Review of the Last Lecture

1. Review of the Last Lecture • Have finished our discussion of the Grossman model of the demand for HK (health capital) • today begin our discussion of the demand for HC (healthcare)

2. Demand Function & Demand Curve • demand curve vs. demand function • movement along the demand curve vs. shifts in the demand curve

3. The Demand for Healthcare is a Derived Demand • healthcare does not yield utility directly • in fact, at the time of consumption it frequently yields disutility (painful, stressful, embarrassing) • healthcare is demanded for its anticipated positive effect on two things that do yield utility directly: 1) our stock of health capital 2) a return to better health when we are sick • our demand for HC is driven by our demand for health capital and better HS when we are ill • The demand for HC is thus a derived demand

4. The Demand Function for Healthcare QD = Q(Y, PHC, PNHC, HS, Z) +  where: QD is the quantity of HC demanded per year Y is nominal annual income PHC is the price of healthcare PNHC is the price of non healthcare goods HS is health status over the year Z is a vector of tastes etc (e.g., belief that a treatment works)  is a random error term NB. Assume for now that there is no health insurance

5. Direct and Indirect Effects on the Demand for HC • A variable may affect the quantity of HC demanded directly (health status is assumed to be constant) and indirectly (via its impact on health status). • The direct and indirect effects may work in the same direction or in opposite directions • only if the two effects work in the same direction can one predict how a change in the variable affects the quantity of HC demanded

6. The Net Effect of a Change in Nominal Income on the Demand for Healthcare QD = Q(Y, PHC, PNHC, HS, Z) +  The direct effect (HS held constant): as nominal income , ceteris paribus, real income , buy more of all goods, HC is a good, Q of HC demanded  (positive direct effect) (DIAGRAM) • The indirect effect: as real income  generally healthier thus need less HC (negative indirect effect) (DIAGRAM) • the direct and indirect effects work in opposite directions => net effect of an increase in nominal income (real income  since prices held constant) on Q of HC demanded cannot be predicted

7. An Increase in the Price of HC on Q of HC Demanded • The direct effect (HS held constant) is negative (PHC=> Q dem) for two reasons ( QD = Q(Y, PHC, PNHC, HS, Z) +  ): i) income effect (Explain) ii) substitution effect (Explain) • The indirect effect: as PHC, use less healthcare and less of all other goods (due to real income down) => not as healthy as before => need more HC (+ve indirect effect) • very unlikely that the +ve indirect effect will more than offset the –ve direct effect (DIAGRAM) • empirical research indicates that the net effect of PHC on Q of HC demanded is negative

8. A Change in the Price of a Non-Healthcare Good • There are many non-healthcare goods and PNHC should really be considered a vector of prices for non-healthcare goods, i.e., PNHC = PNHC1 , PNHC2 , …,PNHCn • The effect of a change in the price of a non-healthcare good on the Q demanded of HC depends on the type of good • We will consider the effect on the Q of HC demanded of price changes for two kinds of non-healthcare goods: i) goods that are good for health ii) goods that are bad for health

9. A Decrease in the Price of a Good that is Good for Health • The direct effect: as the price of a good that is good for health goes down there is an income effect (P  , real income , buy more of all goods, HC is a good) and a substitution effect (P , this good now relatively cheaper, substitute it for some HC) • the income and substitution effects work in opposite directions thus can’t predict if the direct effect is positive or negative • The indirect effect: P , real income => HS . There is also a substitution effect: P , substitute this good for other goods, HS . Both effects work in the same direction => HS  => Q of HC demanded  from the indirect effect • Theory can’t predict if the net impact of the direct and indirect effects on the Q of HC demanded is posititve or negative

10. An Increase in the Price of a Good that is Bad for Health • Some goods are bad for health (tobacco, excessive alcohol consumption, illegal drugs) • If the P of a bad  => direct and indirect effects on the Q of HC dem • the direct effect combines an income effect (P  => real income , buy less all goods, HC is a good, Q of HC ) and substitution effect (P  , substitute other goods that yield utility for the bad, HC such a good, Q of HC demanded ) Can’t sign the direct effect. • The indirect effect: also consists of the income and substitution effects (explain), both reduce the demand for the bad as P  => HS => need less HC • net impact of the direct and indirect effects unknown, likely QD

11. Possible Exception to how Q of HC Demanded Responds to a Change in the Price of a Bad • If the person is totally hooked on the bad: • The direct effect: no substitution effect (no change in smoking since the P elasticity is 0). There is an income effect. The higher P extracts more purchasing power from the smoker => less left over for other goods including HC => Q of HC demanded ). • The indirect effect: no substitution effect (perfectly price inelastic demand). However, the higher P lowers purchasing power for other goods => HS  => more HC demanded • the net impact of the direct and indirect effects could be to increase the demand for HC as the P of the bad !!

12. Other Variables in the Demand Function for HC • Z denotes a set of other variables in the demand function for HC: - illness: +ve effect on QHC demanded ~> DC shifts right and becomes steeper. Why steeper? - belief about efficacy: e.g. homeopathic products and services, dietary supplements taken for their expected HS benefits. - tastes: (“instant fixes” vs. dietary/lifestyle changes) •  random error term e.g. (random incidence of illness).///

13. Own Time Costs and Demand for HC • for a salaried worker the unit price of HC is PHC • for an hourly paid worker the effective unit price is PHC + the wages lost accessing one unit of HC • thus, ceteris paribus, at each PHC a wage labourer will demand less care than a salaried person since the effective price is higher for a wage labourer • Also, if the demand curve for healthcare is non-linear with respect to the effective price of HC, the wage labourer’s demand curve with respect to PHC will be steeper than for the salaried person (see diagram) => i.e., a drop in PHC will increase Q of HC demanded by more for a salaried person than for a wage rate labourer.