 36
 Insurance…

Price

cP

q qc # Visits

 Coinsurance leads to a demand of qc visits at price P,

shared by consumer and insurance company
 Demand curve rotates clock wise 37
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

$150

D1
D0

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Visits
Estimating Demand for Medical Care

• Quantity demanded will be affected by:

– out-of-pocket price
– real income
– time costs
– prices of substitutes and complements
– tastes and preferences
– state of health
– quality of care

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 Empirical Evidence
• Demand for primary care services
(prevention, early detection, & treatment
of disease) has been found to be price
inelastic
– Estimates tend to be in the -.1 to -.7 range
– A 10%  in the out-of-pocket price of
hospital or physician services leads to a 1
to 7% decrease in quantity demanded
– Ceteris paribus, total expenditures on
hospital and physician services increase
with a greater out-of-pocket price 40
 Empirical Evidence…
• Demand for other types of medical care
is slightly more price elastic than
demand for primary care

• Consumers should be more price

sensitive as the portion of the bill paid
out of pocket increases

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 Out-of-Pocket Payments in the U.S.

1960 1980 1990 2003

National health expenditures ($b) $26.9 $247.3 $699.5 $1,678.9
% out of pocket 48.7% 24.4% 20.6% 13.7%

 Hypothesis: Consumers are more price

sensitive if they pay a larger % of the health
care bill
 The fall in the % of out-of-pocket
payments may explain the rapid rise in
health care costs
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 Out-of-Pocket Payments…
Total Expenditures and % Paid Out-of-Pocket, 2003
$b
Hospital care $515.90 3.2%
Physician & Clinical Services 369.7 10.2%
Dentist Service 74.3 44.2%
Prescription Drugs 179.2 29.7%
Nursing Home Care 110.8 27.9%
 Hypothesis: Consumers are more price
sensitive if they pay a larger % of the health
care bill
 Higher hospital and physician expenditures
may be due to the low % paid out-of-pocket
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 Empirical Evidence
• At the individual level, the income
elasticity of demand for medical
services is below +1.0

• The travel time elasticity of demand is

almost as large as the price elasticity of
demand

• Little consensus on whether hospital

care and ambulatory physician services
are substitutes or complements 44
 Applying Demand Theory to
Real Data
• Demand analyses in health care must take
insurance/ exemption into account

• Demand analyses are critical in shaping

managerial and public policy decisions

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The end!

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