Lecture Health economics - Chapter 6: The demand for medical insurance. This chapter presents the following content: A theoretical model of health insurance, when theory meets the real world. | The Demand for Medical Insurance Professor Vivian Ho Health Economics Fall 2009 These slides draw from material in Santerre & Neun, Health Economics: Theories, Industries and Insights, Thomson, 2007 Topics to cover: A theoretical model of health insurance When theory meets the real world. Logic The consumer pays insurer a premium to cover medical expenses in coming year For any one consumer, the premium will be higher or lower than medical expenses But the insurer can pool or spread risk among many insurees The sum of premiums will exceed the sum of medical expenses Characterizing Risk Aversion Recall the consumer maximizes utility, with prices and income given Utility = U (health, other goods) health = h (medical care) Insurance doesn’t guarantee health, but provides $ to purchase health care We assumed diminishing marginal utility of “health” and “other goods” In addition, let’s assume diminishing marginal utility of income Utility Income Assume that we can assign a numerical “utility value” to each income level Also, assume that a healthy individual earns $40,000 per year, but only $20,000 when ill $20,000 $40,000 70 90 Income Utility Sick Healthy Utility Income $20,000 $40,000 90 70 Utility when healthy Utility when sick A B Individual doesn’t know whether she will be sick or healthy But she has a subjective probability of each event She has an expected value of her utility in the coming year Define: P0 = prob. of being healthy P1 = prob. of being sick P0 + P1 = 1 An individual’s subjective probability of illness (P1) will depend on her health stock, age, lifestyle, etc. Then without insurance, the individual’s expected utility for next year is: E(U) = P0U($40,000) + P1U($20,000) = P0•90 + P1•70 For any given values of P0 and P1, E(U) will be a point on the chord between A and B Utility Income $20,000 $40,000 70 90 A B Assume the consumer sets P1=.20 Then if she does not purchase insurance: E(U) = .80•90 + .20•70 = 86 E(Y) | The Demand for Medical Insurance Professor Vivian Ho Health Economics Fall 2009 These slides draw from material in Santerre & Neun, Health Economics: Theories, Industries and Insights, Thomson, 2007 Topics to cover: A theoretical model of health insurance When theory meets the real world. Logic The consumer pays insurer a premium to cover medical expenses in coming year For any one consumer, the premium will be higher or lower than medical expenses But the insurer can pool or spread risk among many insurees The sum of premiums will exceed the sum of medical expenses Characterizing Risk Aversion Recall the consumer maximizes utility, with prices and income given Utility = U (health, other goods) health = h (medical care) Insurance doesn’t guarantee health, but provides $ to purchase health care We assumed diminishing marginal utility of “health” and “other goods” In addition, let’s assume diminishing marginal utility of income Utility Income Assume that we can assign
