THE QUANTITY OF MEDICAL

CARE DEMANDED

Part I: Basic Demand Concepts

Definition - The demand analysis seeks to identify factors that are most influential in determining how much health care that consumers are willing and able to purchase at given prices. Purpose – A better understanding of the demand relations provides insights into the various health care issues to be explored in health care economics.

Points of clarification

1. The demand for medical care is “derived” from consumers’ demand for health (or stock of health).

2. It is not synonymous to an act of purchase or an utilization of health service. A purchase or utilization is “realized demand.”

3. Health care is different and the differences pose a “shopping problem” for patients/consumers.

Is Health Care Different?

Viewed from the perspective of demand, health care differs from ordinary consumer goods in several important respects: 1. Uncertainty 2. Idiosyncratic patient needs3. Asymmetry of information4. The inseparability of diagnose and

treatment and the resulting dual role of physicians

5. Complex price structure of health care

1. Uncertainty

One never knows when he/she will get sick and how bad the condition might be when sick.

Uncertainty refers to the random nature of the incidence of illness and the inherent variations in treatment outcome.“… the special economic problems of medical care can be explained as adaptations to the existence of uncertainty in the incidence of disease and in the efficacy of treatment.”

Kenneth Arrow

Consequences of Uncertainty

Origin TypePrimary coping

strategySecondary

Effects Secondary Strategies

Incident of Illness

Insurance Moral Hazard

Copays, deductibles, Pre-authorization, utilization reviews and other managed care tools, and now payment reform

Uncertainty

Treatment Outcomes

Principal-Agent Relationship

Agency Problem Licensure, Regulation, Nonprofit Hospitals and reliance on PCPs

2. Idiosyncratic patient needs

No two patients are exactly alike; Every patient must be treated individually (no assembly-line production)

Tailor-made services cost more

3. Asymmetry of information

Buyers and sellers need good information about prices and quality of products for the market to function well

Information is scarce in health care Health professionals know more than

patients about diseases and healing processes

Consumers/patients must divulge information to assist in the diagnostic process

4. Physicians as a service provider

Physician care – The product and the activity of production are identical In most instances, the provider has just

one chance to do it right and the customer cannot test the product before deciding to buy or not

Advertising and overt price competition are virtually nonexistent

Patients have a shopping problem

5.Complex price structure of health care

In addition to the numerous prices charged for a myriad of services and procedures, the price of health care is complicated by insurance and price‑like incentives such as deductibles and co-payments

Lack of price transparency Price is not measured solely in the amount of

money must be paid. Other measures of prices include: Price of time Pain and suffering Price of compliance

 

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

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

Utility

Medical Care

Medical Care and Utility

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 Health

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 Health

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

Proof

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 Physician 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 Physician 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 Physician Visits (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 Affecting Demand

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

Other Economic Factors Affecting Demand

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

Other Economic Factors Affecting Demand

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

Other Economic Factors Affecting Demand

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

Other Economic Factors Affecting Demand

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

Elasticities

Price

# Visits

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

Price

# Visits

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

Elasticities

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.

EQP

change in quan tity dem andedchange in priceD

D %%

%%

More price elastic demand leads to a flatter demand curve.

Price

# Visits

Relatively inelastic

Relatively elastic

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.

EQ

Y

change in quan tity dem anded

change in incom eYD

%

%

%

%

Except in special cases, the ED is different on different points of the demand curve

P

Q

4

8

Demand curve: Q = 8 – 2P

4

2ED = -1

ED = -

ED = 0

Insurance

• 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.)

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