DEMAND AND SUPPLY

Demand and Supply in the Healthcare Market



Demand and Supply in the Healthcare Market

Introduction

“Health economics is widely understood to encompass the study of the demand and supply for medical services (physician services, services provided in hospitals and independent laboratories, pharmaceuticals, etc.) and for health insurance, as well as comparative studies of different health care systems” (Currie & Gruber, 1996: 431). It also includes the study of the determinants of demand for health itself, global public health problems, and the nonmedical inputs into health, such as a decent living standard, education, physical and social environment, and personal lifestyle choices, to the extent that they are exogenous (e.g., independent of one's health status). This paper will adhere to that tradition since expenditure on medical care, insurance, and research represents such a high proportion of gross domestic product (GDP), especially in the United Kingdom, and “a proportion that is increasing in all high-income industrialized nations” (Currie & Gruber, 1996: 431). We also focus on medical care as an input into health because it provides no benefits other than its contribution to health, unlike diet, recreation, and exercise.

Medical care also differs from most other expenditures, even those that we think of as human capital investments, because much of it occurs as a result of negative shocks to health's that are largely unanticipated. “It is the combination of the degree of uncertainty about one's future health state and the high cost of medical care (relative to household budgets) that makes the transferring of risk to a third-party payer through insurance such an important phenomenon in the market for health care” (Cutler & McClellan, 2001: 11).

The Demand for Health

“It is important to clearly distinguish between health and health care. Health can be considered a form of human capital (like education), and medical care and other components of health care are inputs into the production of health” (Grossman, 1972, 225). Spending on health is more appropriately treated as an investment in a stock of health (capital) rather than an item of current consumption. The formal model of investment in health, developed by Michael Grossman, employs a marginal efficiency of health capital function (MEC), which we can think of as a quasi-demand function for health (Grossman, 1972, 223). The MEC is specific to an individual in that different people are endowed with different initial stocks of health and also suffer different shocks to their health status over time. It is downward sloping because it assumes diminishing returns to marginal inputs into the production function.

This model can easily be accommodated to incorporate risk or uncertainty. The role of uncertainty in the demand for health and health care is very important. Uncertainty about one's future state of health, uncertainty about what kind of treatment to pursue, and uncertainty about the cost of treatment all contribute to the importance of insurance, or “third-party payment” in the market for health care services. Uncertainty has implications not only for the role of insurance but also for the relationship between ...