Economics 387

1. Economics 387 Lecture 6 Demand for Health Capital Tianxu Chen

2. Outline • The Demand for Health • Labor–Leisure Trade-Offs • The Investment/Consumption Aspects of Health • Investment over Time • The Demand for Health Capital • Changes in Equilibrium: Age, Wage, and Education • Empirical Analyses Using Grossman’s Model • Obesity—The Deterioration of Health Capital • Conclusions

3. THE DEMAND FOR HEALTHConsumer as Health Producer • Grossman used the theory of human capital to explain the demand for health and health care. • According to human capital theory, individuals invest in themselves through education, training, and health to increase their earnings. • Four important aspects of health demand:

4. Consumer as Health Producer • It is not medical care as such that consumers want, but rather health. People want health; they demand medical care inputs to produce it. • Consumers do not merely purchase health passively from the market. Instead, they produce health, combining time devoted to health-improving efforts with purchased medical inputs.

5. Consumer as Health Producer • Health lasts for more than one period. It does not depreciate instantly, and it can be analyzed like a capital good. • Perhaps, most importantly, health can be treated both as a consumption good and an investment good. As a consumption good, health is desired because it makes people feel better. As an investment good, health is desired because it increases the number of healthy days available to work and to earn income.

6. Health Capital • Your body is like a “car.” • Huh ??? • How do we think of the body as a capital good, and medical care as a health investment ???

7. A Schematic Figure 7-1 Investing in Health Care

8. A Model for Time Spent Producing Health • I = I(M,TH), where I is investment in health, M is market health inputs and TH is time used in the production of health • B = B(X,TB), where B is other goods produced, X is market purchased goods and TB is time used producing other goods • The ultimate resource is time: T = TH (improving health) + TB (producing other goods) + TL ( lost to illness) + TW (working)

9. LABOR–LEISURE TRADE-OFFS • Suppose now the time spent creating health investment to be “health-improvement time” TH and call TB the leisure time. • Assume TH and TL are fixed (we will relax this assumption later) • Time available for work or leisure=365- TH – TL= TB + TW • TB is measured toward to the right while TW is measured toward the left.

10. LABOR–LEISURE TRADE-OFFSLabor-Leisure Model • VS represents the labor-leisure trade-off faced which reflects the wage rate. • Given labor-leisure preferences represented with indifference curves, utility is maximized at income of Y2 and leisure time A. Figure 7-2 Labor-Leisure Trade-Off

11. Impact of Investments in Health • Over time investments in health reduce time lost to illness, TL’, and thereby increase leisure time 365 –TH’ – TL’. • The labor-leisure tradeoff line shifts to the right allowing for a choice with more income and more leisure time at E’. Figure 7-3 Increased Amount of Healthy Time Due to Investment

12. THE INVESTMENT/CONSUMPTION ASPECTS OF HEALTHProduction of Healthy Days • This illustrates the production of healthy days using a single input, health stock. • If health stock falls below Hmin, it indicates death. • The shape of the function indicates diminishing marginal returns. Figure 7-4 Relationship of Healthy Days to Health Stock

13. Production of Home and Health Goods • AECD represents production possibilities. • If health is an investment good only, indifference curves look like U1. will not trade any B to get additional health. • If health is a consumption good then indifference curves look like U2. Figure 7-5 Allocation of Production Between Heath and Bread

14. INVESTMENT OVER TIMEThe Cost of Capital • We demand health capital because it helps us earn more and feel better. What does it cost? By analogy, a health clinic purchases thousands of dollars of X-ray equipment. The return to the X-ray equipment is in the future earnings that ownership of the equipment can provide.

15. The Cost of Capital • Suppose that an X-ray machine costs $200,000, and that its price does not change over time. Suppose that the annual income attributable to the use of the X-ray machine is $40,000 for 5 years. Is purchasing the machine a good investment?

16. The Cost of Capital • Consider the alternative: Instead of purchasing the X-ray machine, the clinic could have put the $200,000 in a savings account, at 5 percent interest, yielding the following: 200,000 x 1.05 = 210,000 at the end of Year 1 210,000 x 1.05 = 220,500 at the end of Year 2 220,500 x 1.05 = 231,525 at the end of Year 3 231,525 x 1.05 = 243,101 at the end of Year 4 243,101 x 1.05 = 255,256 at the end of Year 5

17. The Cost of Capital • For the investment in an X-ray machine to be desirable by these criteria, it should provide at least $55,256 in incremental revenue over the five years. • The problem is more complicated, however, because capital goods depreciate over time. • For an investment in an X-ray machine to be worthwhile, then, it must not only earn the competitive 5 percent return each year, but it also must provide enough return to cover depreciation.

18. Cost of Capital • The problem is more complicated, however, because most capital goods depreciate over time. • The clinic must earn enough not only to cover the opportunity cost from the bank, but also to maintain the value of the machine. For the investment to be worthwhile, then, it must not only earn the competitive 5 percent return each year, but it must also provide enough return to cover depreciation of the machine.

19. Cost of capital This suggests that the cost of holding this capital good for any one year, as well as over time, will equal the opportunity cost of the capital (interest foregone) plus the depreciation (deterioration of value).

20. The Demand for Health Capital • Conventional economic analysis provides a powerful conceptual apparatus by which to analyze the demand for a capital good. • The cost of capital, in terms of foregone resources (for health capital, both time and money) is a supply concept. • The other needed tool is the concept of the marginal efficiency of investment, the MEI, a demand concept which relates the return to investment to the amount of resources invested.

21. Marginal Efficiency of Investment and Rate of Return • MEI is the marginal efficiency of investment. As investment in the stock of health increases, the rate of return on additional investment declines. • If the foregone interest rate plus depreciation is r + δ0, then optimal investment is H0, which represents the amount of capital at which the marginal efficiency of investment just equals the cost of capital. Figure 7-6 Optimal Health Stock

22. Marginal Efficiency of Investment • If they considered owning two X-ray machines, they would discover that the rate of return to the second X-ray machine was probably less than the first. • To understand this, consider that a clinic buying only one X-ray machine would assign it to the highest priority uses, those with the highest rate of return. If they were to add a second X-ray machine, then logically it could only be assigned to lesser priority uses (and might be idle on occasion). Thus it would have a lower rate of return than the first. • The clinic would then purchase the second X-ray machine as well, only if its rate of return was still higher than interest plus depreciation.

23. CHANGES IN EQUILIBRIUM: AGE, WAGE, AND EDUCATIONImpact of Age on Investment in Health • As we age, our health stock depreciates faster, that is, the depreciation rate rises from δ0 to δ1 to δD. • The result of aging in this model is a continuously falling optimal level of health stock. Figure 7-6 Optimal Health Stock

24. CHANGES IN EQUILIBRIUM: AGE, WAGE, AND EDUCATIONImpact of Age on Investment in Health • Age may also shift the MEI curve to the left, because the returns from an investment will last for a shorter period of time. • This will reinforce the decrease in investment that occurs due to increased depreciation.

25. Wage Rate • As the wage rate rises, so does the return from healthy days and therefore the MEI curve shifts to the right. • It is now optimal to increase health stock from H0 to H2. Figure 7-6 Optimal Health Stock

26. Education • Education is seen as improving the efficiency of producing health which shifts the MEI curve to the right. • The optimal investment in health stock increases from H0 to H2. Figure 7-6 Optimal Health Stock

27. EMPIRICAL ANALYSES USING GROSSMAN’S MODELResults • Sickles and Yazbeck (1998) developed and estimated a structural model of health production that looks at the demand for leisure and the demand for consumption for elderly males. They find that both health care and leisure consumption tend to improve health.

28. Results • Demand for health is estimated by Gerdtham and Johannesson (1999) and their results are consistent with the theoretical predictions and show that the demand for health increases with income and education and decreases with age, urbanization, being overweight, and being single.

29. OBESITY—THE DETERIORATION OF HEALTH CAPITAL Table 7-1 Weight Status Classified by Body Mass Index

30. Table 7-2 2009 US State Obesity Rates

31. An Economic Treatment of Obesity • Yaniv, Rosin, and Tobol (2009) note that the human body needs energy to function, with food being the fuel that creates this energy. Their theory of obesity views weight gain as the outcome of a rational choice that reflects willingness to tradeoff future health for present pleasures of eating and lower physical activity.

32. An Economic Treatment of Obesity Overweight individuals can consume junk-food meals, F, and healthy meals, H. They may choose their level of exercise, x. The model defines obesity, S, as: where δ and ɛ represent calorie per meal F and H, respectively, and μ represents calories expended per instant of physical activity. BMR is the Basal Metabolic Rate, the largest source of energy expenditure.

33. An Economic Treatment of Obesity People may eat snacks when they are not hungry, so FSand M denote snacks and hunger-induced meals, respectively: When the two equations are combined, we see the following result: When junk food is substituted for a healthy option, S increases by (δ – ɛ).

34. Economic Effects of Obesity • Obesity is a bad health investment, leading to higher medical expenditures and lower earnings. Finkelstein and colleagues (2009) report that medical spending for the obese was about 42 percent higher per year when compared to someone of normal weight. • Cawley (2004) finds that heavier white females, black females, Hispanic females, and Hispanic males tend to earn less, and heavier black males tend to earn more, than their less heavy counterparts.

35. Why Has Obesity Increased? • Cutler, Glaser, and Shapiro (2003) show that there was increased caloric intake for men and women from the late 1970s to the late 1990s. Table 7-3 Changes in Food Consumption, 1977-1978 to 1994-1996

36. Why Has Obesity Increased? • The reductions in the time required to prepare food reduced the per-calorie cost of food by 29 percent from 1965 to 1995. Table 7-4 Time Costs by Demographic Group (minutes)

37. CONCLUSIONS • People benefit from health in four important ways: • They feel better when well. • They lose less time to illness, and hence can work more. • They are more productive when they work and can earn more for each hour they work. • They may live longer.

38. CONCLUSIONS • By analyzing the demand for health in this way, we recognize that the demands for health care inputs— from physicians’ services, to drugs, to therapy—are demands that are derived from the demand for health itself.