1. Farid Abolhassani Risk, Uncertainty and Modelling Demand 7

2. Learning Objectives After working through this chapter, you will be able to: Explain why people take out health insurance Explain why the relationship between doctor and patient could be described as an ‘agency’ type relationship Discuss possible ways of encouraging doctors to act as perfect agents Explain why taking up exercise could be considered an ‘investment in human capital’ Describe the health production model and its theoretical implications for health inequalities

3. Key Terms Agent Agent A person who acts on behalf of another (the principal). Asymmetry of information Asymmetry of information A market situation where all participants do not have access to the same level of information. Expected utility Expected utility The benefit or satisfaction that an individual anticipates getting from consuming a particular good or service. Health production function Health production function The relationship between consumption of health inputs and subsequent health status. Principal Principal A person on whose behalf an agent acts. Risk aversion Risk aversion The unwillingness of an individual to take on an identified risk.

4. Uncertainty and Insurance At the level of the individual, future health status is likely to be uncertain One cannot plan one’s future consumption of health care in the way that one could do so for commodities like food An unregulated market would respond by developing insurance mechanisms for guarantees for: some form of financial reimbursement in the event of illness loss of income compensation insuring against anxiety, pain and suffering resulting directly from illness “Health care” of “Health” insurance People are more likely to insure against larger losses which are unpredictable than against smaller losses which occur more regularly and therefore more predictably

5. Factors Influencing Individuals’ Decision to Take out Insurance risk averse The more risk averse they are the more likely they are to take out insurance Also, they are more likely to take it out if the potential loss is large – modern health care can cost vast amount so, in high income countries at least, many people take out health insurance The larger the risk of loss the more likely they are to take out insurance – so people who perceive themselves as very healthy are unlikely to take out health insurance The cheaper the premium, the more likely they are to take out the insurance Other things remaining equal, the poorer they are, the less likely they are to take out insurance because they cannot afford the premiums; however, rich people may not insure either, because any loss they could incur might be perceived as small next to their entire wealth

6. Demanding Insurance instead of Health Care Household Insurer Premium Payment

7. Asymmetry of Information agent The doctor (agent) is informed about a patient’s health and their treatment options. principal The patient (principal) is relatively uninformed about these matters and therefore has to rely on the doctor to act in their (the patient’s) best interests. their utility afterwards will be greater than without the help of the agent A person will employ the services of an agent if they believe that their utility afterwards will be greater than without the help of the agent.

8. A Perfect Agent The doctor gives the patient all the information they require and the patient makes the decision, to maximize the patient’s health (Williams 1988); The doctor gives the patient all the information but then the doctor makes the decision, to maximize the patient’s health (Culyer 1988, 1989); The doctor acts in a way that maximizes the utility of the patient (Evans 1984); The doctor acts in a way that maximizes social welfare (Mooney 1994).

9. Factor Contributing to Utility of Employing Services of an Agent Their health; Information about their health and treatments; An appropriate level of participation in the decision making process; Process utility: respect from staff, pleasant environment, etc.; Utility from non-health care consumption.

10. Factors Contributing to Doctors’ Utility Their own income (and consumption) Their own leisure time The utility of their family and friends Their professional prestige Their patients’ utility

11. The factors that would limit the doctor from acting in their own (personal) interest Relatively well informed patients Dissemination of evidence on effectiveness of medical interventions Dissemination of evidence on effectiveness of medical interventions The existence of peer review and other forms of professional regulation Publishing data on the performance of health care providers Publishing data on the performance of health care providers Their belief in a set of medical ethics Financial incentives in their contracts which encourage them to act in the interest of the patients

12. Assumptions of Health Production Model People value their health (along with other things); People produce health using health inputs; Neither health production nor other activities are without cost; Individuals have fixed incomes; There is diminishing marginal utility for health and other activities (i.e. the healthier a person becomes the less they value each additional increase in health); There is diminishing marginal product of health inputs (i.e. the more a person invests in health the less they gain from each successive input); Education increases the efficiency of health production (i.e. an educated person gets more health gain from a given health input than a less educated person).

13. How might inequalities in health be addressed? Income redistribution Subsidies of health inputs for poorer people Improving education