chapter 3 demand for health care services. outline theoretical derivation of the demand curve for...
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Chapter 3Demand for Health Care
Services
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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
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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
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We can generally graph the relation between medical care and utility as follows:
Utility
Medical Care
Medical Care and Utility
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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?
Medical Care and Utility
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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
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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
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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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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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Downward sloping demand curve for physician visits
Price changes lead to movements along D curve
Deriving a Demand Curve for Physician Visits
Price
P1
P0
q0q1
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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,…)
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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
q0 q1
Price
P0
DOD1
Physician Visits
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Other Economic Factors Affecting Demand Complements - 2 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
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2. Complements e.g. contact lenses and optometrist visits If contact lenses become cheaper, demand for
optometrist visits ___
Other Economic Factors Affecting Demand
Price
D0
D1
Optometrist Visits
Price of complement falls
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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
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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 ___
Price
D1
D0
Brand name drugs
Demand for brand name drug falls
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Elasticities
A relatively flat demand curve implies that a small increase in price leads to a large fall in # visits demanded
Price
# Visits
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In this case demand is considered to be relatively “elastic” with respect to a change in price
Price
# Visits
Elasticities
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A relatively steep demand curve implies that a small increase in price leads to a small fall in # visits demanded
Price
# Visits
Elasticities
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Price
# Visits
In this case demand is considered to be relatively “inelastic” relative to a change in price
Elasticities
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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
priceinchange
demandedquantityinchange
P
QE DD %
%
%
%
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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|<
Elasticities (cont.)Elasticities (cont.)
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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
Q
P
P
Q
PPQ
Q
P
QD *%
%
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Except in special cases, the ED is different on different points of the demand curve
P
Q
4
8
Demand curve: Q = 8 – 2P
4
2
ED = -1
ED = -
ED = 0
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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
incomeinchange
demandedquantityinchange
Y
QE DY %
%
%
%
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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
Ygoodofpriceinchange
Xgoodofdemandedquantityinchange
P
QE
Y
XC %
%
%
%
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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
ElasticitiesElasticities
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QUIZ
A 1991 study by Frank Chaloupka estimated the price elasticity demand for cigarettes to be:
A. .48B. .83C. 1.02D. 1.33
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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?
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
No insurance : consumer faces price P, makes q visits
W/coinsurance : consumer faces price cP, wants to make qc visits
Price
P
cP
qcq # Visits
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Insurance (cont.)Insurance (cont.)
Coinsurance leads to a demand of qc visits at price P, shared by consumer and insurance company
Price
P
cP
qcq # Visits
Demand curve rotates clock wise
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What if the consumer has full coverage?
i.e., copayment = 0
Price
# Visits
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• Indemnity Insurance Insurer pays a fixed amount for each
purchased service Insurer pays $150 for each overnight
hospital stay, and patient pays the restPrice
Visits
D0
D1
$150
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• Fixed $ copayment Patient pays up to $20 per visit, and insurer
pays the rest
Price
Visits
D0
$20
D1
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• 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