Review of the Last Lecture Began our

Review of the Last Lecture • Began our discussion of the demand for HC • Demand for HC is a derived demand (demand for HK and HS) • HS = HS(HK, ) • Began our discussion of a simplified version of the Grossman model of the demand for HK: maximize U = U(HK, NHC) subject to the CPB. • derived the optimal combination of NHC goods and HK for the utility maximizing individual • Today look at shifts in the CPB and how they affect the demand for HK 317_L 8, Jan 23, 2008, J. Schaafsma 1

Factors Influencing the CPB • The shape and position of the CPB is determined by a variety of factors => examples: education, age, salaried or paid by the hour, lifestyle, price of healthcare • drawing a specific CPB implicitly holds these factors constant • a change in any one of these factors shifts the CPB and/or changes its shape => this will yield a new equilibrium • We will look at some of these shift variables and how they affect the demand for HK 317_L 8, Jan 23, 2008, J. Schaafsma 2

Shifts in the CPB and the Demand for HK: Education • Suppose the consumer acquires more education but everything else, including the wage rate, stays constant. How will this affect the demand for HK? • KEY POINT: better educated consumer => more efficient producer of HK (healthier lifestyle, more efficient HC choices) thus spend less on HC to achieve a given HK thus more money left over for NHC goods consumption => CPB shifts up => also spend less on HC to achieve the next unit of HK • Thus the CPB will: shift up, be steeper, reach a peak at a larger HK, and have a flatter downward sloping arm ( see diagram). /// 317_L 8, Jan 23, 2008, J. Schaafsma 3

The Income and Price Effects: Education • Education ~> CPB shifts ~> income and price effects on the demand for HK • The income effect: better educated => more efficient producer => higher cons’n of NHC goods at any level of HK larger budget to allocate than before => consume more of all goods => HK is a good => more HK consumed. • The Price Effect: opportunity cost of HK (amount of NHC goods that needs to be given up for one more unit of HK) , i. e. , the price of HK in terms of NHC goods => consumer selects more HK • Note: income and price effects work in the same direction => HK 317_L 8, Jan 23, 2008, J. Schaafsma 4

The Income and Price Effects: Wage Rate • suppose hourly wage rate, w, : effect on CPB and HK? • wage rate ~> income effect => CPB shifts • the –ve slope also flattens, why? => the opportunity cost of HK since w • Thus, w ~> two opposite effects on the demand for HK -ve income effect ~> less HK +ve price effect ~> more HK • net effect: indeterminate (theory can’t predict), however, income effect likely dominates ~> HK as w . /// 317_L 8, Jan 23, 2008, J. Schaafsma 5

The Income and Price Effects: Aging • effect of aging on the demand for HK? • with aging need ever larger quantities of HC to maintain a given stock of HK ~> CPB shifts ~> -ve income effect on demand for HK • with aging ~> the opportunity cost of HK ~> -ve price effect on the demand for HK • Hence income and price effects work in the same direction ~> HK • as a person ages HK is allowed to depreciate!! 317_L 8, Jan 23, 2008, J. Schaafsma 6

Lifestyle Effects on the CPB • Assume that a person adopts a healthier lifestyle, eg. , gives up smoking • this will shift the CPB to the right, flatten the downward sloping arm, and arguably also show a higher maximum possible consumption of non-healthcare goods (DIAGRAM) => more HK and more NHC goods (income and price effects work in the same direction) • Reason for the rightward shift: each real expenditure on NHC now allows a higher HS (no money spent on a good bad for HK) • Reason for a flatter slope: a person with a healthier lifestyle likely has to give up less NHC goods for one more unit of HK than a person with an unhealthy lifestyle (don’t have to overcome effects of unhealthy lifestyle) 317_L 8, Jan 23, 2008, J. Schaafsma 7

The Income and Price Effects: HC Costs • suppose unit cost of HC , e. g. , cost of drugs • CPB shifts since at each HK, less can now be spent on NHC ~> -ve income effect on demand for HK • also, unit cost of HC ~> opportunity cost of HK ~> -ve price effect on demand for HK • income and price effects both work in the same direction ~> HK • as HC costs ~> HK . /// 317_L 8, Jan 23, 2008, J. Schaafsma 8

Time in the Grossman Model • have shown: over time ~> person ages ~> allows HK to depreciate Additional ways in which time enters the Grossman model: • accessing HC today is an investment that pays off over a number of years ~> as a person ages ~> pay-off period is reduced ~> less inclined to invest in HC • we have ignored inter-temporal choice in our model ~> discount rate ~> consumers with a high discount rate place a high value on present versus future utility ~> may engage in activities that yield utility now but are injurious to future health. • consumers with a low discount rate value future more ~> invest more in HK. /// 317_L 8, Jan 23, 2008, J. Schaafsma 9

The Demand for Healthcare • the demand function for HC vs. the demand curve for HC • movement along the demand curve vs. shifts in the demand curve 317_L 8, Jan 23, 2008, J. Schaafsma 10

Factors in the Demand for Healthcare • The demand for healthcare is driven by: i) health status, where HS = HS(HK, ) ii) income, the relevant prices, and personal factors (e. g. , tastes) • A variable may affect the demand for healthcare directly (health status is assumed to be constant) and indirectly (health status may change with the change in the variable and thus indirectly alter the demand for HC. • 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 Q of HC demanded 317_L 8, Jan 23, 2008, J. Schaafsma 11

The Demand Function for Healthcare QD = Q(Y, PHC, PNHC, HS, Z) + where: QD is the quantity of HC demanded Y is nominal income PHC is the price of healthcare PNHC is the price of non healthcare goods HS is health status 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 317_L 8, Jan 23, 2008, J. Schaafsma 12

The Net Effect of Nominal Income on the Demand for Healthcare • 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) • The indirect effect: as real income generally healthier thus need less HC (negative indirect effect) • the direct and indirect effects work in opposite directions => net effect of an increase in nominal income (in real income since prices held constant) on Q of HC demanded cannot be predicted 317_L 8, Jan 23, 2008, J. Schaafsma 13

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: 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 demanded is negative 317_L 8, Jan 23, 2008, J. Schaafsma 14