Running Head: Foundations of Health Care Economics

In most countries, health care is the most noteworthy constituent of total government expenditures. Thus, improved concern over public sector deficits has been a strong impulsion for health care reform.

It is often hard to extricate economic realities from ideological pursuits, but a further factor contributing to calls for health care reform has expected been a rise in ideology, questioning the authority and role of government in all sectors.

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This new ideology has not been the individual domain of neo-conservatives; governments of many political stripes have privatized and deregulated before government-owned industries, e.g., telecommunications, electricity, gas, broadcasting, airlines. In a number of countries, the final stages of reinventing government are resulting in re-engineering and/or partial privatization of social service systems such as education and health.

Consumers demand for health care service

The introduction of the consumers demand some 30 years ago (Grossman, 1972) was a major role to economics, and it remains a central theoretical model for the economic analysis of individual health behavior. It was built on customary neoclassical capital theory, the human capital theory developed for educational investments by Becker (1964), the theory of the share of time (Becker, 1965), and Lancaster’s new approach to consumer theory, which draws a sharp dissimilarity between fundamental objects of choice – ‘commodities’ – and market goods.

In his seminal paper, Grossman (1972) emphasized

(a) That health is a durable capital stock;

(b) that health capital differs from other forms of human capital in that its main impact is on the total amount of time a person can use producing money earnings and commodities rather than on his or her wage rate; and (c) that the demand for health care should be derived from the more basic demand for good health.

Utility functions

Utility functions depend on the probable health status, and on a vector, of activities. Health statuses are ranked in terms of healthy days, health status, and they might equivalently be thought of as being distinguished by a number of quality-adjusted healthy days, so that the ranking also takes account of quality-of-life aspects; the key requirement is that the individual is capable to make an unambiguous ranking.

The utility function is a convex combination – weighted by 0 ? y (a) ? 1 – of two components, the first being an ordinary expected utility, and the second one being (a reduced form for) a widespread expected utility.

It is significant to realize that the loss of generality that follows from the reduced form is simply in terms of the flexibility of the utility function (the restriction is qualitatively very similar to imposing, e.g. separability restrictions on a utility function).

There seems to be little theoretical loss of generality in this simplification. If for example an exogenous event – like the alarm about the mad cow disease in Britain in 1996 – simultaneously makes people more genuinely unsure and more dismal regarding the prospect of brain disease, this is captured entirely well by a simultaneous shift in the degree of indecision and in the probabilities.

On the other hand, it is clear that conventional probability-based models are intrinsically incapable of capturing uncertainty.

One may note that at this stage, the model is algebraically equivalent to a model with only risk present and with u0 occurring with probability y, but one should also note that the equivalence is upset as soon as one considers an exogenous change or behavioral implications; for instance, preventive behavior is assumed to have a known effect on the probabilities for the firm states but not on the assessment of the likelihood of uncertain states.