EXAM 2 Chapter 5 Marginal utility decreases because marginal utility Utility Maximizing Rule o Each successive unit of medical care generates a smaller improvement in health than the previous unit due to the law of diminishing marginal productivity o Each increase in health in turn generates a smaller increase in utility due to the law of diminishing o Each consumer chooses the bundle of goods and services that maximizes utility o Basically states that total utility reaches its peak when the consumer receives the maximum bang for the buck in terms of marginal utility per dollar of income from each and every good o The Law of Demand o An inverse relation exists between the price and the quantity demanded of physician services o The substitution and income effects associated with a price change offer another theoretical justification of the inverse relationship between price and quantity demanded Substitution Effect A decrease in the price of physician services causes the consumer to substitute away from the relatively higher priced medical goods such as hospital outpatient services and purchase more physician services Lower priced services are substituted for higher priced ones As a result the quantity demanded of physician services increases as price decreases Income Effect A lower price also increases the real purchasing power of the consumer Because medical care is assumed to be a normal good the quantity demanded of physician services increases with the rise in purchasing power That also generates an inverse relationship between price and quantity demanded because as price falls real income increases and quantity demanded rises o The inverse relationship is sometimes referred to as the law of demand Other Economic Demand Side Factors o Income Because medical care is generally assumed to be a normal good any increase in income which represents an increase in purchasing power should cause the demand for medical services to rise o Complements When two or more goods are jointly used for consumption purposes Because the goods are consumed together an increase in the price of one good inversely influences the demand for the other Ex glasses and optometrist o Substitutes When two or more goods satisfy the same wants or provide the same characteristics The demand for one good is directly related to a change in the price of a substitute good Ex Generic and name brand drugs o Time Cost Include the monetary cost of travel such as bus fare or gasoline plus the opportunity cost of time The demand for medical care falls as time costs increase Coinsurance The consumer pays some fixed percentage of the cost of health care and the insurance carrier picks up the other portion Copayment Represents a fixed amount paid by the consumer that is independent of the market price or actual costs of medical care Like a lower coinsurance rate a reduced copayment results in a movement down the effective demand curve and typically leads to greater quantity of care demanded Deductibles When the consumer must pay out of pocket a fixed amount of health care costs per calendar year before coverage begins Once the deductible is met the insurance carrier pays all or some portion of the remaining medical bills depending on how the plan is specified From the insurance carrier s perspective the purpose is to lower costs in 2 ways o Deductible is likely to lower administrative costs because fewer small claims will be filed over the course of the year o The deductible is likely to have a negative impact on the demand for health care If patient gets sick in the early calendar years he pays his deductible allowing an opportunity to consume more medical care later Moral Hazard Refers to the situation in which consumers alter their behavior when provided with health insurance Ex health insurance may induce consumers to take fewer precautions to prevent illnesses or to shop very little for the best medical prices Noneconomic determinants of the Demand for Medical Care o Four general noneconomic factors influence the demand for medical services Tastes and Preferences Include personal characteristics such as marital status education and lifestyle which might affect how people value their healthy time or might lead to a greater preference for certain types of services There is a direct relation between educational attainment and demand more inclined for periodic doctor visits Physical and Mental Profile Considers the impact of such factors as gender race ethnicity and age on the demand for medical services State of Health Controls for the fact that sicker people demand more medical services Fuchs and Frank 2002 find an increased use of medical care both inpatient and outpatient care among Medicare recipients living in highly polluted Metropolitan areas of the US Market Demand for Medical Care The development of a market demand curve allows us to distinguish between Quality of Care the intensive and extensive margins Intensive Margin Refers to how much more or less of a product consumers buy when its price changes o o Extensive Margin Captures how many more or fewer people buy a product when its price changes Own Price Elasticity of Demand o o 1 Elastic o More substitutes means more elastic o More time to make a decision means more elastic 0 1 Inelastic Income Elasticity of Demand o o 0 Normal Good Cross Price Elasticity o o 0 Substitutes RAND Health Insurance Study 0 Inferior Good 0 Complements o Families from six sites were enrolled in various types of health insurance plans in a controlled experiment to test the impact of differences in insurance coverage on the demand for medical care o All plans cover ambulatory care dental Rx hospital preventive services psychological o Participants were randomly assigned to one of five types of health insurance plans created specifically for the experiment There were four basic types of fee for service plans One type offered free care the other three types involved varying levels of cost sharing 25 percent 50 percent or 95 percent coinsurance the percentage of medical charges that the consumer must pay The fifth type of health insurance plan was a nonprofit HMO style group cooperative Those assigned to the HMO received their care free of charge o As the level of coinsurance rises or the out of pocket price of medical care increases consumers demand o The results from the individual deductible plan illustrate the negative impact of deductibles on the less medical care consumption of