Economics - General

The origins of the Grossman ‘Demand for Health’ model

Michael Grossman’s “Demand for Health” model turns 50 this year. To celebrate, Dr. Grossman himself provided some reflections in an article in Health Economics this month. He notes that the ‘Grossman model’ relies on two fundamental concepts: (i) health–not health care–enters into the utility function; health care services are chosen by individuals but these are only inputs where a production function translates health care goods and services into the actual health people care about, and (ii) health is a stock, similar to a capital stock which may depreciates over time or may improve over time.

Some interesting comments from Grossman include some of the feedback he got from Gary Becker:

[Gary Becker’s] main comment was that the paper ignored that what people demand when they purchase medical care services are not these services per se but rather good health. The latter item enters the utility functions of consumers, and medical care is only one of many inputs into its production. He proceeded to specify a demand function for health whose arguments included the prices of health inputs, the efficiency of the production process as reflected by the number of years of formal schooling completed by the consumer, and income or more precisely, the exogenous components of income. 

In addition, Grossman comments on the logic behind treating health as a stock.

My second building block, also due to Gary, is the theory of investment in human capital (Becker, 1964). Health, like knowledge, is a durable capital stock, and both may be viewed as components of the stock of human capital. Consumers have incentives to invest in this stock in the present because it increases their earnings in the future. In his 1965 paper, Gary points out that investment in human capital is a prominent use of a portion of the time allocated to nonmarket or household production. I proceeded to pursue a distinction between the returns to an investment in knowledge and the returns to an investment in health that Gary suggested to me. Specifically, investments in knowledge raise wage rates while investments in health raise the total amount of time available for market and household production in a given year and may prolong length of life.

The paper goes on to ask questions about whether increased schooling decreases the cost of acquiring more health, whether one should treat schooling as optimal, and what assumptions would be necessary to estimate an “optimal” life span under the Grossman model. Do read the whole article as it not only explains the origin story of the Grossman model but also some of its limitations.

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