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The Theory of Demand for Health Insurance, by John A. Nyman, 2003, Stanford Economics and Finance, Stanford, California: Stanford University Press.
This book exposes a new theory of demand for health insurance. Not only is this theory really new (even radically new), but it is highly welcome as well. If this theory is taken seriously by health economists, the dialogue will be easier and more fruitful between them and physicians, policy makers, health services researchers, and even the general public. To tell it in a nutshell, this book provides a much more realistic theory of demand for health insurance than the one economists routinely use, but without dropping the core of the normative economic approach of demand.
In a way, it is an elegant solution to a long-lasting controversy opposing the welfarist conventional conception of demand for health insurance, which takes the demand for health care of the uninsured as the "true" willingness to pay for health care, on one hand, and the extra-welfarist approach, which takes the guidelines written by medical experts as the "norm" of health-care consumption, on the other hand.
Not only is the solution elegant, it is well written and the author provides several examples to illustrate the theoretical considerations, which helps the reader to understand the key concepts.
What does the new theory have to say?
First, consumers do not demand (health) insurance in order to reduce financial uncertainty; the conventional theory assumes that, due to the concavity of the utility of wealth, individuals always prefer a certain financial loss to an uncertain one of the same expected magnitude. An abundant literature has shown, however, that this assumption is contradicted by empirical results (in experiments, individuals prefer uncertain losses) and yields paradoxical results. Here, Pr. Nyman uses a result (due to Rabin, 2000; Rabin and Thaler, 2001), which is not specific to health insurance, but applies to attitudes toward risk in general: there is no link between the shape of the utility function of wealth and the attitude toward risk.
Second, consumers demand (health) insurance because they exhibit a concave utility of wealth, even if this concavity is not related to risk aversion. To understand the crux of the idea, it is useful to decompose it in sequence: when...