Chapter 5: Demand for Medical Services

Chapter 5:Demand for Medical Services

and Medical Spending

Health Economics

OutlineOutline

Theoretical derivation of the demand curve for medical services.

Economic and noneconomic variables that influence demand.

Elasticities. The impact of health insurance on

demand.

Medical Care and UtilityMedical 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


Medical Care Utility MU

1 2

2 4

3 6

4 8

Example: Do the following values of Medical Care and Utility imply diminishing marginal utility of care?

Medical Care and UtilityMedical Care and UtilityGraph this relation between medical care and utility.

2

4

6

8

4321 Medical Care

Utility


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:

Utility = 2*Medical Care

In practice one would never see this relation between utility and medical care, because it violates the assumption of diminishing marginal utility.


Medical Care Utility MU

1 2

2 6

3 9

4 11

Example: What about these values? Do they satisfy the law of diminishing marginal utility?

Medical Care and UtilityMedical Care and UtilityGraph this relation between medical care and utility.

2

4

6

8

4321 Medical Care

Utility

10


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.


We can generally graph the relation between medical care and utility as follows:

Utility

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?

Define : MU = marginal utility of medical care

P = price

q = quantity of medical services

z = quantity of all other goods

Consumer’s Optimal Choice of Consumer’s Optimal Choice of HealthHealth

tradeoffs

Given the consumer’s 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.

Consumer’s Optimal Choice of Consumer’s Optimal Choice of HealthHealth

i.e. The consumer equalizes “the bang for the buck” across all goods.

ProofProof

Suppose that instead : MUq MUZ

Pq Pz

>

Then MUq would fall, MUz would rise, until the 2 ratios are equalized.

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).

Deriving a Demand Curve for Deriving a Demand Curve for Physician VisitsPhysician Visits

Suppose Pq rises. This will lead to :

MUq MUz

Pq Pz

<

Note : Now let q represent physician visits.

Consumer can U by purchasing less q, and more z.

Pq lower demand for q

Deriving a Demand Curve for Deriving a Demand Curve for Physician VisitsPhysician Visits

Downward sloping demand curve for physician visits.

Price

P1

P0

q0q1

Price changes lead to movements along D curve

Demand Curve for Physician VisitsDemand Curve for Physician Visits

Price per Visit Quantity of Visits Demanded

$100 1

$75 2

$50 3

$25 4

The relation between price and the quantity demanded can be expressed using a demand schedule:

Economists and Reverse Economists and Reverse Graph ReadingGraph Reading

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?

Demand Curve for Physician VisitsDemand Curve for Physician VisitsGraph the previous relation between price and the quantity of physician visits demanded.

$25

$50

$75

$100

4321 Physician Visits

Price

Deriving a Demand Curve for Deriving a Demand Curve for Physician Visits Physician Visits (cont.)(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,…)


P

Q

4

8Demand curves are graphed in the form P = a – bQ.


Which of the following equations is more likely to be a demand curve for physician visits?

Q = 8 + 2P

Q = 8 – 2P

Practice QuestionPractice 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 we’ll look at the answer in the next class.

Other Economic Factors Other Economic Factors Affecting DemandAffecting 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.


If income increases, then at any given price, consumer is willing and able to purchase more q.

1. Income

q0 q1

Price

P0

DOD1

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.

2. Complements - 2 or more goods which are consumed together


e.g. contact lenses and optometrist visits. If contact lenses become cheaper, demand for optometrist

visits ___.

2. Complements

Price

D0D1

Optometrist Visits

Price of complement falls


e.g. Coke and Pepsi e.g. Physicians and Nurse practitioners? e.g. generic and brand name drugs.

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 ___.

3. Substitutes - other goods which satisfy the same wants, or provide same characteristics.

Price

D1D0

Brand name drugs

Demand for generic drug falls

Demand Curve TerminologyDemand Curve Terminology

Price

Quantity

10A

4

8

6

B

A to B: increase in quantity demanded

Demand Curve Terminology Demand Curve Terminology (cont.)(cont.)

Price

Quantity

D0 to D1: Increase in demand

D0

D1

Open Heart Surgery

Deliveries

Knee Surgery

Carpal Tunnel

Facelifts

“My experience with priceline.com was fantastic. This was truly a great bargain. I saved enough on my knee surgery to get the facelift I always wanted! Thank you, priceline!”

Ryan G.Running and looking great!

Online Health Care Purchases?Online Health Care Purchases?

Online Health Care Purchases!Online Health Care Purchases!

Online Health Care Purchases!Online Health Care Purchases!“If you're thinking about a cosmetic procedure -- cosmetic surgery, cosmetic dentistry, laser vision-correction surgery, or podiatric surgery -- then Bid For Surgery can help you find not only the right doctor charging a fair price, but the best total package for your individual medical or dental care.

How? By introducing you to many highly-qualified, well-experienced doctors, and having these doctors offer their "bids" for your procedure -- detailed bids that include:

•their medical education and credentials; •their practice history and practice philosophy; •patient references and typical outcomes; •their associated surgical facilities; •their office location, and languages spoken; •patient financing (coming soon); •and other important information -- including their best price.”

ElasticitiesElasticities

Price

# Visits

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


Price

# Visits

In this case demand is considered to be relatively “elastic” with respect to a change in price.


Price

# Visits

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


Price

# Visits

In this case demand is considered to be relatively “inelastic” relative to a change in price.

ElasticitiesElasticities 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 measure this responsiveness in terms of proportionality.

Elasticities Elasticities (cont.)(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.

EQP

change in quan tity dem andedchange in priceD

D %%

%%


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|<

More price elastic demand leads More price elastic demand leads to a flatter demand curve.to a flatter demand curve.

Price

# Visits

Relatively inelastic

Relatively elastic


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.

%%

QP

QQ

PP

QP

PQ

D

Except in special cases, the EExcept in special cases, the EDD is different is different

on different points of the demand curve.on different points of the demand curve.

P

Q

4

8

Demand curve: Q = 8 – 2P

4

2ED = -1

ED = -

ED = 0


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.

EQ

Y

change in quan tity dem anded

change in incom eYD

%

%

%

%


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 Tylenol leads to a 15% increase in the quantity of Advil demanded.EC is negative for complements.

EC is positive for substitutes.

EQ

P

change in quan tity dem anded o f good X

change in price o f good YCX

Z

%

%

%

%


Total revenue will increase if price is raised when demand is inelastic.

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 %QD I < I %P I

Health Care ExpendituresHealth Care Expenditures

Expenditure=Price x Quantity

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.

Health Care Expenditures in the Health Care Expenditures in the United States, 1960-2001United States, 1960-2001

1960 1970 1980 1990 1995 1999 2001*

Nominal health expenditures $26.9 73.2 247.3 699.4 987.0 1210.7 1424.2(billions of dollars)

Annual rate of growth -- 10.6% 12.9 10.9 6.7 5.2 8.4(average annual % changefrom previous period shown)

Nominal per capita health $143 341 1,052 2,690 3,686 4,358 5,043expenditures

Health expenditures as 5.1% 7.1 8.9 12.2 13.3 13.0 13.4percentage of GDP

*ProjectedSource: Health Care Financing Administration Homepage: http://www.hcfa.gov/stats/stats.htm

Health Care Expenditures 1999 Health Care Expenditures 1999 (cont.)(cont.)

100 1149.1TOTAL

12.2 135.5 Oth. Gov’t

15.4 170.6 Medicaid

17.6 216.6 Medicare

45.3 522.7PUBLIC

6.1 51.8 Other private payments

15.4 199.5 Out-of-pocket payments

33.1 375Private health insurance

54.7 626.4PRIVATE

% of Total$billionsRevenue Source

Health Care Expenditures Health Care Expenditures (cont.)(cont.)

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.

Chapter 5: Demand for Medical Services

Documents

utility medical care

health care

demandthe demand curve

demand schedule

derived demand

quantity of physician

medical carein practice

direct utility