The Demand for Medical Care

Chapter 5

The Demand for Medical Care

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The Demand for Medical Care and the Law of Demand

• Stock of health
• Durable good
• Generates utility
• Follows law of diminishing marginal utility

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The Demand for Medical Care and the Law of Demand

• Production of health
• Input: medical services
• Follows law of diminishing marginal productivity
• Utility
• Function of the quantity of medical care

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The Demand for Medical Care and the Law of Demand

• Marginal utility decreases because
• Each successive unit of medical care generates a smaller improvement in health
• Law of diminishing marginal productivity
• Each increase in health generates a smaller increase in utility
• Law of diminishing marginal utility

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Figure 5.1 – The Relationship between Utility and Medical Care

The shape of the utility curve illustrates that total utility increases at a decreasing rate with respect to the level of medical care consumed.

Utility

Quantity of medical care (q)

Utility

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The Utility Maximizing Rule

• Utility-maximizing rule
• Marginal utility gained from the last dollar spent on each product is equal across all goods and services purchased
• MUq/Pq = MUz/Pz
• MUq – marginal utility derived from the last unit of medical care purchased, q
• Pq – price of physicians
• MUz – marginal utility derived from the last unit of all other goods, z (composite good)
• Pz – price of composite good

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The Law of Demand

• Initial condition
• Optimal mix of physician services and all other goods; MUq/Pq = MUz/Pz
• If price of physician services increases
• MUq/Pq < MUz/Pz
• More satisfaction per dollar from consuming all other goods
• Fewer units of physician services and more units of all other goods are purchased
• MUq/Pq increases and MUz/Pz decreases, until MUq/Pq = MUz/Pz

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The Law of Demand

• Law of demand
• Inverse relation between price and quantity demanded of physician services
• For its derivation, utility analysis, or the income and substitution effects can be used
• Downward sloping demand curve
• Price
• Per-unit out-of-pocket expense
• After the impact of third-party payments has been taken into account

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Figure 5.2 – The Individual Demand Curve for Physician Services

The individual demand curve for physician services is downward sloping, illustrating that quantity demanded increases as the price of physician services drops.

Quantity of physician

services (q)

Price of physician

services

d

P0

P1

q0

q1

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Substitution effect

• Decrease in price of physician services
• Consumer substitutes away from the relatively higher-priced medical goods like hospital outpatient services
• Consumer purchases more physician services
• Quantity demanded for physician services increases

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Income effect

• Decrease in price of physician services
• Increases the real purchasing power of the consumer (real income)
• As medical care is a normal good
• Quantity demanded of physician services increases with the rise in purchasing power

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The Law of Demand

• Law of demand
• Inverse relationship between quantity demanded of physician services and the price
• The income and substitution effects can be used to derive this relationship
• Demand for medical care = derived demand
• It depends on the demand for good health

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Other Economic Demand-Side Factors

• • Demand for medical services depends on
  • Income
  • Prices of other goods
  • Time costs

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Income

• Increase in income
• Increase in purchasing power
• Increase in demand medical services
• Considering medical care to be a normal good
• Demand curve shifts right
• Decrease in income
• Demand curve shifts left

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Figure 5.3 – Shifts in Individual Demand Curve for Physician Services

Shift in the individual demand curve for physician services, from d0 to d1, due an increase in income. At each price, the consumer is now willing and able to purchase more physician services.

Quantity of physician

services (q)

Price of physician

services

d0

d1

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Prices of other goods

• Complements in consumption
• Two or more goods jointly used for consumption purposes
• An increase in the price of one good inversely influences the demand for the other
• Demand for eyewear and services of an optometrist
• Pediatric services and obstetric services

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Prices of other goods

• Substitutes in consumption
• Two or more goods with similar characteristics providing the same utility
• The demand for one good is directly related to a change in the price of a substitute good
• Physician services and hospital outpatient services
• Generic and brand-name drugs
• Eyeglasses and contact lenses

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Time costs

• Monetary cost of travel
• Opportunity cost of time
• Dollar value of the activities the person forgoes while acquiring medical services
• Inversely related to the demand for a medical service
• Examples of increasing time costs
• The farther an individual has to travel to see a physician
• The longer the delay in getting an appointment

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Health Insurance and the Demand for Medical Care

• Growth of health insurance coverage
• Greatly influenced allocation of resources
• Impact on out-of-pocket payments for health care
• 1960: half of total expenditures
• 2010: one-eighth of total expenditures
• Impact on out-of-pocket payments for hospital care
• 1960: about 21%
• 2010: about 3%

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Coinsurance

• The plan
• Consumer pays some fixed percentage of the cost of health
• The insurance carrier picks up the remaining portion
• Effectively lowers the out-of-pocket price of health care

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Coinsurance

• Demand curve for medical care
• Negatively sloped
• A consumer’s willingness to pay (marginal benefit) for each unit of good falls as more of the good is consumed
• Law of diminishing marginal utility
• Utility maximization
• Willingness to pay (marginal benefit) is equal to the out-of-pocket price (marginal cost)

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Coinsurance

• Effective demand (Refer to slide 23 and 25)
• Demand without insurance
• Consumer’s willingness to pay for medical services without health insurance cover
• dWO
• Customer surplus
• Difference between willingness to pay and market price paid

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Coinsurance

• Nominal demand (Refer to slide 23 and 25)
• Demand with insurance, dWI
• Reflects total price paid for medical services
• Takes into account the coinsurance paid by the insured
• Insurance coverage is the gap between the willingness to pay (effective demand) and the actual price (nominal demand)

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Coinsurance

• P = actual price
• C0 = fraction of P pay by consumer
• Pw = consumer’s willingness to pay
• Pw = C0P; P = Pw/C0

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The Demand Curve for Medical Services with Coinsurance

The graph illustrates how a coinsurance health plan impacts the individual demand curve for physician visits.

$100

Quantity of medical services (q)

Per unit price

dWO

dWI

“Effective”

demand

“Nominal”

demand

5

$250

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Coinsurance

• Reduction in coinsurance rate (C0)
• Nominal demand curve, dWI, rotate clockwise and pivot
• dwi becomes steeper
• At zero willingness-to-pay price
• Insurance has no bearing on quantity demanded
• Full coverage (C0 = 0)
• Nominal demand curve rotates out to its fullest extent and becomes completely vertical

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Demand Curve for Medical Services with 100% Coverage

*

The graph illustrates the situation in which the individual has complete medical coverage and the coinsurance rate is zero.

Office visits per year (q)

Price per

visit

dWI

Effective

demand

Nominal

demand

dWO

q0

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Copayment

• Copayment
• Fixed amount paid by the consumer
• Independent of the market price or actual costs of medical care
• Does not automatically change with an adjustment in costs of providing medical care
• Lower copayment
• Movement down the effective demand curve
• Greater quantity of care demanded
• No rotation of the nominal demand curve

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Deductibles

• Deductible
• A fixed amount of health care costs per calendar year paid by a consumer before coverage begins
• Insurance carrier
• Pays all or some portion of the remaining medical bills
• After the deductible is met
• Depends on the plan

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Deductibles

• From the insurance carrier’s perspective
• Lower administrative costs
• Decrease demand for medical care
• Impact on demand for medical care
• Depends on
• Cost of the medical episode
• Point in time when the medical care is demanded
• Probability of needing additional medical care for the remainder of the period

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Moral Hazard

• Moral hazard
• Situation in which consumers alter their behavior when provided with health insurance
• Insured consumers
• Take fewer precautions to prevent illnesses
• Shop very little for the best medical prices
• May purchase more medical care than they would have without insurance coverage

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Noneconomic Determinants of the Demand for Medical Care

• Tastes and preferences
• Marital status
• A married individual demands less medical care
• Literacy
• Educated individuals tend to seek more medical care (direct relationship)
• More use of home-produced health care services (inverse relationship)
• Likely to recognize early symptoms
• Lifestyle (smoking, excess drinking)
• Increased demand for medical care

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Noneconomic Determinants of the Demand for Medical Care

• Physical and mental profile
• Gender
• Females usually need more medical services than males
• Childbearing
• Certain diseases are more prevalent in women
• Cardiovascular disease, osteoporosis, etc.
• Race/ethnicity
• Age
• Older individuals demand more for medical care

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Noneconomic Determinants of the Demand for Medical Care

• State of health
• Sicker people demand more medical services
• Severity of illness
• Quality of care
• Assumed to be positively related to the amount and types of inputs used to produce medical care
• Higher demand for better quality of care

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Demand for Medical Care

• Quantity demanded depends on
• Out-of-pocket price, income, time costs, prices of substitutes and complements, tastes and preferences, profile, state of health, and quality of care
• Movement along the demand curve
• Change in out-of-pocket price
• Shift of the demand curve
• Change in all the other factors

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Market Demand for Medical Care

• Market demand
• Total demand by all consumers in a given market
• Horizontal summation of the individual demand curves
• Amount of medical services that the entire market is willing and able to purchase at every given price
• Downward sloping

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Market Demand for Medical Care

• Intensive margin
• How much more or less of a product consumers buy when its price changes
• Extensive margin
• How many more or fewer people buy a product when its price changes

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The Fuzzy Demand Curve

• Relation between price and quantity demanded is fuzzy
• Lack of medical knowledge
• Providers disagree about the treatment
• Consumers lack the information to make informed choices
• Rely heavily on the advice of their physicians
• Physicians, rather than consumers, choose medical services
• Inability to accurately measure medical care

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Figure 5.6 – The Fuzzy Demand Curve for Medical Care

The gray band represents the possible fuzziness of the demand for medical care given uncertainty and the role of the physician.

Quantity of medical care

Price per

visit

D

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The Fuzzy Demand Curve

• Implications
• For a given price
• Some variation in the quantity or types of medical services rendered
• For a given quantity or type of medical service
• Price differences can exist

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Elasticities

• Elasticity of demand
• Responsiveness of quantity demanded to a change in an independent factor
• Own-price elasticity
• Income elasticity
• Cross price elasticity

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Own-Price Elasticity of Demand

• Amount of change in consumption of a good or a service when its price changes
• ED = %ΔQD / %ΔP
• ED – price elasticity of demand
• % ΔQD – percentage change in quantity demanded
• % ΔP – percentage change in price

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Own-Price Elasticity of Demand

• ED < 0
• Shows inverse relationship between price and quantity demanded
• |ED| > 0
• Absolute value of the price elasticity of demand is positive
• |ED| > 1
• Price elastic demand: |%ΔP| < |%ΔQD|
• |ED| < 1
• Price inelastic demand: |%ΔP| > |%ΔQD|

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Own-Price Elasticity of Demand

• |ED| = 1
• Unit elastic demand: |%ΔP| = |%ΔQD|
• |ED| = 0
• Perfectly inelastic demand: |%ΔQD| = 0
• Vertical demand curve
• |ED| = ∞
• Perfectly elastic demand: |%ΔP| = 0
• Horizontal demand curve

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Own-Price Elasticity of Demand

• Greater elasticity means
• Quantity demanded is more sensitive to a change in price
• Flatter demand curve at any given price
• Elasticity of demand varies with
• Portion of the consumer’s budget allocated to the good
• Decision-making time frame
• Extent to which the good is a necessity
• Availability of substitutes

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Figure 5.7 – Elasticity of Demand and the Slope of the Demand Curve

The figure illustrates the changes in quantity demanded for a relatively inelastic and a relatively elastic demand curves, when the Price changes from P0 P1.

Quantity of medical services(q)

Per unit price

Da (Relatively elastic)

Db (Relatively inelastic)

Q0

P0

P1

Qa

Qb

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Own-Price Elasticity of Demand

• Own-price elasticity of demand for medical services
• Inelastic with respect to price
• Because the consumer typically pays a small portion of the cost of medical services
• Because medical services are sometimes of an urgent nature
• Medical services are necessities
• More elastic
• For elective medical care (luxury)
• If more substitutes available

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Own-Price Elasticity of Demand

• Total revenue, TR = P*QD
• Effect on an increase in price
• Elastic demand: TR decreases
• Inelastic demand: TR increases
• Unit elastic demand: no change in TR

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Income Elasticity of Demand

• Income elasticity of demand, EY
• Percentage change in quantity demanded (%ΔQD) divided by the percentage change in income (%ΔY)
• EY = %ΔQD / %ΔY
• The amount of change in demand for a product with change in real income

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Income Elasticity of Demand

• If EY > 0 , normal good
• Any increase in income leads to an increase in quantity demanded
• If EY < 0, inferior good
• An increase in income leads to a decrease in the amount consumed
• Most types of medical care: EY > 0

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Cross Price Elasticity of Demand

• Cross-price elasticity, EC
• Extent to which the demand for a product changes when price of another good is altered
• EC = %ΔQX / %ΔPZ
• %ΔQX: percentage change in demand for good X
• %ΔPZ: percentage change in price of good Z

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Cross Price Elasticity of Demand

• If EC < 0, complements in consumption
• If EC > 0, substitutes in consumption
• If EC = 0, unrelated goods

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Empirical Estimation

• Data unavailability
• Dependent variable
• Quantity of medical care consumed
• Such as number of physician visits
• Independent variables
• Need to include variables for:
• Health insurance
• Consumer’s income
• Time cost
• Prices of complements and substitutes

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Own-Price, Income, Cross-Price,
and Time-Cost Elasticity Estimates

• Demand for primary health care
• Relatively inelastic
• Total expenditures on hospital and physician services increase with a greater out-of-pocket price
• Demand for other types of medical care
• Slightly more price elastic than the demand for primary care
• Percentage of out-of-pocket payments tend to be the lowest for hospital and physician services

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Table 5.2 – Price Elasticity of Demand for Health Care: Selected Studies

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Table 5.2 – Price Elasticity of Demand for Health Care: Selected Studies

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Own-Price, Income, Cross-Price,
and Time-Cost Elasticity Estimates

• • Income elasticity of demand
  • Household data
  • Health care: normal good, with income elasticity < 1
  • Country-level data
  • Aggregate income elasticity is slightly >1
  • Health care: luxury good
  • Travel time elasticity of demand
  • Approximately equals to own-price elasticity

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The Impact of Insurance on the Demand for Medical Care

• RAND Health Insurance Study (HIS) (Manning et al., 1987)
• Families were randomly assigned
• 14 different fee-for-service health insurance plans
• Test: impact of differences in insurance coverage on the demand for medical care

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The Impact of Insurance on the Demand for Medical Care

• Results
• As the level of coinsurance rises
• Consumers demand less medical care
• Consumers cut back on the number of visits to health care providers and not on the amount spent on each visit
• The probability of using any medical services, along with total medical expenditures diminishes
• Own-price elasticity of demand is sensitive to the level of insurance
• Consumers become more sensitive to price changes
• Negative impact of deductibles on the consumption of medical care

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Table 5.3 – Sample Means for Annual Use of Medical Care per Capita

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The Impact of Noneconomic Factors
on the Demand for Medical Services

• Age and severity of illness
• Directly influence the demand for medical care
• Overall health of the individual
• Inversely affects the demand for medical care
• Education
• No consensus
• Direct impact: greater willingness to seek care
• Offset by the inverse effect (a greater ability to produce health care at home

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The Impact of Noneconomic Factors
on the Demand for Medical Services

• Effect of medical knowledge on the demand for medical care
• Positive relationship
• Consumers with a more extensive background in medicine tend to consume more medical services
• Consumers with a lack of medical knowledge tend to underestimate the impact of medical care on overall health
• Often fail to consume an appropriate amount

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The Impact of Noneconomic Factors
on the Demand for Medical Services

• Effect of medical knowledge on the demand for medical care
• Years of schooling, whether the individual worked in the health care field, medical insurance, and income
• Positively influenced the level of health information acquired
• Age and whether the individual drank or smoked
• Inversely affected the quantity of health information collected

(c) 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Patient Protection and Affordable
Care Act (PPACA) of 2010

• Objective
• to extend health insurance coverage to millions of uninsured Americans
• Approach
• Medicaid to cover all non-Medicaid under the age of 65 with incomes up to 133 percent of the federal poverty level
• All individuals mandated to have health insurance coverage by 2014
• Those elect not to acquire insurance will face a penalty

(c) 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Patient Protection and Affordable
Care Act (PPACA) of 2010

• Approach
• States required to design and create American Health Benefit Exchanges
• Providing individuals and small businesses access to affordable health insurance
• Offering health plans with an established set of minimum benefits
• Providing subsidies to those who cannot afford the premium payments
• A number of insurance market regulations