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- 1. Chapter 5: Demand for Medical Services and Medical Spending Health Economics
- 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. 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. 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. Medical Care and Utility Graph this relation between medical care and utility. 2 4 6 8 4 3 2 1 Medical Care Utility
- 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. 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. 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. 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. 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. Medical Care and Utility We can generally graph the relation between medical care and utility as follows: Utility Medical Care
- 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. <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. <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. 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. 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. 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. 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. 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. 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. 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. Deriving a Demand Curve for Physician Visits (cont.) P Q 4 8 Demand curves are graphed in the form P = a – bQ.
- 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. 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. 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. 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. 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. 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. 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. 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. Demand Curve Terminology Price Quantity 10 A 4 8 6 B A to B : increase in quantity demanded
- 32. Demand Curve Terminology (cont.) Price Quantity D 0 to D 1 : Increase in demand D 0 D 1
- 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. Online Health Care Purchases!
- 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 "bids" 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. Elasticities Price # Visits A relatively flat demand curve implies that a small increase in price leads to a large fall in # visits demanded.
- 37. Elasticities Price # Visits In this case demand is considered to be relatively “elastic” with respect to a change in price.
- 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. Elasticities Price # Visits In this case demand is considered to be relatively “inelastic” relative to a change in price.
- 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. 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. 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. More price elastic demand leads to a flatter demand curve. Price # Visits Relatively inelastic Relatively elastic
- 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. 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. 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. 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. 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. 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. 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. 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. 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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