Rising Health Care Expenditures: A Demand Side Analysis

In this paper we consider a utility-maximization model for health care. On the basis of the equilibrium conditions derived for patients and the providers of the medical service, we evaluate the importance of cost-sharing between the patients and the third party and provide an explanation for the rising medical expenditures. We effectively assume that some form of third-party payer is always involved in the health care market and this involvement has significant consequences for the incentives of both consumers and providers of health care. The proposed demand specification explains why the empirical estimates of the price elasticity of demand for medical services could exhibit a wide range. We analyze how medical insurance can result in a market failure and evaluate ideas that can correct some of the distortions in resource allocation for medical services. Some guidelines also emerge for a national health insurance policy.