Optimal demand for medical and long-term care

For the population over 65, long-term care (LTC) expenditure constitutes a considerable share in health care expenditures. In this paper, we decompose health care into medical care, intended to improve one’s state of health, and personal care required for daily routine. Personal care can be either carried out autonomously or by a third party. In the course of aging, autonomous personal care is gradually substituted by LTC. We set up a life-cycle model in which individuals are subject to physiological aging, calibrate it with data from gerontology, and analyze the interplay between medical care and LTC. In comparative dynamic analyses, our theory-based approach allows us to causally investigate the impact of better health and rising life expectancy, triggered by higher income and better medical technology, on the expected expenditures for LTC in the future. We predict that a one percentage increase in life expectancy is associated with a 1.75-percentage increase in expected LTC expenditure. In terms of present value at age 20, this elasticity declines to about 1.0 percent. Even when considering different magnitudes and compositions of shocks in medical technology and income, we find that these elasticities remain remarkably stable.