Demand for Health

Demand for Health and the Grossman Model

Demand for health explains why people devote money, time and other resources to maintaining or improving their health. The framework distinguishes the health a person values from the healthcare and other inputs used to produce it, and its canonical formal statement is the Grossman model, in which health is a form of human capital demanded for both consumption and investment reasons. Health in this framework is a stock that depreciates over time and can be built up through investment, and the model yields testable predictions about how age, wages, education and prices affect the demand for both health and medical care.

Health is valued differently from healthcare

People generally value health because it contributes directly to wellbeing and increases the time available for work, family life and other activities. Healthcare is therefore one possible input into producing or protecting health, distinct from health itself. The demand for healthcare can consequently be described as derived from the underlying demand for health.

• Health is the outcome or stock that individuals value.
• Healthcare is one input that may help maintain, restore or improve health.
• Personal time and behaviour can also contribute to health through activities such as exercise, rest, preventive action and treatment adherence.
• Social and environmental conditions affect health even when they are not chosen or controlled by the individual.
• Healthcare utilisation records services used, but it does not reveal the complete demand for health.

This distinction matters because greater healthcare use does not automatically mean that a person desires health more strongly. Use also depends on need, access, insurance, prices, provider recommendations, available time and the productivity of the care received.

Health as a durable stock

The Grossman framework represents health as a durable capital stock that produces healthy time. Individuals inherit an initial stock of health, which depreciates at a rate the model takes as given but which rises with age, at least after some stage of the life cycle. Investment can offset some or all of that deterioration, although the relationship between inputs and health outcomes is uncertain in practice.

A simplified health-stock equation is shown below.

$$H_{t+1} = (1-\delta_t)H_t + I_t$$

The terms are defined as follows.

• $H_t$ is the health stock at the beginning of period $t$.
• $\delta_t$ is the proportion of the health stock that depreciates during the period.
• $I_t$ is gross investment in health during the period.
• $H_{t+1}$ is the health stock carried into the next period.

Health investment can be represented as a production process, written as follows.

$$I_t = f(M_t, T_t, B_t; E_t)$$

The inputs to this production function are defined as follows.

• $M_t$ represents medical-care and other purchased inputs.
• $T_t$ represents personal time devoted to producing health.
• $B_t$ represents health-related behaviours and other relevant inputs.
• $E_t$ represents factors affecting production efficiency, such as knowledge or education.

Grossman's own specification contains only purchased goods and own time as inputs, with the stock of knowledge (measured mainly by years of schooling) shifting the efficiency of production; behaviours are shown separately here for clarity. These equations are analytical simplifications. Health cannot usually be observed as a single physical stock, depreciation is not directly measurable, and the same healthcare input may produce different outcomes for different people.

How individuals choose a health investment

The framework treats health investment as a choice made under limited money and time. An individual compares the additional value expected from better health with the additional cost of producing it. The economically desired health stock occurs where further investment is no longer expected to provide benefits sufficient to justify its full cost.

Grossman gives two reasons for demanding health. As a consumption commodity, health enters the utility function directly, so sick days are a source of disutility. As an investment commodity, health determines the total time available for market and non-market activities, and the value of the reduction in time lost to illness is the return on the investment. Grossman analyses a pure investment version and a pure consumption version of the model because some of their predictions differ. The full cost of health capital, which Grossman calls its shadow price, depends on much more than the price of medical care. It rises with age if the depreciation rate rises over the life cycle and falls with education if more educated people are more efficient producers of health.

An additional health investment can bring several expected benefits.

• Better health can directly improve an individual's wellbeing.
• Better health can increase the number of healthy days available for paid work and other activities.
• Better health can reduce future illness time or other health-related losses.

The relevant costs may include several elements.

• Healthcare prices and other financial expenditure.
• Time spent obtaining care, exercising or undertaking other health-producing activities.
• Income or valued activities forgone while time is used to produce health.
• The effect of health depreciation on the resources required merely to maintain the existing stock.
• Uncertainty about whether an investment will improve health.

The model therefore does not predict that individuals pursue perfect health regardless of cost. It predicts that desired health and investment depend on the expected marginal benefits, production costs, available resources and constraints facing the individual.

Factors that can change demand for health

The demand-for-health framework helps organise how economic and personal circumstances may affect desired health investment. These effects are not mechanical empirical laws; their direction and magnitude depend on how the factor changes benefits, costs, constraints or the productivity of health production. The age, wage, education and wealth rows follow Grossman's own comparative statics; the others extend the same logic.

Worked health-stock example

A simple calculation shows how investment and depreciation interact, but it does not determine whether the investment is optimal. Suppose an illustrative health stock begins at 100 units, 8% depreciates during the year and health-producing activities add 12 units.

$$H_{t+1} = (1-0.08)(100) + 12$$ $$H_{t+1} = 92 + 12 = 104$$

The health stock rises from 100 to 104 illustrative units. If investment had been only 5 units, the resulting stock would have been 97 units, as shown below.

$$H_{t+1} = 92 + 5 = 97$$

Holding the stock at 100 units requires gross investment of 8 units, exactly equal to depreciation. If the depreciation rate rises to 12%, as it might later in life, the same 12 units of investment only maintain the stock, as the next equation shows.

$$H_{t+1} = (1-0.12)(100) + 12 = 88 + 12 = 100$$

The calculation shows the stock transition, not whether 12 units of investment represent the best choice. That judgement would also require the financial and time costs of the investment, the value of the resulting health and the available alternatives. The last step also shows why the model predicts more gross investment, and more medical care, alongside a lower health stock as depreciation rises with age.

What the framework helps explain

Demand for health provides a theoretical connection between health outcomes, healthcare use, personal behaviour and economic constraints. It is especially useful for explaining why healthcare is a means of producing health rather than the final objective of the individual. The framework can also guide hypotheses for empirical research, although observed associations do not automatically identify the causal mechanisms proposed by the model.

The framework has several applications.

• Analysing preventive care and other investments intended to protect future health.
• Examining how age, education, wages, prices and insurance may influence health-related choices.
• Distinguishing the demand for health from the observed use of healthcare services.
• Studying how time and purchased inputs combine in the production of health.
• Exploring the relationship between health, healthy time and labour-market participation.

Empirical tensions and later extensions of the Grossman model

The model's predictions have been tested against survey data since the early 1970s, and several findings sit uneasily with its simplest form. Grossman's own estimates, using a nationally representative United States survey from 1963, found that education and the wage rate had positive and significant effects on health, and that age reduced health while raising medical spending, as the pure investment version predicts. In the same data the wage coefficient in the medical care equation was negative but not significant, and ordinary least squares estimates of the health production function gave negative elasticities of health with respect to medical care, which Grossman attributes to the strong positive relation between medical care and the depreciation rate.

The negative association between good health and medical care use is the best-known tension. Healthy people seldom visit doctors, yet in the canonical model a larger desired health stock raises the demand for health inputs, and a structural study of Danish survey data that found a negative and highly significant coefficient on good health in the demand for physician visits was later used by critics to reject the approach. Grossman's reply is that treating health as exogenous in such an equation biases its coefficient downward, because unobserved depreciation raises medical care use and lowers health at the same time, and that omitting non-medical inputs can produce the same result.

Later theoretical work identifies further limitations of the health-capital literature. In its standard solution the optimal health stock does not depend on initial health or on the history of investment, so the model has no memory of early-life conditions. With a constant depreciation rate it implies that complete repair of health, and therefore an unlimited lifespan, is possible. It also has difficulty explaining why health deteriorates faster in lower socio-economic groups. A related technical problem is that when health production is linear in investment and investment is produced with constant returns to scale, the first-order conditions do not determine optimal investment. A generalised version with decreasing returns to investment and endogenous longevity has been proposed as a way of addressing these limitations while keeping the human capital structure.

Important limitations

The demand-for-health framework is influential, but it is a simplified model of individual choice rather than a complete description of how health is produced. Real decisions are shaped by uncertainty, information gaps, clinical need, provider agency, behavioural influences and constraints that individuals may not be able to overcome. The model should therefore be used as an analytical framework, not as evidence that all observed health differences result from voluntary choices.

Several limitations stand out.

• Health status and health capital are difficult to measure as a single stock.
• Individuals may not know how particular inputs will affect their future health; the original model rules out uncertainty, which later extensions introduce.
• Acute illness, disability and inherited conditions may sharply restrict meaningful choice.
• Clinicians and healthcare institutions influence utilisation through diagnosis, recommendations and service availability.
• Present bias, habits and limited attention may conflict with the model's assumption of forward-looking optimisation.
• Income, working conditions, housing, discrimination, geography and public policy constrain the opportunities available for producing health.
• The framework can describe individual incentives without determining how resources ought to be distributed or whether resulting inequalities are equitable.

Demand for health is therefore most useful when combined with evidence about healthcare access, health production, uncertainty, provider behaviour and the wider social determinants of health.

Sources

• Grossman, M. (1972). On the concept of health capital and the demand for health. Journal of Political Economy, 80(2), 223-255. https://doi.org/10.1086/259880
• Grossman, M. (2000). The human capital model. In A. J. Culyer and J. P. Newhouse (eds), Handbook of Health Economics, Volume 1, Chapter 7, pp. 347-408. Amsterdam: Elsevier. https://doi.org/10.1016/S1574-0064(00)80166-3
• Galama, T. J. (2015). A contribution to health-capital theory. Human Capital and Economic Opportunity Global Working Group, Working Paper No. 2015-008. University of Chicago.