Health Economics Lecture 8 Grossman Model PDF

Health Economics Lecture 8 Dr. Pakinam Fikry  Grossman Model  People choose their health care, but do they choose their own health?  Is health something that happens to us? Or do we choose it?  The Grossman model helps us think about this question...

Health Economics Lecture 8 Dr. Pakinam Fikry  Grossman Model  People choose their health care, but do they choose their own health?  Is health something that happens to us? Or do we choose it?  The Grossman model helps us think about this question Fall 2024 2  Grossman Model  Grossman (1972) was concerned with how individuals allocate their resources to produce health.  The model goes beyond traditional demand analysis and has been extremely influential in health economics.  It utilises the idea of the individual as a producer of health (not simply a consumer) by removing the artificial separation of consumption and production.  It also introduces the idea of investing in human capital (health and education) to improve outcomes in both the market (work) and non-market (household) sectors Fall 2024 3  Grossman Model  Demand for health care is derived from demand for health (few people want health care for its own sake).  Demand for health is derived from the demand for utility (e.g. healthy days in which to participate in leisure and work).  Individuals are not passive consumers of health but active producers who spend time and money on the production of health.  Health can be seen as lasting over time periods. It depreciates (perhaps at a non-constant rate) and can therefore be analysed as a capital good. Fall 2024 4  Grossman Model  Individuals value health but do not value it above all else (if they did, they would not over-eat, smoke, drink too much, or drive too fast).  We have limited incomes with which to finance health and other activities, and neither is costless  We exert a relatively high degree of control over our health by virtue of the fact that we can influence our health-affecting consumption patterns, our health care utilisation and our environment. Fall 2024 5 Grossman Model  According to Grossman model, health plays three roles: 1. A consumption good 2. An input into production 3. A form of stock/capital (an investment) Fall 2024 6 1- Health as a consumption good  Health is inherently valuable to all of us, or in other words, health has a direct utility  Health also impacts our ability to work and make money, so it indirectly has utility through these channels. Fall 2024 7 1- Health as a consumption good  Health as a consumption good enters directly into utility:  utility at time t is made up of 2 components: Ut =U(Ht, Zt) Where, Ht = health Zt = everything else (non-health) that has utility (Home good) e.g. time with family and friends, movie tickets, clothes Fall 2024 8 1- Health as a consumption good  Note that: health doesnot exactly equal health care  Health care is not explicitly in this utility function (i.e. getting vaccines doesnot provide utility but staying healthy does) Fall 2024 9 1- Health as a consumption good  Constraints: There are only 24 hours in a day to contribute to utility: Total time (Θ) Θ=24=TW + TZ + TH + TS Divide total time between working (TW ), playing (TZ ), improving health (TH ) and being sick (TS ) Fall 2024 10 1- Health as a consumption good  Time working (TW ) It allows you to get money that helps you to buy things that contribute to utility (H, Z)  Time sick (TS ) doesnot increase utility Every hour spent sick takes away time to do other utility-increasing activities (loss of time)  Time playing (TZ ) enhances Z  Time improving health (TH ) enhances H Fall 2024 11 1- Health as a consumption good  The labor-leisure tradeoff Given levels of TS and TH , individual chooses how to allocate time between work TW and play TZ. TW U1 U0 TZ Fall 2024 12 1- Health as a consumption good Optimal point is at tangency point. More health---> More leisure and more time available for work When health improves, more productive time is available for use This pushes the time constraint outward from (U0 to U1 ) and hence higher utilities can be reached. Fall 2024 13 2- Health as an input into production  Health is an input into the production of health  Both health H and home goods Z must be produced with time and market inputs Ht = H(Ht-1 , Tt H, Mt ) Zt = Z( Tt Z, Jt ) where Mt = market inputs for health H (weights, treadmill) Jt = market inputs for home goods Z (videogames, opera tickets)  Today’s health Ht depends on yesterday’s health Ht-1 (Health as a stock). Fall 2024 14 2- Health as an input into production  Can we use the PPF to show the possible combinations of H and Z attainable given an individual’s budget and time constraints? Z H Fall 2024 15 2- Health as an input into production  No, we cannot.  It shows them as substitutes (maximum Z is minimum H)  If an individual is at minimum H (Zero health), they are dead and cannot produce Z  This means that there should be a minimum amount of health that is greater than zero Fall 2024 16 2- Health as an input into production Z C B D A E Hmin H Fall 2024 17 2- Health as an input into production  Point A: Hmin No productive time for work, play or health improvement  Point B : A small increase in health yields a large increase in total productive time and can increase Z without giving up H. Fall 2024 18 2- Health as an input into production  Point C: Maximum Z possible cannot increase health without taking away Z An increase in investment in H will not produce extra time to offset time spent improving health. If you try to increase Z by shifting resources, sick time will increase and outweigh the gain in Z Fall 2024 19 2- Health as an input into production  Point D: “Tradeoff Zone” Increases in H only yield small decreases in sick time. Increases in H takes away from Z.  Point E: Spend all time and money on health. Ignore all home goods. Fall 2024 20 2- Health as an input into production  Choosing Optimal H and Z Z C Z* F U2 U1 U0 H* H Fall 2024 21 2- Health as an input into production  Optimal H and Z Someone who values both H and Z chooses a point between C and E in order to maximize their utility. U2 is unattainable given PPF constraints At U0 , an individual can attain more utility At Point F: U1 and PPF are tangent H* and Z* are optimal levels of health and home goods. Fall 2024 22 2- Health as an input into production  What if an individual cares only about H?  What if an individual cares only about Z? Fall 2024 23 2- Health as an input into production  What if an individual cares only about health?  If that is the case, then we will have vertical indifference curves and H* and Z* will be at point E. Z U0 U U 1 2 C E Z* H Fall 2024 24 H* 2- Health as an input into production  What if an individual cares only about Z?  If that is the case, then we will have horizontal indifference curves and H* and Z* will be at point C. Z U2 C Z* U1 U0 E H Fall 2024 25 H* 2- Health as an input into production  Health is an input into the production of productive time (Tp ).  Health affects your productive time by lowering the time you spend being sick (TS ). Fall 2024 26 2- Health as an input into production  TP = Θ - TS = TW + TZ + TH  The healthier you are, the less time you spend sick (i.e. the only way to reduce sick time is to improve health).  TP is productive time spent on useful activities  Increased productive time can be reinvested into health (TH ) or other useful activities (TW , TZ ) Fall 2024 27 2- Health as an input into production  Diminishing returns: as we produce more and more health, there will be less time being sick and the additional productive time we have will be increasing at a decreasing rate. TP Hmin H Fall 2024 28 3- Health as an investment  Investment in health is similar to the idea of human capital.  Health increases the number of days available to participate in market and non- market activities.  The analysis is based on human capital theory which shows how individuals invest in themselves e.g. through training or education, to increase their productivity Fall 2024 29 3- Health as an investment  However, health capital differs from other forms of human capital.  In particular Grossman argues that a person’s stock of knowledge affects his market and nonmarket activity, while his stock of health determines the total amount of time he can spend producing money earnings and commodities Fall 2024 30 3- Health as an investment  On any day, an individual considers not only today’s utility U(H0 , Z0 ) but all future utility as well. 𝑈 = U(H0 , Z0 )+ 𝛿 U(H1 , Z1 ) +𝛿 2 U(H2 , Z2 ) + ⋯ + 𝛿 Ω U(HΩ, ZΩ) = Ω ෍ 𝛿 𝑡 U(𝐻𝑡 , 𝑍𝑡 ) 𝑡=0 Fall 2024 31 3- Health as an investment  Health is a stock, some of it carries over each new period.  Home good Z is a flow (it lasts for only 1 period)  𝛿 is individual’s discount rate (how much less weight we put on the future versus today)  Ω is the individual’s lifespan (total number of time periods). Fall 2024 32 3- Health as an investment  Some of yesterday’s health lasts to today but not all of it (as you age, you lose some of your health) 𝐻𝑡 = 𝐻( 1 − 𝛾 𝐻𝑡−1 , 𝑇𝑡𝐻 , 𝑀𝑡 ) Where, 𝛾:rate of depreciation 𝐻𝑡 : health at time period t 𝐻𝑡−1 :health from previous periods 𝑇𝑡 𝐻 : time spent on health in time period t 𝑀𝑡 : market inputs for health Fall 2024 33 3- Health as an investment  Marginal efficiency of capital curve Rate of return MEC H Hmin Fall 2024 34 3- Health as an investment  Marginal efficiency of capital curve: it measures the amount of lifetime utility for each of your investments in health.  In other words, how efficient each unit of health capital is in increasing overall lifetime utility.  When the level of health is low , small investments have high returns to productive time. Fall 2024 35 3- Health as an investment  There are two costs to that investment: 1. Opportunity Cost: (r) represented by Z forgoes putting money into other investments r= interest rate of alternative market investments Fall 2024 36 3- Health as an investment  There are two costs to that investment: 2. Depreciation due to ageing: (𝛾) Health depreciates over time  Health must pay a return at least r+ 𝛾  If return is less than r+ 𝛾, then market return beats health investment Fall 2024 37 3- Health as an investment H*: optimal amount of health (marginal cost Rate of return balances with marginal benefit of health investment) r+ 𝛾 MEC H* H Hmin Fall 2024 38 Predictions of the Grossman Model 1. Health and Education 2. Aging Fall 2024 39 1- Health and Education  Well-educated individuals are more efficient producers of health.  Hence, higher levels of education can enhance their investment in health (they can make better use of their time in addition to health care info and services available) Fall 2024 40 1- Health and Education Rate of return r+ 𝛾 MEC1 MEC H* H1* H Hmin Fall 2024 41 2- Ageing  Declining health among the ageing population.  Depreciation increases with age (𝛾), hence it is not constant.  As 𝛾 increases, costs (r+ 𝛾) increase and it takes more resources to maintain same level of health  As a result of increasing depreciation (𝛾) over time, optimal health H* also declines over time. Fall 2024 42 2- Ageing r+𝛾𝐻𝑚𝑖𝑛 Rate of return r+𝛾1 r+𝛾0 MEC Hmin H1* H0* H Fall 2024 43 To sum up  Grossman model tries to explain our daily behavior when health is an important factor.  Grossman believes that health is chosen not something that happens to us. Fall 2024 44