Price Elasticity of Healthcare

Yesterday’s Senate rejection of the public option for healthcare is bringing the issue into sharper focus. Whether you are pro or con healthcare reform, it is an interesting topic to apply to economic theory.

When discussing price elasticity, or rather, own price elasticity of demand in healthcare we are looking for the change in demand, i.e. will people seek less or more healthcare, as the price of obtaining healthcare changes incrementally.

Now there are some externalities that affect the concept. For example, some people go to the doctor all the time because they have really great health insurance and are either very sick, or have münchausen syndrome. Others never go to the doctor unless something is falling off or they run out of blood. So removing these outliers from the argument and focusing on those utilizing essential services only (and I recognize that the in-between population is a big piece of the whole healthcare debate but for purposes of this academic exercise, please bear with me) basic economic theory indicates that when the price of a widget goes up, demand for the widget goes down. Over time as demand drops, prices will adjust downward in search of equilibrium. That type of consumer behavior would be said to have high price elasticity.

However, healthcare is not widgets and there are several clues that indicate the elasticity of healthcare. For bona-fide health issues the question is whether consumers will seek healthcare at approximately the same rate as before, regardless of change in cost. In other words, if a person is dying, will that person pay whatever price is asked for healthcare? If the answer is yes meaning the percentage change in demand does not follow a percent change in the cost then the service is price inelastic. Another clue is that inelastic products never go on sale (Tufte Chapter 3 lecture). So in the example of healthcare, I would say that healthcare is price inelastic and the demand curve would be curved due to unequal percentage changes in slope.

The elasticity of a commodity is always changing because of natural behavior of market forces. So let’s re-introduce the outlier population, those who would purchase more healthcare when it is cheaper and less when it is more expensive. What that produces is a demand curve with two inflection points and inverse elasticities at the extremes. What would the demand curve look like that included non-essential healthcare consumers in the model?


Dr. Tufte said...

Ooh Rebecca, I think you've missed the forest for the trees.

We don't have much evidence on price elasticity of healthcare because we have entire generations of people who haven't been exposed to meaningful price changes. We only get evidence for things like Lasik, and cosmetic surgery that people pay for out of pocket, and there it seems to be inelastic.

The HUGE thing that people miss though is the income elasticity, which for healthcare is close to 2. This means that it is a luxury good: when someone's income goes up by 10% their healthcare spending goes up by 20%. This is a phenomenon that has been measured in a wide variety of countries, and for several decades now.

The importance of this is that it indicates that the "problem" that we spend too much on healthcare is nothing of the sort. We spend that much because we can, and we like to. It doesn't hurt that our healthcare is also pretty effective and prolonging our lives.

So what we have is a major growth industry, fueled by our steadily improving standard of living, that some people want to rein in because our spending on it is going up.

Let me draw a parallel: this is like saying that eating out is a problem, because we are spending a lot more on it than we did a generation or two ago. That's clearly nonsense. So is worrying about the amount we spend on healthcare.

Rebecca said...

Dr. Tufte, thanks for the correction. If I am understanding your comment correctly you are saying healthcare with respect to income may not be price inelastic even though it otherwise fits the profile. Healthcare is a luxury good upon which folks spend greater amounts of disposable income on because they like it and it is beneficial.
The Review Questions at the end of Chapter 3 raise questions about price elasticity and perhaps you can help clarify.
Q1 asks “Why is the demand for business travel less elastic than that for leisure travel?” Obviously business travelers travel, with low price sensitivity, because they must do so in order to make money. But leisure travel seems to take on the same flavor of elasticity as healthcare as it relates to income. And perhaps that is the difference. As income goes up the demand for leisure travel (greater amount of disposable income) seems like it would go up as well. While I can’t derive a percentage value, intuitively it seems likely that a 1% change in income would result in a change in quantity demanded less than 1%.
Q2 states “The demand for medical services is price inelastic…” From my notes on your Chapter 3 lecture (and I get that a general rule cannot apply to all scenarios, goods or services) demand is price elastic if a 1% change in price leads to more than 1% change in quantity demanded and price inelastic if a 1% change in price leads to less than 1% change in quantity demanded. So a value of 2 would indicate healthcare is price elastic with respect to income and the book is stating the opposite. How do I justify the two positions or is this just something we deal with and accept as how we economists may hope to keep ourselves employed?