3 Basic Steps in Economic Evaluation

1
Demand for Medical Services and Medical
Spending
2
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

3
Medical Care and Utility
Example relation between medical care and utility.
Utility
TU
10
?TU
8
MU
?Q
6
4
2
MU
4
3
2
1
Medical Care
4
Medical Care and Utility

• The previous graph illustrates an example of
  diminishing marginal utility
• After 2 units each additional unit of medical
  care yields a smaller increase in utility, the
  relation cannot be graphed using a straight line.

5
Medical Care and Utility
6
Medical Care and Utility

• The graph shows that as the level of medical
  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?

7
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

8
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.
9
Proof

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

10
Deriving a Demand Curve for Physician Visits
Note Now let q represent physician visits.

• If youve had Econ 301, you know there is also
  an income
• Effect. We are assuming that health care is a
  normal good.

11
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

12
Demand Curve for Physician Visits
The relation between price and the quantity
demanded can be expressed using a demand schedule
13
Demand Curve for Physician Visits
Graph the previous relation between price and the
quantity of physician visits demanded.
Price
100
75
50
25
4
3
2
1
Physician Visits
14
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

15
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.

16
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
17
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.

18
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
19
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.

20
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 generic drug falls
Brand name drugs
21
Demand Curve Terminology
Price
A to B increase in quantity demanded
A
10
B
8
4
6
Quantity
22
Demand Curve Terminology (cont.)
Price
D0 to D1 Increase in demand
D1
D0
Quantity
23
Elasticities
A relatively flat demand curve implies that a
small increase in price leads to a large fall in
visits demanded.
Price
Visits
24
Elasticities
In this case demand is considered to be
relatively elastic with respect to a change in
price.
Price
Visits
25
Elasticities
A relatively steep demand curve implies that a
small increase in price leads to a small fall in
visits demanded.
Price
Visits
26
Elasticities
In this case demand is considered to be
relatively inelastic relative to a change in
price.
Price
Visits
27
Elasticities

• We would like a way to quantify the elasticity of
  a demand curve with respect to price.
• More generaly, elasticity measures the
  responsiveness of quantity demanded to a change
  in an independent factor.
• Elasticities measure this responsiveness in terms
  of proportionality.

28
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.

29
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
• The demand curve is elastic if
• 1

30
More price elastic demand leads to a flatter
demand curve.
Price
Relatively elastic
Relatively inelastic
Visits
31
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.

32
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
33
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.

34
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 Tylenol leads to a 15
  increase in the quantity of Advil demanded.
• EC is negative for complements.
• EC is positive for substitutes.

35
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 I

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

36
Health Care Expenditures

• ExpenditurePrice x Quantity
• Although expenditures are rising, we have seen
  that health status has also improved.
• The size of the entire economy has grown, so that
  the of GDP spent on health care has held steady.

37
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 5,0
43 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
38
Health Care Expenditures 1999 (cont.)
39
Health Care Expenditures (cont.)

• The private and public sources of health
  expenditure are relatively equal.
• Private health insurance pays for a substantial
  amount of health care.
• The Medicare and Medicaid programs account for a
  majority of public health care expenditures.

40
Health Care Demand
At a price of P1, the quantity demanded is Q1.
Price per unit
At a lower price, P2, the quantity demanded is Q2.
P1
P2
D
Q of HC
Q1
Q2
We would generally expect the demand for HC to be
relatively inelastic. Why?
41
Health Care Demand with Insurance
Price per unit
Insurance lowers the out-of-pocket price,
effectively increasing the quantity demanded for
health care
P1
P2
D
Q of HC
Q1
Q2
42
Health Care Demand with Insurance
Most plans have an out-of-pocket maximum, many
use 250 per person or 1000 per family.
Price per unit
P1
After that maximum is reached, price goes to 0
and quantity demanded to Q3.
P2
D
0
Q of HC
Q1
Q2
Q3
43
Table 5-2 Use of health services and insurance
Out-of-pocket expenses
Key point is to compare the probability of using
to the out-of-pocket cost. Higher out-of-pocket
share indicates lower probability of using health
care.
44
We can use Table 5-2 to figure the elasticity of
demand for health care

• From row 2 to 3 shows a 25 increase in the price
  of health care.
• ? in P (0.5P-0.25P)/P 0.25
• The probability of using goes down from 78.8 to
  77.2 a 2 percent decline
• (78.8-77.2)/77.2
• So elasticity of demand 2/25 0.08
• Notice, total expenses per capita increased from
  634 to 674
• Inelastic demand, increase price, total spending
  goes up.

45
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