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Understanding Health Insurance Demand

The document discusses the theory of demand for health insurance, focusing on factors that influence this demand such as risk aversion, probability of events, magnitude of loss, insurance price, and individual income. It illustrates the concept through a scenario comparing two options for managing health-related financial risk. Ultimately, it concludes that a risk-averse individual may prefer to avoid uncertainty despite having the same expected wealth from different options.

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Terecha Bekele
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15 views11 pages

Understanding Health Insurance Demand

The document discusses the theory of demand for health insurance, focusing on factors that influence this demand such as risk aversion, probability of events, magnitude of loss, insurance price, and individual income. It illustrates the concept through a scenario comparing two options for managing health-related financial risk. Ultimately, it concludes that a risk-averse individual may prefer to avoid uncertainty despite having the same expected wealth from different options.

Uploaded by

Terecha Bekele
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd

The Demand for Health Insurance

(Insurance Theory)
Session Objectives

Overview the theory of the


demand for health insurance;
Outline the factors that affect
the demand for health
insurance
The Demand for Health Insurance

When Does Risk Pooling Make


a Person Better Off ?
1. Being risk-averse
2. Diminishing marginal
Utility of Wealth
The Demand for Health Insurance

Person has 50,000 birr wealth with


– 90% chance of being healthy in a
year, and
– 10% chance of falling ill and
paying 20,000 birr
Factors Affecting the Demand for Health
Insurance

1. How risk averse the individual is


2. The probability of the event’s occurring
3. The magnitude of the loss - the higher the more
willing
4. The price of insurance - the higher the less
5. The income of the individual - At both low and
high income the marginal utility of income is
either relatively high or low, so that such
persons might prefer to self insure
DEMAND FOR HEALTH INSURANCE

 Risk aversion of individual


 Probability of event’s occurrence
 Magnitude of the loss
 Price of insurance
 Income of the individual
DEMAND FOR HEALTH INSURANCE

Total Utility

U0
U2

U1
Actual Utility
Expected Utility

U3 Wealth
W1 = 48,000
W2 = 48,000
W3 = 30,000 W0 = 50,000
The Demand for Health Insurance

Option 1: Do nothing
Option 2;
– Insure for 2,000 birr
The Demand for Health Insurance

Expected Wealth of Options:


Expected wealth of Option 1 =
48,000 birr (90%X50,000) +
10%(50,000 - 20,000)
Expected wealth of Option 2 =
48,000 birr (50,000 - 2,000)
The Demand for Health Insurance

Even though the expected


wealth is the same, a risk-
averse person chooses
option 1 for the benefit of
avoiding uncertainty
The Demand for Health Insurance

W2 = 48,000
W1 = 48,000;

Therefore:
W2 = W1

However,
U2 > U1

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