Demand for Medical Services Part 1

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Demand for Medical ServicesPart 1

• Health EconomicsProfessor Vivian HoFall 2009

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Outline

• Theoretical derivation of the demand curve for
  medical services
• Economic and noneconomic variables that influence
  demand
• Elasticities
• The impact of health insurance on demand

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Medical 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

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Medical Care and Utility
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Medical Care and Utility

• 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?

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Consumers Optimal Choice of Health

• Define MU marginal utility of medical care
• P price
• q quantity of medical
  services
• z quantity of all other goods

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Consumers Optimal Choice of Health

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

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

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

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Deriving a Demand Curve for Physician Visits
Note Now let q represent physician visits
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Deriving a Demand Curve for Physician Visits

• Downward sloping demand curve for physician
  visits

Price
P1
P0
q0
q1

• Price changes lead to movements along D curve

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Deriving a Demand Curve for Physician Visits
(cont.)

• Consumers purchase of medical care is a derived
  demand

• i.e., no direct utility from visiting the
  doctor

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Other Economic Factors Affecting 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

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Other Economic Factors Affecting Demand
1. Income

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

q0
q1
Physician Visits
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Other Economic Factors Affecting Demand
2. Complements - 2 or more goods which are
consumed together

• 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

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Other Economic Factors Affecting Demand
2. Complements

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

Price
Price of complement falls
Optometrist Visits
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Other Economic Factors Affecting Demand
3. Substitutes - other goods which satisfy the
same wants, or provide same characteristics

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

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Other Economic Factors Affecting Demand
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
  ___

Price
Demand for brand name drug falls
Brand name drugs
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Elasticities
A relatively flat demand curve implies that a
small increase in price leads to a large fall in
visits demanded
Price
Visits
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Elasticities
In this case demand is considered to be
relatively elastic with respect to a change in
price
Price
Visits
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Elasticities
A relatively steep demand curve implies that a
small increase in price leads to a small fall in
visits demanded
Price
Visits
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Elasticities
In this case demand is considered to be
relatively inelastic relative to a change in
price
Price
Visits
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Elasticities (cont.)

• 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

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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
• 0ltEDlt1
• The demand curve is elastic if
• 1ltEDlt?

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Elasticities (cont.)

• 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

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Except in special cases, the ED is different on
different points of the demand curve
P
ED -?
4
ED -1
2
ED 0
4
8
Q
Demand curve Q 8 2P
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Elasticities (cont.)

• 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

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Elasticities (cont.)

• 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 demanded
• EC is negative for complements
• EC is positive for substitutes

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Elasticities

• Own price elasticity of demand critical for
  determining
• a health care managers total revenue
• TR PQ D

If demand for physician services is inelastic,
and the price is raised, then I DQD I lt I DP
I

• Total revenue will increase if price is raised
  when demand is inelastic

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QUIZ

• A 1991 study by Frank Chaloupka estimated the
  price elasticity demand for cigarettes to be
• .48
• .83
• 1.02
• 1.33

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Insurance

• 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
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Insurance
Price
P
cP
Visits
qc
q

• No insurance consumer faces price P, makes q
  visits

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

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Insurance (cont.)

• Coinsurance leads to a demand of qc visits at
  price P,
• shared by consumer and insurance company

• Demand curve rotates clock wise

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What if the consumer has full coverage?

• i.e., copayment 0

Price
Visits
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• Indemnity Insurance
• Insurer pays a fixed amount for each
  purchased service
• Insurer pays 150 for each overnight hospital
  stay, and patient pays the rest

Price
150
D1
D0
Visits
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• Fixed copayment
• Patient pays up to 20 per visit, and insurer
  pays the rest

Price
D1
20
D0
Visits
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• Deductibles - Consumer must pay a fixed amount
  out of pocket per year before coverage begins
• e.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