Economics 387

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Economics 387

• Lecture 6
• Demand for Health Capital
• Tianxu Chen

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Outline

• The Demand for Health
• LaborLeisure 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 Grossmans Model
• ObesityThe Deterioration of Health Capital
• Conclusions

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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

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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.

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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.

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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 ???

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A Schematic

• Figure 7-1 Investing in Health Care

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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)

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LABORLEISURE 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 leisure365- TH TL
  TB TW
• TB is measured toward to the right while TW
• is measured toward the left.

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LABORLEISURE TRADE-OFFSLabor-Leisure Model

• Figure 7-2 Labor-Leisure Trade-Off

• 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.

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Impact of Investments in Health

• Figure 7-3 Increased Amount of Healthy Time Due
  to Investment

• 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.

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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

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Production of Home and Health Goods

• Figure 7-5 Allocation of Production Between Heath
  and Bread

• 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.

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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.

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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?

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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

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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.

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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.

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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).

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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.

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Marginal Efficiency of Investment and Rate of
Return

• Figure 7-6 Optimal Health Stock

• 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 d0, then optimal investment is H0,
  which represents the amount of capital at which
  the marginal efficiency of investment just equals
  the cost of capital.

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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.

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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 d0 to
  d1 to dD.
• The result of aging in this model is a
  continuously falling optimal level of health
  stock.

• Figure 7-6 Optimal Health Stock

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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.

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Wage Rate

• Figure 7-6 Optimal Health Stock

• 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.

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Education

• Figure 7-6 Optimal Health Stock

• 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.

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EMPIRICAL ANALYSES USING GROSSMANS 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.

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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.

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OBESITYTHE DETERIORATION OF HEALTH CAPITAL

• Table 7-1 Weight Status Classified by Body Mass
  Index

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Table 7-2 2009 US State Obesity Rates
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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.

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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 d and ? 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.

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An Economic Treatment of Obesity

• People may eat snacks when they are not hungry,
  so FS and 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 (d ?).

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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.

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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
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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)
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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.

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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
  therapyare demands that are derived from the
  demand for health itself.