The Demand for Medical Care

1. 4 The Demand for Medical Care

2. Learning Goals • Follow the logic for shifting from “demand for health” to “demand for medical care” with specific illnesses. • Understand how to derive demand curves for medical care from indifference curves (and how these relate to the demand for health). • Interpret demand curves as “value” measures. • Learn how health insurance of various types alters the price of medical care and affects demand curves.

3. 4.1 Indifference Curves for Health and Other Goods Continuing from Chapter 2, we start with the utility function: U = U(X,H), where X is a vector of other goods and H is health. • Consumer must pay for X and medical care (m)to produce H, and is constrained by income. • The production process translates medical care into health, H = g(m) • Subject to diminishing returns, so that g’(m), the rate at which health improves for a small change in m, is decreasing.

4. 4.1 Indifference Curves for Health and Other Goods Continuing from Chapter 2, we start with the utility function: U = U(X,H), where X is a vector of other goods and H is health. • Consumer must pay for X and medical care (m)to produce H, and is constrained by income. (Figure 4.1b, next slide) • The production process translates medical care into health, H = g(m) • Subject to diminishing returns, so that g’(m), the rate at which health improves for a small change in m, is decreasing. • Figure 4.1a (next slide) shows the production possibilities, feasible combination of X and H, given the budget and the production function. • Concave because of diminishing returns • Utility maximization implies that the consumer chooses a bundle such that the budget constraint is tangent to the highest possible indifference curve in Figure 4.1b, choosing goods (X) and medical care (m). • The companion point in Figure 4.1a shows choice of goods (X) and health (H).

5. 4.1 Indifference Curves for Health and Other Goods

6. 4.1 Indifference Curves for Health and Other Goods Now consider “getting sick.” • The level of health drops from Ho to H1 • Define the health loss as l • PP shifts inward, and the new optimum is at less consumption of goods and more health, as the consumer pays more for medical care. • The tradeoff between consumption and medical care changes, so the indifference curves in Figure 4.2 b shift. • If the illness reduces earnings, too, the budget constraint may shift (Figure 4.2c).

7. 4.1 Indifference Curves for Health and Other Goods How does increased income change medical care consumption? • Figure 4.3a shows the expansion path, holding all else constant. • Figure 4.3b shows a similar expansion path for purchase of medical care. • As income rises, health and spending on health typically increase.

8. 4.1 Indifference Curves for Health and Other Goods The expansion paths can be used to derive Engel curves, income-demand curves for H and m. • At low incomes, the “sanitation effect” may cause health outcomes to rise rapidly with income. • The “fast lane” effect may reduce health (increase spending) at higher incomes due to lifestyle choices. • The “health spa” effect may increase health (reduce spending) at higher incomes.

9. 4.2 From Indifference Curves to Demand Curves The demand for medical care can be derived by holding all else constant and changing the price of medical care. • Figures 4.5a and 4.5b • Assuming that medical care is a normal good, an increase in income increases demand (4.5c). • While indifference curves may not be observable, demand curves can be observed in the real world.

10. 4.3 How Demand Curves Depend on Illness Events The larger the health loss (l) due to illness, the more the health loss (and thus the flatter the indifference curves in Figure 4.2b). • Demand increases with the extent of health loss

11. 4.4 Demand Curves for Many Medical Services Health can be affected by more than one type of medical care, and various types of care can be complements or substitutes. • For multiple health inputs, H = g(m1,m2, … mn)for the n types of medical care available. • Each type of medical care would have its own demand curve. • Medical goods are substitutes if the demand for one good rises with the price of another good. • Medical goods are complementsif the demand for one good falls with the price of another good.

12. 4.5 The Demand Curves for a Society: Adding Up Individual Demands The aggregate demand curve for health adds up the individual demands at each price (Figure 4.7). • Since individual demand curves depend on illness, they would shift if individual illnesses changed, which would shift the aggregate demand curve.

13. 4.6 Use of the Demand Curve to Measure Value of Care The willingness to pay interpretation of the demand curve states that the incremental value of consuming more medical care is equivalent to the consumer’s willingness to pay for a bit more m. • The marginal value to consumers (incremental willingness to pay) falls as the amount consumed rises. • Inverse demand curves or value curves. • Downward sloping due to diminishing marginal productivity of medical care in producing health and the decreasing marginal utility of H • Consumers will increase purchases until the marginal value of m is equal to the marginal cost. • Total value of a given amount of health care is the area under the demand curve. • Consumer surplus is the extra value to consumers (beyond the amount paid) for care.

14. 4.6 Use of the Demand Curve to Measure Value of Care Dental visit example: • At a marginal cost of $30, the patient purchases three dental visits. • The total value of the visits is $210, and the cost is $90 • Consumer surplus is $120.

15. BOX 4.1: Elasticities of Demand Curves Elasticity of Demand • η=(Δq/q)/(Δp/p) = % Δq/% Δp • Scale-free • Along a linear demand curve, slope is constant but elasticity changes. • In the figures below, the left figure would have changing elasticity, and the right figure would have a constant elasticity.

16. BOX 4.1: Elasticities of Demand Curves Elasticity of Demand • For a more severe illness, the elasticity of demand is smaller in absolute value (more inelastic) when demand is linear. • In the figure, elasticity is -1 at a price of 10 on the mild illness demand curve. • Elasticity is -0.25 at the same price on the serious illness demand curve. • For constant-elasticity curves, only the quantity demanded changes, not elasticity.

17. 4.7 How Insurance Affects a Demand Curve for Medical Care Flat Per-Visit Copays • Flat copays are common in private health plans, with typical levels of $20-$40 per physician visit. • Popular due to ease of administration, but give little incentive to shop for better prices. • Typically higher copays for specialists, to steer consumers toward less expensive alternatives

18. 4.7 How Insurance Affects a Demand Curve for Medical Care Coinsurance • Consumer pays a fraction of the bill (typically 20-25% up to 50% for dental plans), and insurance pays the remainder. • Let C = consumer share, so (1-C) is the insurer’s share. • Figure 4.9 shows demand without insurance. • With insurance, each amount of care is less expensive, and the demand curve rotates outward. • At a given price, the consumer will purchase more medical care. • The demand curve is steeper. • The demand curve is less elastic at any given price.

19. 4.7 How Insurance Affects a Demand Curve for Medical Care Indemnity Insurance • Pays the consumer a flat amount for each medical service consumed, with the amount preestablished in the insurance contract; often called “supplemental” insurance. • For example, $500 per day in the hospital. • Effect on demand: if the insurance plan specifies that p* will be paid each time the consumer uses a particular medical service, demand shifts upward by p*

20. 4.7 How Insurance Affects a Demand Curve for Medical Care Deductibles • Fixed amount that the consumer must pay before insurance payments are made. • Figure 4.11 shows the effect of a deductible on the apparent price of care, dropping the price to 20 percent of its normal level after a deductible of size D has been met, where D =pm* (where m* is the quantity such that buying just that amount of medical care at a price of p leads to an expenditure of amount D)

21. 4.7 How Insurance Affects a Demand Curve for Medical Care Deductibles, continued. • For a mild illness, the deductible has no effect (D1). • For a very serious illness (D3), the insurance company pays, and the result is similar to any insurance. • Demand curve (D2) intersects the price line in several places, so it is not clear what the customer will choose. • In the simple case, choose the option that maximizes consumer surplus. • More complicated in reality, because meeting the insurance deductible reduces the cost of future (and usually unknown) medical treatments. • In general, similar to uninsured demand for small illnesses and to insured demand for large illnesses.

22. 4.7 How Insurance Affects a Demand Curve for Medical Care High-Deductible Plans • Largedeductible, and then typically full coverage for all expenses above the deductible. • Initially known as consumer directed health plans (CDHPs) • Coupled with a “health savings account” (HSA) that allows consumers to add pre-tax dollars into the HSA to smooth cash flows over the year. • Eligible plans must have a deductible of at least $1,300 (for an individual) or $2,600 (for a family) to be eligible for the tax-preferred HSA savings plan. • Designed to give protection against catastrophic risk, while at the same time providing strong incentives to reduce unnecessary care.

23. 4.8 Time Costs and Travel Costs • Medical visits impose costs both in terms of time and direct travel costs. • Cost of time depends on lost earnings, sick-leave policies, and opportunity costs. Waiting (Delay to Appointment) • Delays to appointment can reduce the demand for medical care, because some conditions resolve themselves. • In extreme cases, the patient may die of illness before treatment. • Some patients may opt out of the wait by seeking medical care outside of the plan. • Canadian citizens may seek health care in U.S. cities rather than waiting. • Now many private plans have a stop-loss feature that places an upper limit on out-of-pocket spending by the consumer.

24. 4.9 The Role of Quality in the Demand for Care • Quality of care depends both on the appropriateness of the medical intervention and on the amenities associated with medical, such as pleasant offices. • Demand for services also depends on the quality of case, and so there is a family of demand curves reflecting different quality levels.

25. 4.9 The Role of Quality in the Demand for Care Measuring Quality • Example:in New York State, the Department of Health (NYSDOH) began publishing mortality rates for doctors and hospitals doing open heart surgery, adjusted for information known about the patients’ underlying severity of illness • The NYSDOH publishes (and widely publicizes) these measures annually. How do patients respond? • Patients did shift their treatment choices away from the poorer and toward the better doctors and hospitals (as measured by survival rates) • The market responded by having higher prices for the better outcomes, with prices increasing on average by $250 for each percentage point improvement in mortality, and the overall state mortality data improved considerably as doctors and hospitals all worked to improve their outcomes in the harsh glare of public information about mortality outcomes. • The typical cardiac surgery patient is elderly, and has (if not harmed by the surgery) an expected life span of (for discussion purposes) ten years. • Thus, a decrease of 1 percentage point in mortality creates about 0.1 “expected life-years.” • This implies a cost per life-year to the patient (paying more for the higher quality) of about $2,500 per life-year.

26. 4.9 The Role of Quality in the Demand for Care Linking Payment to the Quality of Care • Recent changes in the U.S. Medicare program have linked payments of hospitals and individual health care providers to measures of quality of care. • Participation by individual providers is voluntary, but for hospitals, quality adjustments became mandatory in 2013. • Payment reductions for hospitals with excessive readmission rates, reductions in hospital-acquired conditions, and a large array of scores in the Hospital Value-Based Purchasing Program.

27. 4.9 The Role of Quality in the Demand for Care Patients’ Beliefs and the (Un)Informed Consumer • Demand curves depend on the consumer’s perceptions of the quality, productivity, or desirability of treatment. • Demand is higher when the patient believes that medical intervention or the specific treatment is more effective or desirable. • Demand is lower for groups that do not believe in medical intervention or fear unpleasant treatments.

28. 4.10 Revisited: The Price Index for Health Care Returning to Chapter 1 and the path of medical care prices over time, it is notable that the quality of care has generally increased over time. • Failure to take quality improvements into consideration understate the extent to which consumers have gained or lost from changes in health care. • Recent studies suggest that when quality is taken into consideration, the costs of health care are falling over time rather than rising. • While real medical care costs have increased by about 70 percent since the 1990s, consumers would generally prefer current health care at current prices to health care of that period. • Suggests higher consumer surplus and increase in consumer welfare even with rising prices.