MARCO INSTITUCIONAL DE LA IED

Health, like any other durable goods, generates a flow of services. These services yield satisfaction, or what economists call utility. Your television set is another example of a durable good that generates a flow of services. It is the many hours of programming, or viewing services, that your television provides that yield utility, not the set itself. As a good, health is desired for consumption and investment purpose. From a consumption perspective, an individual desire to remain healthy because she receives utility from an overall improvement in the quality of life. In simple terms, a healthy person feels greet and thus is in a better position to enjoy life. The investment element concerns the relation between health and time. If you are in a positive state of health, you allocate less time to sickness and pursue other activities, such as leisure. Economists look at education from the same perspective. Much as a person invests in education to enhance the potential to command a higher wage, a person invests in health to increase the likelihood of having healthier days to work and generate income.

The investment element of health can be used to explain some of the lifestyle choices people make. A person who puts a high value on future events is more inclined to pursue a healthy lifestyle to increase the likelihood of enjoying healthier days than a person who put a low value on future events. A preference for the future explains why a middle-aged adult with high cholesterol orders a salad with dressing on the side instead of a steak served with a baked potato smothered in sour cream. In this situation, the utilities generated by increasing the likelihood of

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having more healthy days in the future outweigh the utility received from consuming the steak dinner. In contrast, a person who puts a much lower value on future events and prefers immediate gratification may elect to order the steak dinner and ignore the potential ill effects of high cholesterol and fatty foods.

Naturally, each individual chooses to consume that combination of goods and services, including the services produced from the stock of health that provides the most utility. The isolated relation between an individual’s stock of health and utility is captured in figure 1.3, where the quantity of health, H, is measured on the horizontal axis and the level of utility, U, is represented on the vertical axis. The positive slope of the curve indicates that an increase in a person’s stock of health directly enhances total utility. The shape of the curve is particularly important because it illustrates the fundamental economic principle of the law of diminishing marginal utility. This law states that each successive incremental improvement in health generates smaller and smaller additions to total utility. in other words, utility increases at a decreasing rate with respect to health.

Fig. 1.3: The Total Utility Curve for Health

H1

H0 H2 H3

Total Utility Utility

(U)

Health (H) U3

U2

U1

U0

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For example, in figure 1.3 an increase in health from H0 to H1 causes utility to increase from U0

to U1 while an equal increase in health from H0 to H1 generates a much smaller increase in utility, from U0 to U1. In the second case, the increase in utility is less when the stock of health is greater due to the law of diminishing marginal utility. The implication is that a person values a marginal improvement in health more when sick (i.e., when having a lower level of health) than when healthy. This does not mean that every individual derives the same level of utility from a given stock of health. It is possible for two more people to receive a different amount of utility from the same stock of health. The law of diminishing marginal utility requires only that the addition to total utility decreases with successive increases in health for a given individual.

Another way to illustrate the law of diminishing marginal utility is to focus on the marginal utility associated with each unit of health. Marginal utility equals the addition to total utility generated by each successive unit of health in mathematical terms,

MUH = >U/>H. (1.4)

Fig. 1.4: The Marginal Utility Curve for Health

Where MUH equals the marginal utility of the last unit of health consumed and > represents the change in utility of health in figure 1.4. Equation 1.4 represents the slope of a tangent line at

MU Marginal

Utility (U)

Health (H)

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each point on the total utility curve. The bowed shape of the total utility curve implies that the slope of the tangent line falls as we move along the curve, or that MUH falls as health increases.

Figure 1.4 captures the relation between marginal utility and the stock of health. The downward slope of the curve indicates that the law of diminishing marginal utility holds because each new unit of health generates less additional utility than the previous one.

SELF ASSESSMENT EXERCISE

Briefly discuss the concept of utility as it applies to health care.