Chapter 4

Additional Topics in the Demand for Health and Health Care

4.1 INTRODUCTION

4.2 IMPLICATIONS OF HEALTH CARE FOR LIFE AND DEATH

4.3 EXTERNAL AND SOCIAL DEMAND FOR HEALTH CARE

4.4 INFLUENCE OF QUALITY ON THE DEMAND FOR HEALTH CARE

4.5 TIME AND MONEY COSTS

4.6 THE DEMAND FOR HEALTH

4.7 AGENCY THEORY AND SUPPLIER-INDUCED DEMAND

Many consumers do not know the effect of health care on health and physicians have been regarded as having two main roles: (1) to act in an advisory capacity and inform patients of their level of health and courses of treatment that might improve their health and (2) to undertake treatments their patients have decided upon.

Let H = level of patient’s health (measured by number of healthy days)

M = units of health care

X = units of food

To analyze the physician’s role as an agent, we make the following assumptions:

· Health creates utility (U) in such a way that the additional satisfaction or utility from 1 additional unit of health, or the marginal utility of health (ΔU/ΔH) diminishes. Total utility still increases with additional health.

· All else equal, the marginal productivity of health (ΔH/ΔM) = Δ in health with an additional unit of health care received, becomes progressively less as health care increases.

· Each unit of health care is purchased at a cost to the patient of C_M

· The other commodity, X, has declining marginal utility (ΔU/ΔX). It has a per unit cost of C_X

· Patient knows values of all relevant variables (H, M, C_X, C_M, and most importantly, ΔH/ΔM)

· Patient’s goal is to maximize utility.

In equilibrium,

((ΔU/ΔH)(ΔH/ΔM))/C_M =(ΔU/ΔX)/C_X

Where (ΔU/ΔH)(ΔH/ΔM) is the change in satisfaction associated with an extra unit of health care (Δ in health care changes Δ in health which in turn changes utility).

If we assume that the physician knows the patient’s health level and the effectiveness of health care in producing health, and if the physician has an awareness of the patient’s tastes and other circumstances (prices and income), then, assuming the physician behaves as a “perfect agent”, he or she will prescribe and/or provide a quantity of health care such that the patient him- or herself, if fully informed, would have chosen. However, principal-agent relationships are such that the agent (physician) may not behave in the best interests of the principal (patient). A deviation of the agent from the principal’s own interests is called moral hazard.

When the patient interacts with a provider, there are four types of costs which he or she incurs in addition to the price and wait and travel costs:

1. Search costs, or the costs of determining specifications of the services needed and the prices of these services

2. Contract costs, or the costs of reaching an agreement with the provider as to what services are to be provided

3. Monitoring costs, or the costs of identifying the desired outcomes, collecting data on these outcomes, and determining whether the outcomes have been achieved

4. Enforcement costs, or the costs of ensuring that the provider meets the agreed criteria

4.7.1 Demand under Uncertainty: The Demand for Health Promotion

Assumptions:

1. Time frame. All activities and consequences occur in the current time period.

2. Consumer Tastes If health has diminishing MU for one individual, that individual is said to be risk averse, i.e., for a given wealth level, a loss of a given amount is of greater importance (utility) to the person than would be a gain of an equal amount.

3. Level of Wealth Individual initially has a level of wealth of $1,000.

4. Medical Expenses in the Event of Illness. If individual becomes sick, he or she will face medical expenses of $150.

5. Likelihood of Illnesses Without any health promotion activities there is a .3 probability of illness and a .7 probability the individual will remain well and will not incur any medical costs. With health promotion activities the probability of being healthy increases to 0.9 and the probability of being ill falls to 0.1.

6. The cost of health promotion activities. Individual can shift risk of loss onto an insurer but will have to pay a premium to do so. We will assume that these costs total $20.

7. Behavioral assumption. Individual wants to maximize his/her utility. (Table 4-1, p. 89)

Not engaging in health promotion, the expected utility for the individual is 92.8 [(0.7 × 100) + (0.3 × 76.0)]. This is because when the individual is healthy, he or she has a utility of 100.0 (corresponding to a wealth of $1,000), and when he or she is ill, the utility is 76.0 (corresponding to a wealth level of $850). If individual engages in health promotion activities, the expected utility is 95.3 [(.9 × 99.4) + (.1 × 69.0)]. This is because when individual is healthy, he or she has a utility of 99.4 (corresponding to a wealth of $980 (= $1000 - $20 on health promotion activities)), and when he or she is ill, the utility id 69 (corresponding to a wealth of $830 (= $1000 – 150 -20)).

The individual is better off when he or she engages in health promotion activities under these circumstances, and so we predict that he or she will choose that option.

4.7.2 Limitations of the Model

4.7.3 Discounting Future Values

4.7.4 Insurance and Moral Hazard

Assume individual has same utility function as in model discussed earlier. Other basic assumptions are:

· Prob (sick) = .2

· If insured gets sick, he or she will pay $5 for each unit of health care demanded.

· Individual’s initial wealth level is $1,000.

3 situations: 1. No insurance, individual pays $5/unit.

2. Fully insured and pays zero price for health care

3. 10% copayment → faces price of $.50/unit

Assume when P = $5, 10 units demanded

“ P = $0, 30 units demanded

P = .50, 12 units demanded

First compare situations 1 and 2

Sit. 1: -20% of getting sick, pay $50, and have $950 left over.

U($950) = 97

-80% of not sick, wealth stays at $1000, and U(1000) = 100 →E(U) = .2(97) + .8(100) = 99.4

Sit. 2. Assume premium = $30 →U(970) = 98.8

E(U) = 98.8 less than E(U) in sit. 1 → No insurance demanded

Sit. 3 Because of 10% copayment, insurance company pays $4.50/unit and since individual demands 12 units if sick, insurance company pays $54.00 total ($4.50 times 12)

Assume premium = $10.80

Individual pays $6.00 if becomes sick (.5 times 12)

Cost to individual = $10.80 + 6.00 if sick

U(1000-10.8-6) = U(983.2) ≈ 99.6

If not sick U(1000 – 10.8) = U(989.2) ≈ 99.8 →E(U) = .2(99.6) + .8(99.8) = 99.76 more than sit. 1 →Individual will buy insurance.