The Demand for Health: An Empirical test of the Grossman Model Using Panel Data

Abstract

Grossman derives the demand for health from an optimal control model in which health capital is both a consumption and an investment good. In his approach, the individual chooses his level of health and therefore his life span. Initially an individual is endowed with a certain amount of health capital, which depreciates over time but can be replenished by investments like medical care, diet, exercise, etc. Therefore, the level of health is not treated as exogenous but depends on the amount of resources the individual allocates to the production of health. The production of health capital also depends on variables which modify the efficiency of the production process, therefore changing the shadow price of health capital. For example, more highly educated people are expected to be more efficient producers of health who thus face a lower price of health capital, an effect that should increase their quantity of health demanded. While the Grossman model provides a suitable theoretical framework for explaining the demand for health and the demand for medical services, it has not been too successful empirically. However, empirical tests up to this date have been exclusively based on cross section data, thus failing to take the dynamic nature of the Grossman model into account. By way of contrast, the present paper contains individual time series information not only on the utilization of medical services but also on income, wealth, work, and life style. The data come from two surveys carried out in 1981 and 1993 among members of a Swiss sick fund, with the linkage between the two waves provided by insurance records. In all, this comparatively rich data set holds the promise of permitting the Grossman model to be adequately tested for the first time.