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Demand for Health Care

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Outline • Demand & purpose of demand analysis• Need, want & demand• Michel Grossman model of demand for health• Factors affecting demand for health• Distinctive characteristics of health sector• Law of demand, demand schedule & curve• Economic factors that affect demand for health• Equilibrium of demand & supply• Elasticity of demand• Factors affecting elasticity of demand• Elastic & inelastic demand curves

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Demand • Demand describes the behavior of consumers. It

does not mean the desire to obtain something (Health care)

• The hungry man who can not pay for food has no demand for it

• An individual’s demand for a good is the various quantities of goods & services that the consumer is willing and able to buy at each specific price

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Demand for health care

• The major purpose of demand analysis for medical care is to determine those factors which on the average, most affect a persons utilization of medical services

• Demand analysis seeks to identify which factors are most influential in determining how much care people are willing to purchase

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Need Vs. want

• A need is something that is necessary for humans to live a healthy life.

• Needs are distinguished from wants because a deficiency would cause a clear negative outcome, such as dysfunction or death.

• In economics, a want is something that is desired. • It is said that people have unlimited wants, but

limited resources. • Thus, people cannot have everything they want and

must look for the best alternatives which they can afford.

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Need versus demand

Need Demand

Someone's subjective idea (may be based on a formula applied objectively, but the choice to use the formula was someone's subjective idea. Money is not a factor.

Objectively observable as behavior in the market. Money is a key factor. "Demand" is also called "effective demand," because it's expressed only by spending money.

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Need versus demand…

• Health plans that focus on need and ignore demand will face under- or over-utilization of service capacity

• If one believes quantity demanded is too little or too much (e.g. under-use or over-use of emergency room) relative to need, then quantity demanded must be manipulated by changing, – price or other costs to buyer, or – demand through marketing or de-marketing

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A model of demand for medical care

• Consumer purchase goods and services for the utility

• If the commodity demanded by consumers is good health, then health can be produced by goods and services purchased in the market as well as by the time devoted to preventive measures

• Demand for medical care is derived from the more basic demand for health

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A model of demand for medical care…

• According to Michel Grossman, consumers have a demand for health for two reasons:

– Health is a consumption commodity—it makes the consumer feel better

– Health is an investment commodity—a state of health will determine the amount of time available to the consumer for productivity

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Grossman’s demand model

Individual/client factors [age, sex, education, occupation]

Environmental factors(physical, economic, social, cultural)

Health care resources factorsE.g. supply, access,acceptability

Prepayment factorsE.g. private insurance, tax based healthInsurance, national health system, Out of pocket payment

Demand

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Grossman’s demand model… According to this model every one inherits a

stock of health when born

• Health depreciated overtime, however an investment is required to sustain health

• As peoples’ age advances there is an increase in rate of illness and in the utilization of health services.

• The stock of health can be sustained by investment to maintain health., such as use of health services and health promoting activities

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Grossman’s demand model…

• A view of medical care demand being derived from the demand for health implies the following:– increase in age result in an increase in the

rate at which the person’s stock of health depreciates

– Over the life cycle people will attempt to offset part of the increased rate of depreciation in their stock of health by increasing their expenditure on health

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– the demand for medical care will increase with increases in person’s income

– education may have a negative effect on the demand for health care, because more highly educated people are presumed to be more efficient in producing health

Grossman’s demand model…

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Distinctive characteristics of health sector

– Consumer ignorance

– Non-profit motive

– Large components of personal service

– Restrictions on competition

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Distinctive characteristics of health sector…

– The uneven and unpredictable incidence of illness

– External effects e.g. Herd immunity

– Mixture of consumption and investment elements

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Deriving a Demand Curve for institutional Visits

• Downward sloping demand curve for the visits

Price

P1

P0

q0q1

• Price changes lead to movements along D curve

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Other Economic Factors Affecting Demand

• The demand curve illustrates the effect of changes in the price of the good on quantity demanded holding all other factors (income, prices of other goods) constant.

• Changes in factors other than the price of the good itself lead to shifts in the demand curve.

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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

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Other Economic Factors Affecting Demand…

• e.g. laser printers and toner cartridges• e.g. sugar and milk?• e.g. contact lenses and optometrist visits

2. Complements - 2 or more goods which are consumed together

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Other Economic Factors Affecting Demand…

• e.g. contact lenses and optometrist visits• If contact lenses become cheaper, demand for

optometrist visits will increase

2. Complements

Price

D0D1

Optometrist Visits

Price of complement falls

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Other Economic Factors Affecting Demand…

• e.g. Doctor and Health Officer?• Generic and brand name drugs• Private and public hospitals

3. Substitutes - other goods which satisfy the same wants, or provide same characteristics

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Other Economic Factors Affecting Demand…

• e.g. generic and brand name drugs• If generic drugs in price, D for brand name will decrease

3. Substitutes - other goods which satisfy the same wants, or provide same characteristics

Price

D1D0

Brand name drugs

Demand for brand name drug falls

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Equilibrium of supply and demand

• Market equilibrium occurs when two economic variables [supply and demand] are in balance

• The market equilibrium comes at that price and quantity where supply and demand forces are in balance

• At such a price the quantity and amount that buyers wish to buy is just equal to the amount that sellers wish to sell

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Equilibrium of supply and demand…

• At the equilibrium, price and quantity tend to stay same as long as other things remain equal

• Equilibrium price and quantity come at that level where the amount willingly supplied equals the amount willingly demanded.

• In a competitive market, this equilibrium is found at the intersection of supply and demand curves.

• No shortages or no surplus are found at equilibrium price.

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Equilibrium of demand and supply

S

D

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Elasticity

• In economics elasticity refers to the ratio of the relative change in a dependent variable to the relative change in an independent variable.

• A change in any of the demand factors will cause a change in quantity purchased of a good per time period.

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Factors affecting elasticity of demand

• Price change• Availability & price of substitutes• Availability & price of complements• Income change• Nature of commodity • Multiple uses• Deferred consumption• Position of the commodity in consumers budget

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Elasticity of demand in heath care

• Demand may be affected by factors determined by the consumer, the provider, the supply or location of services

• Elasticity of demand relates quantity demanded to the price of the goods or services

• Cost to the consumer is a factor in choosing to purchase goods or services

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Elasticity

Price

# Visits

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

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Price

# Visits

In this case demand is considered to be relatively “elastic” with respect to a change in price

Elasticity…

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Price

# Visits

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

Elasticity…

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Price

# Visits

In this case demand is considered to be relatively “inelastic” relative to a change in price

Elasticity…

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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

EQP

change in quan tity dem andedchange in p riceD

D %%

%%

Elasticity…

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• ED is expected to be negative. Thus, price elasticities of demand are often quoted in terms of absolute value

• The demand curve is inelastic if

• 0<|ED|<1

• The demand curve is elastic if

1<|ED|<

Elasticity…

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• If you are given a formula for a demand curve, you can compute the elasticity of demand for any combination of price and quantity along that demand curve

%%

QP

QQ

PP

QP

PQ

D

Elasticity...

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• 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

%

%

%

%

Elasticity…

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Total revenue will increase if price is raised when demand is inelastic

•Price elasticity of demand is critical for determining a health care manager’s total revenue TR = PQ D

• Demand theory tells us that P QD

If demand for physician services is inelastic, and

if the price is raised, then I %QD I < I %P I

Elasticity…

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Insurance

The above demand analysis assumed that the patient pays for care out-of-pocket

How does insurance affect the demand for care?

1. Coinsurance - Patient pays only a fixed % of the cost of each visit (often C = .20)

e.g. If the visit costs $100 : patient pays $20, insurance pays $80

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Insurance…

• No insurance : consumer faces price P, makes q visits

Price

P

cP

qcq # Visits

• With coinsurance : consumer faces price cP, wants to make qc visits

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Insurance…

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

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Indemnity Insurance– Insurer pays a fixed amount for each

purchased service• Insurer pays $150 for each overnight hospital

stay, and patient pays the rest

Price

Visits

D0

D1

$150

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Estimating Demand for Medical Care

• Quantity demanded will be affected by:– out-of-pocket price– real income– time costs– prices of substitutes and complements– tastes and preferences– state of health– quality of care

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Empirical Evidence • Demand for primary care services

(prevention, early detection, & treatment of disease) has been found to be price inelastic– Estimates tend to be in the -.1 to -.7 range– A 10% in the out-of-pocket price of

hospital or physician services leads to a 1 to 7% decrease in quantity demanded

– Ceteris paribus, total expenditures on hospital and physician services increase with a greater out-of-pocket price

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Empirical Evidence…• Demand for other types of medical care

is slightly more price elastic than demand for primary care

• Consumers should be more price sensitive as the portion of the bill paid out of pocket increases

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Out-of-Pocket Payments in the U.S.

Hypothesis: Consumers are more price sensitive if they pay a larger % of the health care bill

The fall in the % of out-of-pocket payments may explain the rapid rise in health care costs

1960 1980 1990 2003National health expenditures ($b) $26.9 $247.3 $699.5 $1,678.9% out of pocket 48.7% 24.4% 20.6% 13.7%

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Total Expenditures and % Paid Out-of-Pocket, 2003

Out-of-Pocket Payments…

$bHospital care $515.90 3.2%Physician & Clinical Services 369.7 10.2%Dentist Service 74.3 44.2%Prescription Drugs 179.2 29.7%Nursing Home Care 110.8 27.9%

Hypothesis: Consumers are more price sensitive if they pay a larger % of the health care bill

Higher hospital and physician expenditures may be due to the low % paid out-of-pocket

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Empirical Evidence• At the individual level, the income

elasticity of demand for medical services is below +1.0

• The travel time elasticity of demand is almost as large as the price elasticity of demand

• Little consensus on whether hospital care and ambulatory physician services are substitutes or complements

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Applying Demand Theory to Real Data

• Demand analyses in health care must take Demand analyses in health care must take insurance/ exemption into accountinsurance/ exemption into account

• Demand analyses are critical in shaping Demand analyses are critical in shaping managerial and public policy decisionsmanagerial and public policy decisions

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The end!