Chapter 5: Demand for Medical Services and Medical Spending Health Economics
Outline <ul><li>Theoretical derivation of the demand curve for medical services. </li></ul><ul><li>Economic and noneconomi...
Medical Care and Utility <ul><li>Medical care is an input in producing health </li></ul><ul><li>Subject to law of diminish...
Medical Care and Utility Example: Do the following values of Medical Care and Utility imply diminishing marginal utility o...
Medical Care and Utility Graph this relation between medical care and utility. 2 4 6 8 4 3 2 1 Medical Care Utility
Medical Care and Utility <ul><li>The previous graph illustrates an example of constant marginal utility </li></ul><ul><li>...
Medical Care and Utility <ul><li>Because this relation is linear, it can also be represented using the following algebraic...
Medical Care and Utility Example: What about these values? Do they satisfy the law of diminishing marginal utility? 11 4 9...
Medical Care and Utility Graph this relation between medical care and utility. 2 4 6 8 4 3 2 1 Medical Care Utility 10
Medical Care and Utility <ul><li>The previous graph illustrates an example of diminishing marginal utility </li></ul><ul><...
Medical Care and Utility We can generally graph the relation between medical care and utility as follows: Utility Medical ...
Medical Care and Utility <ul><li>The graph shows that as the  level  of medical rises, each additional unit of medical car...
<ul><li>Define  :  MU = marginal utility of medical care </li></ul><ul><li>P  = price </li></ul><ul><li>q  = quantity of m...
<ul><li>Total utility reaches its peak when the marginal utility gained from the last $ spent on each product is equalized...
Proof <ul><li>Then  MU q  would fall,  MU z  would rise, until the 2 ratios  </li></ul><ul><li>are equalized. </li></ul><u...
Deriving a Demand Curve for Physician Visits Note : Now let q represent physician visits. <ul><li>Suppose  P q  rises. Thi...
Deriving a Demand Curve for Physician Visits <ul><li>Downward sloping demand curve for physician visits.  </li></ul>Price ...
Demand Curve for Physician Visits The relation between price and the quantity demanded can be expressed using a demand sch...
Economists and Reverse  Graph Reading <ul><li>When we read graphs, we usually ask how a change in the variable on the hori...
Demand Curve for Physician Visits Graph the previous relation between price and the quantity of physician visits demanded....
Deriving a Demand Curve for Physician Visits  (cont.) <ul><li>Consumer’s purchase of medical care is a “derived demand”.  ...
Deriving a Demand Curve for Physician Visits  (cont.) P Q 4 8 Demand curves are graphed in the form  P = a – bQ.
Deriving a Demand Curve for Physician Visits  (cont.) <ul><li>Which of the following equations is more likely to be a dema...
Practice Question <ul><li>Can you come up with an algebraic formula for the demand curve for physician visits that we grap...
Other Economic Factors Affecting Demand <ul><li>The demand curve illustrates the effect of changes in the price of the goo...
Other Economic Factors Affecting Demand <ul><li>If income increases, then at any given price, consumer is willing and able...
Other Economic Factors Affecting Demand <ul><li>e.g. left shoes and right shoes. </li></ul><ul><li>e.g. laser printers and...
Other Economic Factors Affecting Demand <ul><li>e.g. contact lenses and optometrist visits. </li></ul><ul><li>If contact l...
Other Economic Factors Affecting Demand <ul><li>e.g. Coke and Pepsi </li></ul><ul><li>e.g. Physicians and Nurse practition...
Other Economic Factors Affecting Demand <ul><li>e.g. generic and brand name drugs. </li></ul><ul><li>If generic drugs  in ...
Demand Curve Terminology Price Quantity 10 A 4 8 6 B A to  B :  increase in quantity demanded
Demand Curve Terminology  (cont.) Price Quantity D 0  to  D 1 : Increase in  demand D 0 D 1
Online Health Care Purchases? “ My experience with priceline.com was fantastic. This was truly a great bargain. I saved en...
Online Health Care Purchases!
Online Health Care Purchases! <ul><li>“ If you're thinking about a cosmetic procedure -- cosmetic surgery, cosmetic dentis...
Elasticities Price # Visits A relatively flat demand curve implies that a small increase in price leads to a large fall in...
Elasticities Price # Visits In this case demand is considered to be relatively “elastic” with respect to a change in price.
Elasticities Price # Visits A relatively steep demand curve implies that a small increase in price leads to a small fall i...
Elasticities Price # Visits In this case demand is considered to be relatively “inelastic” relative to a change in price.
Elasticities <ul><li>We would like a way to  quantify  the elasticity of a demand curve with respect to price. </li></ul><...
Elasticities  (cont.) <ul><li>Own-Price Elasticity of Demand : </li></ul><ul><li>Example: If the elasticity of demand for ...
Elasticities  (cont.) <ul><li>E D  is expected to be negative.  Thus, own-price elasticities of demand are often quoted in...
More price elastic demand leads to a flatter demand curve. Price # Visits Relatively inelastic Relatively elastic
Elasticities  (cont.) <ul><li>If you are given a formula for a demand curve, you can compute the elasticity of demand for ...
Except in special cases, the E D  is different on different points of the demand curve. P Q 4 8 Demand curve: Q = 8 – 2P 4...
Elasticities  (cont.) <ul><li>Income elasticity of demand: </li></ul><ul><li>Example: If the elasticity of demand for phys...
Elasticities  (cont.) <ul><li>Cross-price elasticity of demand: </li></ul><ul><li>Example: If the elasticity of demand for...
Elasticities <ul><li>Total revenue will increase if price is raised when demand is inelastic.  </li></ul><ul><li>Own price...
Health Care Expenditures <ul><li>Expenditure=Price x Quantity </li></ul><ul><li>Although expenditures are rising, we have ...
Health Care Expenditures in the United States, 1960-2001 1960 1970 1980 1990 1995 1999 2001 *   Nominal health expenditure...
Health Care Expenditures 1999  (cont.) 100 1149.1 TOTAL 12.2 135.5 Oth. Gov’t 15.4 170.6 Medicaid 17.6 216.6   Medicare 45...
Health Care Expenditures  (cont.) <ul><li>The private and public sources of health expenditure are relatively equal. </li>...
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Chapter 5: Demand for Medical Services

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Chapter 5: Demand for Medical Services

  1. 1. Chapter 5: Demand for Medical Services and Medical Spending Health Economics
  2. 2. Outline <ul><li>Theoretical derivation of the demand curve for medical services. </li></ul><ul><li>Economic and noneconomic variables that influence demand. </li></ul><ul><li>Elasticities. </li></ul><ul><li>The impact of health insurance on demand. </li></ul>
  3. 3. Medical Care and Utility <ul><li>Medical care is an input in producing health </li></ul><ul><li>Subject to law of diminishing marginal productivity </li></ul><ul><li>Health yields utility to the consumer </li></ul><ul><li>Subject to law of diminishing marginal utility </li></ul>
  4. 4. Medical Care and Utility Example: Do the following values of Medical Care and Utility imply diminishing marginal utility of care? 8 4 6 3 4 2 2 1 MU Utility Medical Care
  5. 5. Medical Care and Utility Graph this relation between medical care and utility. 2 4 6 8 4 3 2 1 Medical Care Utility
  6. 6. Medical Care and Utility <ul><li>The previous graph illustrates an example of constant marginal utility </li></ul><ul><li>Because each additional unit of medical care yields the same increase in utility, the relation can be graphed using a straight line. </li></ul>
  7. 7. Medical Care and Utility <ul><li>Because this relation is linear, it can also be represented using the following algebraic equation: </li></ul><ul><li>Utility = 2*Medical Care </li></ul><ul><li>In practice one would never see this relation between utility and medical care, because it violates the assumption of diminishing marginal utility. </li></ul>
  8. 8. Medical Care and Utility Example: What about these values? Do they satisfy the law of diminishing marginal utility? 11 4 9 3 6 2 2 1 MU Utility Medical Care
  9. 9. Medical Care and Utility Graph this relation between medical care and utility. 2 4 6 8 4 3 2 1 Medical Care Utility 10
  10. 10. Medical Care and Utility <ul><li>The previous graph illustrates an example of diminishing marginal utility </li></ul><ul><li>Because each additional unit of medical care yields a smaller increase in utility, the relation cannot be graphed using a straight line. </li></ul>
  11. 11. Medical Care and Utility We can generally graph the relation between medical care and utility as follows: Utility Medical Care
  12. 12. Medical Care and Utility <ul><li>The graph shows that as the level of medical rises, each additional unit of medical care yields a smaller increase in utility. </li></ul><ul><li>Given this fact, how does the consumer decide how much health care to purchase? </li></ul>
  13. 13. <ul><li>Define : MU = marginal utility of medical care </li></ul><ul><li>P = price </li></ul><ul><li>q = quantity of medical services </li></ul><ul><li>z = quantity of all other goods </li></ul>Consumer’s Optimal Choice of Health tradeoffs <ul><li>Given the consumer’s income, she chooses q and z to maximize utility. </li></ul><ul><li>Utility maximization rule : </li></ul><ul><li>MU q MU Z </li></ul><ul><li>P q P z </li></ul>
  14. 14. <ul><li>Total utility reaches its peak when the marginal utility gained from the last $ spent on each product is equalized. </li></ul>Consumer’s Optimal Choice of Health i.e. The consumer equalizes “the bang for the buck” across all goods.
  15. 15. Proof <ul><li>Then MU q would fall, MU z would rise, until the 2 ratios </li></ul><ul><li>are equalized. </li></ul><ul><li>Suppose that instead : </li></ul><ul><li>MU q MU Z </li></ul><ul><li>P q P z </li></ul>> <ul><li>Last $ spent on medical care generates more U than </li></ul><ul><li>last $ spent on other goods </li></ul><ul><li>Consumer could U by purchasing more medical care </li></ul><ul><li>(q), and less other goods (z). </li></ul>
  16. 16. Deriving a Demand Curve for Physician Visits Note : Now let q represent physician visits. <ul><li>Suppose P q rises. This will lead to : </li></ul><ul><li>MU q MU z </li></ul><ul><li>P q P z </li></ul>< <ul><li>Consumer can U by purchasing less q, and more z. </li></ul><ul><li>P q lower demand for q </li></ul>
  17. 17. Deriving a Demand Curve for Physician Visits <ul><li>Downward sloping demand curve for physician visits. </li></ul>Price P 1 P 0 q 0 q 1 <ul><li>Price changes lead to movements along D curve </li></ul>
  18. 18. Demand Curve for Physician Visits The relation between price and the quantity demanded can be expressed using a demand schedule: 4 $25 3 $50 2 $75 1 $100 Quantity of Visits Demanded Price per Visit
  19. 19. Economists and Reverse Graph Reading <ul><li>When we read graphs, we usually ask how a change in the variable on the horizontal axis affects the variable on the y axis. </li></ul><ul><li>However, when economists draw demand curves, price is on the vertical axis, and quantity is on the horizontal axis. </li></ul><ul><li>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? </li></ul>
  20. 20. Demand Curve for Physician Visits Graph the previous relation between price and the quantity of physician visits demanded. $25 $50 $75 $100 4 3 2 1 Physician Visits Price
  21. 21. Deriving a Demand Curve for Physician Visits (cont.) <ul><li>Consumer’s purchase of medical care is a “derived demand”. </li></ul><ul><li>i.e., “no direct” utility from visiting the doctor </li></ul><ul><li>U derived from health resulting from </li></ul><ul><li>dr. visit: </li></ul><ul><li>U = U(h,z) h = h(q,…) </li></ul>
  22. 22. Deriving a Demand Curve for Physician Visits (cont.) P Q 4 8 Demand curves are graphed in the form P = a – bQ.
  23. 23. Deriving a Demand Curve for Physician Visits (cont.) <ul><li>Which of the following equations is more likely to be a demand curve for physician visits? </li></ul><ul><li>Q = 8 + 2P </li></ul><ul><li>Q = 8 – 2P </li></ul>
  24. 24. Practice Question <ul><li>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) </li></ul><ul><li>Try this at home, and we’ll look at the answer in the next class. </li></ul>
  25. 25. Other Economic Factors Affecting Demand <ul><li>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. </li></ul><ul><li>Changes in factors other than the price of the good itself lead to shifts in the demand curve. </li></ul>
  26. 26. Other Economic Factors Affecting Demand <ul><li>If income increases, then at any given price, consumer is willing and able to purchase more q. </li></ul>1. Income q 0 q 1 Physician Visits Price P 0 D O D 1
  27. 27. Other Economic Factors Affecting Demand <ul><li>e.g. left shoes and right shoes. </li></ul><ul><li>e.g. laser printers and toner cartridges. </li></ul><ul><li>e.g. alcohol and cigarettes? </li></ul><ul><li>e.g. contact lenses and optometrist visits. </li></ul>2 . Complements - 2 or more goods which are consumed together
  28. 28. Other Economic Factors Affecting Demand <ul><li>e.g. contact lenses and optometrist visits. </li></ul><ul><li>If contact lenses become cheaper, demand for optometrist visits ___. </li></ul>2 . Complements Price Optometrist Visits Price of complement falls D 0 D 1
  29. 29. Other Economic Factors Affecting Demand <ul><li>e.g. Coke and Pepsi </li></ul><ul><li>e.g. Physicians and Nurse practitioners? </li></ul><ul><li>e.g. generic and brand name drugs. </li></ul>3 . Substitutes - other goods which satisfy the same wants, or provide same characteristics.
  30. 30. Other Economic Factors Affecting Demand <ul><li>e.g. generic and brand name drugs. </li></ul><ul><li>If generic drugs in price, D for brand name ___. </li></ul>3 . Substitutes - other goods which satisfy the same wants, or provide same characteristics. Price Brand name drugs Demand for generic drug falls D 1 D 0
  31. 31. Demand Curve Terminology Price Quantity 10 A 4 8 6 B A to B : increase in quantity demanded
  32. 32. Demand Curve Terminology (cont.) Price Quantity D 0 to D 1 : Increase in demand D 0 D 1
  33. 33. Online Health Care Purchases? “ 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! Open Heart Surgery Deliveries Knee Surgery Carpal Tunnel Facelifts
  34. 34. Online Health Care Purchases!
  35. 35. Online Health Care Purchases! <ul><li>“ 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. </li></ul><ul><li>How? By introducing you to many highly-qualified, well-experienced doctors, and having these doctors offer their &quot;bids&quot; for your procedure -- detailed bids that include: </li></ul><ul><ul><li>their medical education and credentials; </li></ul></ul><ul><ul><li>their practice history and practice philosophy; </li></ul></ul><ul><ul><li>patient references and typical outcomes; </li></ul></ul><ul><ul><li>their associated surgical facilities; </li></ul></ul><ul><ul><li>their office location, and languages spoken; </li></ul></ul><ul><ul><li>patient financing (coming soon); </li></ul></ul><ul><ul><li>and other important information -- including their best price.” </li></ul></ul>
  36. 36. Elasticities Price # Visits A relatively flat demand curve implies that a small increase in price leads to a large fall in # visits demanded.
  37. 37. Elasticities Price # Visits In this case demand is considered to be relatively “elastic” with respect to a change in price.
  38. 38. Elasticities Price # Visits A relatively steep demand curve implies that a small increase in price leads to a small fall in # visits demanded.
  39. 39. Elasticities Price # Visits In this case demand is considered to be relatively “inelastic” relative to a change in price.
  40. 40. Elasticities <ul><li>We would like a way to quantify the elasticity of a demand curve with respect to price. </li></ul><ul><li>More generaly, elasticity measures the responsiveness of quantity demanded to a change in an independent factor. </li></ul><ul><li>Elasticities measure this responsiveness in terms of proportionality . </li></ul>
  41. 41. Elasticities (cont.) <ul><li>Own-Price Elasticity of Demand : </li></ul><ul><li>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. </li></ul><ul><li>Elasticities are scale-free </li></ul><ul><ul><li>We can compare the ED for physician visits vs. nursing home days , even though they are consumed in different units. </li></ul></ul>
  42. 42. Elasticities (cont.) <ul><li>E D is expected to be negative. Thus, own-price elasticities of demand are often quoted in terms of absolute value. </li></ul><ul><li>The demand curve is inelastic if </li></ul><ul><li>0< |E D |<1 </li></ul><ul><li>The demand curve is elastic if </li></ul><ul><li>1< |E D |<  </li></ul>
  43. 43. More price elastic demand leads to a flatter demand curve. Price # Visits Relatively inelastic Relatively elastic
  44. 44. Elasticities (cont.) <ul><li>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. </li></ul>
  45. 45. Except in special cases, the E D is different on different points of the demand curve. P Q 4 8 Demand curve: Q = 8 – 2P 4 2 E D = -1 E D = -  E D = 0
  46. 46. Elasticities (cont.) <ul><li>Income elasticity of demand: </li></ul><ul><li>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. </li></ul><ul><li>For most types of medical care, E Y should be positive. </li></ul>
  47. 47. Elasticities (cont.) <ul><li>Cross-price elasticity of demand: </li></ul><ul><li>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. </li></ul><ul><ul><li>E C is negative for complements. </li></ul></ul><ul><ul><li>E C is positive for substitutes. </li></ul></ul>
  48. 48. Elasticities <ul><li>Total revenue will increase if price is raised when demand is inelastic. </li></ul><ul><li>Own price elasticity of demand critical for determining </li></ul><ul><li>a health care manager’s total revenue. </li></ul><ul><li>TR = PQ D </li></ul>If demand for physician services is inelastic, and the price is raised, then I %  Q D I < I %  P I <ul><li>Demand theory tells us that P Q D </li></ul>
  49. 49. Health Care Expenditures <ul><li>Expenditure=Price x Quantity </li></ul><ul><li>Although expenditures are rising, we have seen that health status has also improved. </li></ul><ul><li>The size of the entire economy has grown, so that the % of GDP spent on health care has held steady. </li></ul>
  50. 50. Health Care Expenditures in the United 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 % change from previous period shown) Nominal per capita health $143 341 1,052 2,690 3,686 4,358 5,043 expenditures Health expenditures as 5.1% 7.1 8.9 12.2 13.3 13.0 13.4 percentage of GDP *Projected Source: Health Care Financing Administration Homepage: http://www.hcfa.gov/stats/stats.htm
  51. 51. Health Care Expenditures 1999 (cont.) 100 1149.1 TOTAL 12.2 135.5 Oth. Gov’t 15.4 170.6 Medicaid 17.6 216.6 Medicare 45.3 522.7 PUBLIC 6.1 51.8 Other private payments 15.4 199.5 Out-of-pocket payments 33.1 375 Private health insurance 54.7 626.4 PRIVATE % of Total $billions Revenue Source
  52. 52. Health Care Expenditures (cont.) <ul><li>The private and public sources of health expenditure are relatively equal. </li></ul><ul><li>Private health insurance pays for a substantial amount of health care. </li></ul><ul><li>The Medicare and Medicaid programs account for a majority of public health care expenditures. </li></ul>

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