Raymond Yeung

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Econ 6038 Lecture Two Grossmans health
investment model

• Raymond Yeung
• 26 September 2005

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Background

• Before Grossman, medical care was modeled as a
  risky, financial loss Arrows convention
• Medical care is exogenous - a response to
  illness
• Grossman (1972, 1972b) recognizes health as a
  human capital

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Features

• Health / medical care
• By choosing a level of medical care, the person
  can influence the duration of healthy period
• The dynamic features of this model allow the
  agent to determine the length of life know when
  to die therefore, only a heavily used model in
  academic economics, not for public health
  researchers
• Form an authoritative framework for behavioural
  health studies, i.e. economics of addiction

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Preference and dynamics
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Budget constraints
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Summary constraint
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The maximization problem
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Equilibrium
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Interpretations

• PV of marginal cost of health investment (through
  medical care) at t-1 equals the PV of discounted
  marginal benefit from this investment, i.e. the
  derived benefit from the increase in healthy time
  per period
• The derived benefit is the wage rate and direct
  marginal utility from healthy time

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Interpretations

• The maximization problem determines the optimal
  level of investments in t-1 and the condition of
  the cost of producing a given quantity of
  investment
• The value (undiscounted) of marginal product of
  optimal health stock must equal its supply price
  a function of exogenous parameters e.g.
  interest rate, depreciation, endowments etc

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Static analysis

• By simplifying the model into single period, one
  can present the intuition using graphical
  analysis (Folland et al Chapter 6)
• Income vs leisure tradeoff
• Production possibility frontier
• Marginal efficiency of investment

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Application from the framework

• In Grossman (2000 NBER), the general model was
  simplified into two extremes pure investment
  model and pure consumption model
• The simplification allows unambiguous prediction
  of demand for health
• One can assume the end time conditions and
  simulate the numerical solution of the model,
  which can be your research paper
• One can also conduct hypothesis testing of
  implication drawn from Grossman model using
  empirical data

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Grossmans empirical results

• Grossman fitted the pure investment model using
  1963 US data. Results are consistent with the
  model prediction
• Education and wage rate are positively correlated
  with health demand function
• Increase in age reduces health and increase
  medical expenditure

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Subsequent empirical studies

• Wagstaff (1986)
• Erbsland et al (1995)
• Longitudinal - Van Doorslaer (1987), Wagstaff
  (1993)

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Subsequent theoretical extensions

• Muurinen (1982)
• Cropper (1977)
• Daranoni and Wagstaff (1987)
• Selden (1993)
• Chang (1996)
• Liljas (1998)

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Empirical studies of demand for healthcare

• Grossman modeled the healthcare demand derived
  from health investment
• Healthcare services demand depends on factors
  such as price of healthcare, prices of other
  goods, marginal utility of income, time, wage
  rate etc.
• Policy makers are interested in estimating the
  income and price elasticity of demand for
  healthcare

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Issues in empirical demand functions

• How to measure prices in healthcare?
• Lack of data sources
• Non experimental in nature
• Individual versus country as a unit
• Different in healthcare systems for international
  data

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RAND Health Insurance Experiment

• Conducted by RAND funded by US Public Health
  Services in 1974
• Households in 6 cities were randomly assigned to
  groups with different medical insurance plan
• Randomized experiment minimizes many desirable
  effects due to confounding and selection bias
• Newhouses study stimulates a new wave of health
  economics study

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Observations from empirical studies

• Price elasticity of healthcare is not inelastic
• Patients respond to price more for choice of
  physicians but not physician services
• Income elasticity of healthcare for individuals
  is less than unity
• Empirically income elasticity of healthcare
  across countries is however more than one
• Lower coinsurance rate leads to greater demand
  for the care moral hazard??