Summary Chapter 1, Introduction (Mattias Fritz)




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Chapter 8. Consumer Choice and Demand (Fredrik Borg)

Applying the Standard Budget Constraint Model (p.165)


Standard indifference curve analysis of customer choice under a budget constraint describes the consumer with fairly strong assumptions.

We assume that: - The customer is rational and perfectly informed

  • There is no uncertainty about the future

  • Important decisions are made as if the future were known with certainty



The consumers Equilibrium


The indifference curves behaviour U1, U2 and U3 in figure 8.2 (p.167) represents some of a person’s possible indifference curves, and together they describe his preferences. The budget line is shown as line MN and its slope will be given by –PV/POG which is the negative of the ratio of prices. The slope of the indifference curve is called the marginal rate of substitution or MRS. It tells the rate at which a person is willing to trade other goods for physician visits.



Demand Shifters


Figure 8.3 (p.168) shows the effects of changes in prices of physician visits at constant income Y. The number of visits, V, increases because visits have become less expensive relative to other goods. Figure 8.4 plots a demand curve relating the price of visits to equilibrium quantity demanded. The data come from Figure 8,3. Point E1 in figure 8.3 corresponds to point A in figure 8.4 and E2=B and E3=C


The responsiveness of the consumer´s demand to price is measured by the price elastcity. Price elasticity, EP, is the ratio of the percentage change in quantity demanded to the percentage change in price.

Elasticity = Ep = (Q/Q)/(P/P)


A similar analysis develops the consumer´s response to changes in income. Income elasticity, EY, is the percentage change in quantity demanded divided by the percentage change in income:

Income elasticity = Ey = (Q/Q)/(Y/Y)

Two additional Demand shifters Time and Coinsurance (p.169)

The role of time


Time is an important element in the demand for health. Given the opportunity cost of time, a focus on the money cost of health care ignores a substantial portion of the economic costs. The discrepancy between the total economic costs and the money costs will be especially large for low-priced services, for services where patient copayments are small, and for patients with high opportunity costs of time.

To show the importance of taking time in consideration, assume for example that:

  • 1 hour of time is valued at $10.

  • 1 visit at the doctor is priced at $25.

  • Travel and parking costs at $5.

The full price of each visit is then $40. A money price increase of $5 now causes the new full price to be $45 at which the demand is five visits.

The full price elasticity in this case would be:

Ep = (Q/Q)/(P/P) = -(1/5,5)/(5/42.5) = -1.545

In contrast, the money price elasticity, in which the opportunity cost of time not is considered, in this case is:

Epm = -(1/5,5)/(5/27.5) = -1.00

The role of Coinsurance (p.172)


When a third party, such as an insurance company, pays a portion of one’s hospital bill, the remaining portion paid by the consumer is called the coinsurance rate I. If someone is given a health insurance policy at no charge that pays 50% of each of his bills, the coinsurance rate of r = 0,5. The market price is no longer the effective price, the effective price becomes 0.5*P1=P1’ as shown in figure 8.7.


This makes two theoretical facts clearer: insurance will increase this person’s demand for health care, and insurance will make his demand for health care less elastic.
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