The goals of this paper are: to identify key issues concerning quality elasticity of demand in healthcare and, to identify pertinent findings from the theoretical and empirical literature on this topic.   The theoretical economics literature on quality elasticity, and the theoretical health economics literature on this topic are reviewed.   The empirical findings are surveyed and assessed.

Measuring quality elasticity in healthcare is difficult.  Quality is usually defined in terms of the characteristics of goods other than the physical units in which the goods are priced.  Nursing homes price their services in terms of patient days but provide a package of commodities and services that include medical care, social activities, and room and board.   Note that, “patient days†is a measure of quantity, and the package of commodities and services are quality characteristics.  Additionally, the number of quality characteristics may well be quite large and difficult to measure.  One study identified 383 discrete quality indicators currently in use.  Most often no single commonly accepted indicator captures all the dimensions of care quality.

As a result, empirical researchers have needed to intuitively construct techniques to measure quality elasticity.  One study models quality elasticity such that it requires no explicit specification of a quality measure.  Instead, income and quantity elasticities are first estimated, and the quality elasticity is then derived as the difference between the two.   Yet a different approach used to understand quality elasticity of demand is through the lens of the structure of production: economies of scale and average and marginal cost curves.   Here findings suggest that quality elasticity is solely a function of the economies of scale in quality regardless of the cost.

Quality elasticity of demand has also been measured by stated preference theories like contingent valuation (CV).  Because it creates a hypothetical marketplace where no actual transactions are made, CV has been successfully used for commodities that are not exchanged in regular markets, or when it is difficult to observe market transactions under the desired conditions.

Shadow prices can be derived for quality attributes.  The term “shadow price†refers to monetary values assigned to currently unknowable or difficult to calculate costs.  Informally, a shadow price can be thought of as the cost of decisions made at the margin without consideration for the total cost.   More formally, the shadow price is the Lagrange multiplier at the optimal solution in a producer efficiency model.

The authors note that economic theory does not provide an unambiguous model of quality discrimination in healthcare, but it does provide guidance for thinking about the issue.