The Grossman Model

MODULE 02: LECTURE 05

LECTURE-05: The Grossman Model
REQUIRED READING:
Chapter 3 in the
BHATTACHARYA textbook
The Demand for Health
 Last time…
 Demand for health care is downward sloping
 People CHOOSE the amount of HEALTH CARE they
receive based, in part, on price

 Do people CHOOSE their own HEALTH?

 Ishealth something that happens to us?
 Or do we choose it?

 Explore this question with the GROSSMAN MODEL

Do People CHOOSE Their Own Health?
Is health something that happens to us?
 Health can be unpredictable and outside our control

Is health something that we choose?

 There are many actions that we can take to reduce the
likelihood of undesirable health outcomes
(especially in the long run)
 NOTE: A single, seemingly beneficial action can have a wide
variety of costs and consequences
Do People CHOOSE Their Own Health?
Is health something that happens to us?
 Health can be unpredictable and outside our control

Is health something that we choose?

 There are many actions that we can take to reduce the
likelihood of undesirable health outcomes
(especially in the long run)
 NOTE: A single, seemingly beneficial action can have a wide
variety of costs and consequences
Jogging will help you get in shape (and avoid heart attacks) …
but will increase your exposure to buses
… and jogging will reduce the time
that you have available for other
health-producing activities

TRADEOFFS
(finite time)
… and jogging will reduce the time
that you have available for other
activities that you enjoy

TRADEOFFS
(finite time)
… and jogging will reduce the time
that you have available for other
activities that you enjoy

TRADEOFFS
Health isn’t the only
important thing in life!
Demand for Health: THE GROSSMAN MODEL
 Developed by Michael Grossman in 1972
 Captures the complex tradeoffs involved in
health management
 Framework treats health as something people
choose in part for themselves, rather than
something that happens to them
 Provides a powerful set of explanations for a
variety of health phenomena, including the link
between socioeconomic status and health
↑ LECTURE 06
THE GROSSMAN MODEL
HEALTH PLAYS THREE IMPORTANT ROLES
THE GROSSMAN MODEL
HEALTH PLAYS THREE IMPORTANT ROLES

Health is a consumption good

Health contributes directly to an individual’s utility
Health is valuable in and of itself
THE GROSSMAN MODEL
HEALTH PLAYS THREE IMPORTANT ROLES

Health is an input into production

Better health means less time spent sick
Better health means more productive time
THE GROSSMAN MODEL
HEALTH PLAYS THREE IMPORTANT ROLES

Health is a form of capital

Health endures from period to period
Health depreciates over time
Health is a Consumption Good
Health is a Consumption Good
Single-Period Utility

Ut = U(Ht , Zt)
READ: An individual’s utility (happiness) today depends on just
two things: their health and their consumption of other goods.
Health is a Consumption Good
Single-Period Utility

Ut = U(Ht , Zt)
READ: An individual’s utility (happiness) today depends on just
two things: their health and their consumption of other goods.
Health is a Consumption Good
Single-Period Utility

Ut = U(Ht , Zt)
READ: An individual’s utility (happiness) today depends on just
two things: their health and their consumption of other goods.

Ht ≡ health
Ht ≠ health care
The purchase of health care contributes to utility only
through its effects on health
Health is a Consumption Good
Single-Period Utility

Ut = U(Ht , Zt)
READ: An individual’s utility (happiness) today depends on just
two things: their health and their consumption of other goods.

Zt ≡ "home good"
video games, chocolate chip cookies, football tickets, hanging
out with friends… and everything else
Health is a Consumption Good
Single-Period Utility

Ut = U(Ht , Zt)
TRADEOFFS:
An individual’s choices may simultaneously affect Ht and Zt
Health is a Consumption Good
Single-Period Utility

Ut = U(Ht , Zt)

↑ Zt …BUT ↓ Ht
Health is a Consumption Good
Single-Period Utility

Ut = U(Ht , Zt)

↑ Zt …AND↑ Ht
Health is an Input Into Production
Time Constraint
There are
only 24
hours in a
day

θ= T W + T Z + T H + TS

READ: An individual’s time is divided between four activities:

working, playing, improving their health, and being sick.
Health is a Consumption Good
Time Constraint
There are
only 24
hours in a
day

θ= T W + T Z + T H + TS

READ: An individual’s time is divided between four activities:

working, playing, improving their health, and being sick.
Health is a Consumption Good
Time Constraint
There are
only 24
hours in a
day

θ= T W + T Z + T H + TS

READ: An individual’s time is divided between four activities:

working, playing, improving their health, and being sick.
Health is a Consumption Good
Time Constraint
There are
only 24
hours in a
day

θ= T W + T Z + T H + TS

READ: An individual’s time is divided between four activities:

working, playing, improving their health, and being sick.
Health is a Consumption Good
Time Constraint
There are
only 24
hours in a TS depends on health (Ht)
day

θ= T W + T Z + T H + TS

READ: An individual’s time is divided between four activities:

working, playing, improving their health, and being sick.
Health is a Consumption Good
Time Constraint

θ= T W + T Z + T H + TS
INCREASING
UTILITY
Health is a Consumption Good
Time Constraint

θ= T W + T Z + T H + TS
INCREASING
UTILITY
Health is a Consumption Good
Time Constraint

θ= T W + T Z + T H + TS
INCREASING
UTILITY
Health is a Consumption Good
Time Constraint
TS depends on health (Ht)

θ= T W + T Z + T H + TS
 The Grossman Model with
↑H
TW x wage

WEDNESDAY PM
TW TH

TUESDAY
↑H
MONDAY

TZ

WEDNESDAY AM
TW x wage
TS

↑Z
TIME SICK = WASTED TIME
↑Z ↓↓H TS DOES NOT CONTRIBUTE
TO HOMER’S UTILITY
 Sick Time vs. Productive Time
There are NOT A CHOICE,
just 24 hours but a function
in a day θ = T W + T Z + TH + T S of HEALTH

Each hour an individual spends sick (TS) comes at a cost:

There is one less hour available to spend on utility-producing
activities (TP = TW + TZ + TH)

TP = - T S
The only way to increase productive time TP is to increase Ht

Health is an Input into Production

Health is an Input into Production
Sick Time vs. Productive Time
THE ILLNESS AVOIDANCE FUNCTION
THINK: Figure 3.1. Illness-avoidance
When we are healthy, function. As health (H) increases,
sick time (TS) falls. At Hmin, there is
we tend to spend less no productive time for any other
time incapacitated activities left since health is so low.

↑Ht CONCLUSION:
The only way to increase
↓TS
productive time (θ – TS)
is to improve health (Ht)

Health is an Input into Production

Sick Time vs. Productive Time
THE ILLNESS AVOIDANCE FUNCTION
Figure 3.1. Illness-avoidance
function. As health (H) increases,
sick time (TS) falls. At Hmin, there is
no productive time for any other
activities left since health is so low.
There are only 24 hours in a day

CONCLUSION:
The only way to increase
productive time (θ – TS)
is to improve health (Ht)

Health is an Input into Production

Sick Time vs. Productive Time
THE ILLNESS AVOIDANCE FUNCTION
Figure 3.1. Illness-avoidance
function. As health (H) increases,
sick time (TS) falls. At Hmin, there is
no productive time for any other
TS = 24 hours activities left since health is so low.

TS = 24 → TW = TL = TH=0
It is impossible for individual to
improve health for next period

Health is an Input into Production

Sick Time vs. Productive Time
THE HEALTH PRODUCTION CURVE
CONCLUSION:
TP = θ – TS The only way to increase
productive time (θ – TS)
is to improve health (Ht)

Figure 3.6. At low levels of

health, small improvements reap
large increases in productive time
↑TP
TP, and large drops in sick time
↑Ht TS. But the same amount of health
improvement at high levels of
health returns a much smaller
gain in TP. Thus, marginal returns
to health are diminishing.

Health is an Input into Production

Sick Time vs. Productive Time
THE HEALTH PRODUCTION CURVE
CONCLUSION:
TP = θ – TS The only way to increase
productive time (θ – TS)
is to improve health (Ht)
There are only 24 hours in a day

Figure 3.6. At low levels of

health, small improvements reap
large increases in productive time
↑TP
TP, and large drops in sick time
↑Ht TS. But the same amount of health
improvement at high levels of
health returns a much smaller
gain in TP. Thus, marginal returns
to health are diminishing.

Health is an Input into Production

Sick Time vs. Productive Time
THE HEALTH PRODUCTION CURVE
Diminishing Marginal Returns to Health:
When an individual is in poor health (low H),
a small increase in health leads to a relatively
large increase in productive time TP

Figure 3.6. At low levels of

health, small improvements reap
large increases in productive time
TP, and large drops in sick time
TS. But the same amount of health
improvement at high levels of
health returns a much smaller
gain in TP. Thus, marginal returns
to health are diminishing.

Health is an Input into Production

Sick Time vs. Productive Time
THE HEALTH PRODUCTION CURVE
Diminishing Marginal Returns to Health:
When an individual is in good health (high H),
the exact same increase in health leads to a
much smaller increase in productive time TP

Figure 3.6. At low levels of

health, small improvements reap
large increases in productive time
TP, and large drops in sick time
TS. But the same amount of health
improvement at high levels of
health returns a much smaller
gain in TP. Thus, marginal returns
to health are diminishing.

Health is an Input into Production

Health is an Input into Production
In a typical economic model of consumer behavior,
inputs to utility are purchased directly from the market

Ut = U(bananat , kalet)
Health is an Input into Production
READ: Health and the home good must be produced with a
combination of market goods and time inputs.

Ht = H(Ht-1, Tt , Mt)
H

Zt = Z(TtZ, Jt)
Health is an Input into Production
READ: Health and the home good must be produced with a
combination of market goods and time inputs.

Ht = H(Ht-1, Tt , Mt)
H market goods that promote
health (vaccines, vitamins,
treadmill, etc.)

all other market goods (video games,

Zt = Z(TtZ, Jt) football tickets, McRib sandwiches, US
Weekly, etc.)
Health is an Input into Production
READ: Health and the home good must be produced with a
combination of market goods and time inputs.

time individual spends

Ht = H(Ht-1, Tt , Mt)
H improving her health
You actually have to run on
treadmill

time individual spends engaged in

Zt = Z(TtZ, Jt) leisure activities
You actually have to eat delicious fried
chicken
Production Possibilities Frontier (PPF)

Health is an Input into Production

Production Possibilities Frontier (PPF)
Production Possibilities Frontier (PPF)
Production Possibilities Frontier (PPF)
A TYPICAL PPF
Butter Opportunity
Butter Guns Cost
A [100 guns]
B C A 936 0 ---
D
E B 891 100 45 butter
C 828 200 63 butter
F D 732 300 96 butter
E 609 400 123 butter
G F 444 500 165 butter
G 244 600 200 butter
H 0 700 244 butter
H
Guns
 A TYPICAL PPF
DOES NOT APPLY IN THE GROSSMAN MODEL

Zt = Z(TtZ, Jt)
RECALL: TS = Θ at HMIN
To produce the home
good (Z) an individual
needs productive time
• TZ
• TW → income → Jt

HMIN
Attainable Combinations of H and Z
THE PRODUCTION POSSIBILITIES FRONTIER
Figure 3.3. Points A and B are in the
free-lunch zone of this individual’s PPF
curve since C is strictly better than
both. The individual will never choose
a point left of C.
TS = Θ
NO TIME LEFT for T W, TL, or TH

At HMIN, Zt = 0

Health is an Input into Production

Attainable Combinations of H and Z
THE PRODUCTION POSSIBILITIES FRONTIER
Figure 3.3. Points A and B are in the
free-lunch zone of this individual’s PPF
curve since C is strictly better than
both. The individual will never choose
a point left of C. Combinations of health
H and the home good Z
along the frontier
(between points C and E)
are EFFICIENT

Health is an Input into Production

Attainable Combinations of H and Z
THE PRODUCTION POSSIBILITIES FRONTIER
Figure 3.3. Points A and B are in the
free-lunch zone of this individual’s PPF
curve since C is strictly better than Combinations of
both. The individual will never choose
a point left of C.
health H and the
home good Z
inside the frontier
are ATTAINABLE
BUT INEFFICIENT

Health is an Input into Production

Attainable Combinations of H and Z
THE PRODUCTION POSSIBILITIES FRONTIER
Figure 3.3. Points A and B are in the Point B or Point D are
free-lunch zone of this individual’s PPF both possibilities, but
curve since C is strictly better than
both. The individual will never choose which combination
a point left of C. (H,Z) should I choose??

Health is an Input into Production

Attainable Combinations of H and Z
THE PRODUCTION POSSIBILITIES FRONTIER
Combinations of health
Figure 3.3. Points A and B are in the H and the home good Z
free-lunch zone of this individual’s PPF
curve since C is strictly better than
beyond the frontier are
both. The individual will never choose UNATTAINABLE
a point left of C.

Health is an Input into Production

Attainable Combinations of H and Z
THE PRODUCTION POSSIBILITIES FRONTIER
Figure 3.3. Points A and B are in the
free-lunch zone of this individual’s PPF  The optimal levels of
curve since C is strictly better than health H* and the
both. The individual will never choose home good Z* are
a point left of C.
identified at the point
where the individual’s
PPF is tangent to an
Z* indifference curve

 At (H*, Z*) the

individual enjoys the
highest attainable level
of utility

H*
Health is an Input into Production
Health as a Form of Capital
Health is a Form of Capital
Health Production Function

Ht = H ((1- ϒ)Ht-1, THt, Mt)

READ: An individual’s health (today) depends on three things:
their health yesterday, time spent on health-related activities, and
their consumption of health-promoting market goods.
Health is a Form of Capital
Health Production Function

Ht = H ((1- ϒ)Ht-1, THt, Mt)

READ: An individual’s health (today) depends on three things:
their health yesterday, time spent on health-related activities, and
their consumption of health-promoting market goods.
Health is a Form of Capital
Health Production Function

Ht = H ((1- ϒ)Ht-1, THt, Mt)

READ: An individual’s health (today) depends on three things:
their health yesterday, time spent on health-related activities, and
their consumption of health-promoting market goods.
Health is a Form of Capital
Health Production Function

Ht = H ((1- ϒ)Ht-1, THt, Mt)

READ: An individual’s health (today) depends on three things:
their health yesterday, time spent on health-related activities, and
their consumption of health-promoting market goods.
Health is a Form of Capital
Multi-Period Health Production Function
depreciation rate

Ht = H ((1- ϒ)Ht-1, THt, Mt)

READ: An individual’s health (today) depends on three things:
their health yesterday, time spent on health-related activities, and
their consumption of health-promoting market goods.
Health is a Form of Capital
Multi-Period Utility Function
If health is a stock, an individual will make decisions that are right
for a lifetime, not just the current period (today).
Investments in health pay out dividends over individual’s lifetime

total utility summed over individual’s lifetime

U = U(H0 , Z0) + δ1U(H1 , Z1) + δ2U(H2 , Z2) +…+ δΩU(HΩ , ZΩ)

TODAY TOMORROW THURSDAY FINAL DAY
[Tuesday]
Individual lives
for Ω periods
Health is a Form of Capital
Multi-Period Utility Function
If health is a stock, an individual will make decisions that are right
for a lifetime, not just the current period (today).
Investments in health pay out dividends over individual’s lifetime

total utility summed over individual’s lifetime

U = U(H0 , Z0) + δ1U(H1 , Z1) + δ2U(H2 , Z2) +…+ δΩU(HΩ , ZΩ)

TODAY TOMORROW THURSDAY FINAL DAY

δ = discount factor
 individual values utility now more than utility in the future

 δ has a value between 0 and 1

The Return to Health Capital
THE MARGINAL EFFICIENCY OF HEALTH CAPITAL CURVE
THINK: If individual increases their
investment in health by just a little bit, how
much extra lifetime utility will they enjoy?
U = U(H0 , Z0) + δ1U(H1 , Z1) + δ2U(H2 , Z2)
+…+ δΩU(HΩ , ZΩ)

Figure 3.10. The marginal efficiency of

health capital curve (MEC) captures all
lifetime return from a marginal
investment in health at any given level
of health stock. That the MEC curve is
downward-sloping reflects the
diminishing marginal returns to health.

Health is a Form of Capital

The Return to Health Capital
THE MARGINAL EFFICIENCY OF HEALTH CAPITAL CURVE

The return to an
increase in health
depends on the
starting level of H
because of the
diminishing marginal
returns to health
Health is a Form of Capital
The Return to Health Capital
THE MARGINAL EFFICIENCY OF HEALTH CAPITAL CURVE
Costs of Investing in Health H
1. Opportunity cost: individual
forgoes putting her resources into
other market investment options
which pay interest rate r
2. Depreciation: health gets more
expensive as γ rises (acts as a
continual tax on health purchases)
Figure 3.11. Optimal investment in
health depends both on the
opportunity cost of foregone market
investment opportunities r and the
individual’s depreciation of health γ.
High r and γ lower the individual’s
optimal level of health

Health is a Form of Capital

The Return to Health Capital
THE MARGINAL EFFICIENCY OF HEALTH CAPITAL CURVE
Costs of Investing in Health H
1. Opportunity cost: individual
forgoes putting her resources into
other market investment options
which pay interest rate r
2. Depreciation: health gets more
expensive as γ rises (acts as a
continual tax on health purchases)
Figure 3.11. Optimal investment in
health depends both on the
opportunity cost of foregone market
investment opportunities r and the
H* individual’s depreciation of health γ.
High r and γ lower the individual’s
optimal level of health

Health is a Form of Capital

LECTURE-05: Next Steps
 Don’t forget to submit Self-Check Exercise: LECTURE-05
 Post your questions to the LECTURE-05: The Grossman
Model thread in the MODULE 02 discussion forum.
 Student participation on the Blackboard discussion
board is a significant part of this course
 It is OK to post questions about and ask for help
completing self-check exercises on the discussion board.