07/10/2021

CHAPTER 3
DEMAND FOR HEALTH:
THE GROSSMAN MODEL

Intro
 Previously…
 Demand for health care is downward sloping
 People choose amount of health care they receive
based on price
 People choose their health care, but do they
choose their own health?
 Ishealth something that happens to us? Or do we
choose it?
 We use the Grossman model to explore this question

Bhattacharya, Hyde and Tu – Health Economics

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07/10/2021

The 3 Roles of Health (H)

Health plays three roles in the Grossman

model:
1. A consumption good
2. An input into production

3. A form of stock/capital (an investment)

Bhattacharya, Hyde and Tu – Health Economics

Health as a consumption good

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Health as a direct input into utility

 Health as a consumption good enters directly into utility
 Single-period Utility at time t
Ut= U(Ht, Zt)
 Ht = level of health
 Zt= “home good”
◼ Everything non-health that contributes to utility
◼ E.g. video games, time with friends, movie tickets
**Note: health ≠ health care
 Health care is not explicitly in the utility function
◼ i.e. Getting vaccines does not provide utility but staying
healthy does

Health as a consumption good Bhattacharya, Hyde and Tu – Health Economics

Time constraints in the Grossman model

 In a single period, there are only 24 hours in a day

to contribute to your utility:
Θ = 24 = TW + TZ + TH + TS
 Divide total time Θ between:
 Working TW
 Playing TZ
 Improving health TH
 Being sick TS

Health as a consumption good Bhattacharya, Hyde and Tu – Health Economics

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Time constraint means time tradeoffs

 Time working TW produces income

 Buy things that contribute to utility (H, Z) but need to spend time in
those activities (TH, TZ)
 Time sick TS does not increase utility
 Every hour spent sick takes away time to do other utility-increasing
activities (loss time)

Health as a consumption good Bhattacharya, Hyde and Tu – Health Economics

The labor-leisure tradeoff

 Given levels of TS and TH,
individual chooses how to
allocate time between work
TW and play TZ.
 Optimal point decides on
indifference curves
 When health improves,
more productive time is
available for use
 Pushes time constraint
outward (from U0 to U1)
 Can reach higher utilities

Health as a consumption good Bhattacharya, Hyde and Tu – Health Economics

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Health as an input into production

The three roles of health (H)

Health plays three roles in the Grossman

model:
1. A consumption good
2. An input into production
 Of health (H)
 Of productive time (TP)
3. A form of stock/capital (an investment)

Bhattacharya, Hyde and Tu – Health Economics

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Producing H and Z
Both Health and Home good Z must be produced with
time and market inputs

Ht = H (Ht-1, TtH, Mt)

Zt = Z (TtZ, Jt)

 Mt= market inputs for health H

 Ex: weights, treadmill

 Jt= market inputs for home goods Z

 Ex: video games, opera tickets

 Today’s health Ht also depends on yesterday’s health Ht-1

 This is health’s third role as a stock which we discuss later

Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

Health affects production by lowering T S

TP= Θ – TS = TW + TZ + TH

 Healthier you are, the less time you spend sick

 TP is productive time spent on useful activities
 Increased productive time can be reinvested
into health (TH) or other useful endeavors
(TW, TZ)
 Only way to reduce sick time (TS) is to improve
health

Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

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Production Possibility Frontier

 Production Possibility Frontier An INCORRECT PPF
(PPF): the possible
combinations of H and Z
attainable, given an individual’s
Problem point
budget and time constraints

 Standard economic PPF shows

H and Z as substitutes
 Wrong! Why?

 Maximum Z is minimum H
 If individual is at minimum H,
they are dead and cannot
produce any Z

Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

PPF in the Grossman model

 Point A A CORRECT PPF
Hmin: no productive time
for work, play, or
improvement of health
 Point B
 “free-lunch zone”
 Small improvements in
health yield large
increases in productive
time; can increase Z
without giving up H

Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

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PPF in the Grossman model

 Point C A CORRECT PPF

 Maximum Z possible
 Can’t improve health
without taking away Z
 If try to increase Z by
shifting resources, sick
time will increase and
outweigh gain in
resources for Z
 Increases in health will
not produce extra time to
offset time spent
improving health

Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

PPF in the Grossman model

 Point D A CORRECT PPF
 “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
 Ignores all home goods

Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

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Choosing optimal H* and Z*

 Someone who values
both H and Z chooses a
point between C and E
in order to maximize
their utility
 Chooses point F
 U2 is unattainable given
PPF constraints
 At U0, an individual can
attain more utility
 At F: U1 and PPF are
tangent
 H* and Z* are optimal
levels of health and home
goods
Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

Exotic preferences and indifference curves

Cares only about Health H Cares only about home good Z

 If individual only cares about  If individual only cares about

Health home goods (Z)
 Horizontal indifference
 Vertical indifference curves
curves
 H* and Z* at point E
 H* and Z* at point C

Health as an input into production Bhattacharya, Hyde and Tu – Health Economics

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Health as an investment

The three roles of health (H)

Health plays three roles in the Grossman

Model:
1. A consumption good
2. An input into production
3. A form of stock/capital (an investment)

Bhattacharya, Hyde and Tu – Health Economics

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07/10/2021

Lifetime of utility

 On any day, an individual considers not only

today’s utility U(H0,Z0) but all future utility as well!

 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 = individual’s discount rate
 A person values utility now more than in the future
 Ω = individual’s lifespan (total number of periods)

Health as an investment Bhattacharya, Hyde and Tu – Health Economics

Health depreciates over time

Some of yesterday’s health lasts to today but not

all of it
Ht = H ( (1- γ)Ht-1, TtH, Mt )
 γ = rate of depreciation

 Recall:

 Ht = health at time period t

 Ht-1 = health from previous period

 TtH = time spent on health in period t

 Mt = market inputs for health (like checkups and

prescription pills)
Health as an investment Bhattacharya, Hyde and Tu – Health Economics

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MEC curve and investments in health

 Marginal Efficiency of
Capital (MEC) curve:
indicates how efficient
each unit of health capital
is in increasing lifetime
utility
 When level of H is
low, small
investments have high
returns to productive
time
Health as an investment Bhattacharya, Hyde and Tu – Health Economics

Costs to investing in health

 Opportunity cost
 Forgoes putting money into
other investments
 r = interest rate of alternative
market investment
 Depreciation due to aging (γ)
 Health must pay a return of at
least r + γ
 If return is less than
r + γ, then market return
beats health investment
return
 H* = optimal amount of health
 Marginal cost balances with
marginal benefit of health
investment

Health as an investment Bhattacharya, Hyde and Tu – Health Economics

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Predictions of the Grossman model

The Grossman model helps explain why we
observe:

1. Better health among the educated

2. Declining health among the aging

Bhattacharya, Hyde and Tu – Health Economics

Health and education

 Well-educated individuals are more efficient

producers of health
 College grads benefits more than a high
school dropout.
 Explanations?

Bhattacharya, Hyde and Tu – Health Economics

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07/10/2021

MEC and efficiency of health investment

Better educated are

more efficient at each
level of health
investment
 MECC > MECH
 H*C is higher than H*H

 MECC = college graduate

 MECH = high school
dropout
Bhattacharya, Hyde and Tu – Health Economics

Predictions of the Grossman model

The Grossman model helps explain why we
observe:

1. Better health among the educated

2. Declining health among the aging

Bhattacharya, Hyde and Tu – Health Economics

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07/10/2021

Depreciation of health
 Recall:
Ht = H ( (1- γ)Ht-1, TtH, Mt )
 Depreciation γ is not
constant
 γ increases with age
 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!

Bhattacharya, Hyde and Tu – Health Economics

Optimal death in the Grossman model

 Because of rising
depreciation, there are
better investments in the
market than the individual’s
health
 H* eventually reaches Hmin
 Why would anyone choose
Hmin?
 How is Hmin utility-
maximizing?

Bhattacharya, Hyde and Tu – Health Economics

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Conclusion

 Is health something that happens to us or is

chosen?
 Grossman model says it is chosen
 In fact, we even choose when we die

 While that may seem far-fetched, Grossman model a

useful tool for understanding the roles and tradeoffs
of health
 Next we use the Grossman model to understand
empirical findings about the relationship between
socioeconomic status and health

Bhattacharya, Hyde and Tu – Health Economics

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