Lec3_Demand1_handout..

Demand for Medical ServicesDemand for Medical ServicesPart 1Part 1

Health EconomicsProfessor Vivian Ho

Fall 2007

OutlineOutline

Theoretical derivation of the demand curve for medical services

Economic and noneconomic variables that influence demand

Elasticities The impact of health insurance on

demand

Medical Care and UtilityMedical 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

We can generally graph the relation between medical care and utility as follows:

Utility

Medical Care


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?


Define : MU = marginal utility of medical care

P = price

q = quantity of medical services

z = quantity of all other goods

Consumer’s Optimal Choice of Consumer’s Optimal Choice of HealthHealth

tradeoffs

Given the consumer’s income, she chooses q and z to maximize utility.

Utility maximization rule :

MUq MUZ

Pq Pz

Total utility reaches its peak when the marginal utility gained from the last $ spent on each product is equalized

Consumer’s Optimal Choice of Consumer’s Optimal Choice of HealthHealth

i.e. The consumer equalizes “the bang for the buck” across all goods

ProofProof

Suppose that instead : MUq MUZ

Pq Pz

>

Then MUq would fall, MUz would rise, until the 2 ratios are equalized

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)

Deriving a Demand Curve for Deriving a Demand Curve for Physician VisitsPhysician Visits

Suppose Pq rises. This will lead to :

MUq MUz

Pq Pz

<

Note : Now let q represent physician visits

Consumer can U by purchasing less q, and more z

Pq lower demand for q

Deriving a Demand Curve for Deriving a Demand Curve for Physician VisitsPhysician Visits

Downward sloping demand curve for physician visits

Price

P1

P0

q0q1

• Price changes lead to movements along D curve

Deriving a Demand Curve for Deriving a Demand Curve for Physician Visits Physician Visits (cont.)(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,…)

Other Economic Factors Other Economic Factors Affecting DemandAffecting 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


If income increases, then at any given price, consumer is willing and able to purchase more q

1. Income

q0 q1

Price

P0

DOD1

Physician Visits


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

2. Complements - 2 or more goods which are consumed together


e.g. contact lenses and optometrist visits If contact lenses become cheaper, demand for optometrist

visits ___

2. Complements

Price

D0D1

Optometrist Visits

Price of complement falls


e.g. Coke and Pepsi e.g. Physicians and Nurse practitioners? e.g. generic and brand name drugs

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 ___

3. Substitutes - other goods which satisfy the same wants, or provide same characteristics

Price

D1D0

Brand name drugs

Demand for brand name drug falls

Open Heart Surgery

Deliveries

Knee Surgery

Carpal Tunnel

Facelifts

“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!

Online Health Care Purchases?Online Health Care Purchases?

Online Health Care Purchases!Online Health Care Purchases!

“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.

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:

•their medical education and credentials; •their practice history and practice philosophy; •patient references and typical outcomes; •their associated surgical facilities; •their office location, and languages spoken; •patient financing (coming soon); •and other important information -- including their best price.”

Online Health Care Purchases!Online Health Care Purchases!

ElasticitiesElasticities

Price

# Visits

A relatively flat demand curve implies that a small increase in price leads to a large fall in # visits demanded

Price

# Visits

In this case demand is considered to be relatively “elastic” with respect to a change in price


Price

# Visits

A relatively steep demand curve implies that a small increase in price leads to a small fall in # visits demanded


Price

# Visits

In this case demand is considered to be relatively “inelastic” relative to a change in price


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

EQP

change in quan tity dem andedchange in priceD

D %%

%%

Elasticities (cont.)Elasticities (cont.)

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|<


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

%%

QP

QQ

PP

QP

PQ

D


Except in special cases, the EExcept in special cases, the EDD is different is different

on different points of the demand curveon different points of the demand curve

P

Q

4

8

Demand curve: Q = 8 – 2P

4

2ED = -1

ED = -

ED = 0

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

EQ

Y

change in quan tity dem anded

change in incom eYD

%

%

%

%


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 demandedEC is negative for complements

EC is positive for substitutes

% %

% %X

CY

Q change in quantity demanded of good XE

P change in price of good Y


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


QUIZQUIZ

A 1991 study by Frank Chaloupka estimated the price elasticity demand for cigarettes to be:

A. .48

B. .83

C. 1.02

D. 1.33

InsuranceInsurance

The above demand analysis assumed that the patient pays for care out-of-pocket

How does insurance affect the demand for care?

1. 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

InsuranceInsurance

• No insurance : consumer faces price P, makes q visits

Price

P

cP

qcq # Visits

• W/ coinsurance : consumer faces price cP, wants to make qc visits

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

What if the consumer has full What if the consumer has full coverage?coverage?

• i.e., copayment = 0

Price

# Visits

• Indemnity InsuranceInsurer pays a fixed amount for each

purchased service Insurer pays $150 for each overnight hospital

stay, and patient pays the rest

Price

Visits

D0

D1

$150

• Fixed $ copaymentPatient pays up to $20 per visit, and insurer

pays the rest

Price

Visits

D0

$20

D1

• Deductibles - Consumer must pay a fixed amount out of pocket per year before coverage beginse.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

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