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What Good Is Wealth without Health? The Effect of Health on the Marginal Utility of Consumption

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  • Finkelstein, Amy

    (Massachusetts Institute of Technology)

  • Luttmer, Erzo F. P.

    (Harvard U)

  • Notowidigdo, Matthew J.

    (Massachusetts Institute of Technology)

Abstract

We estimate how the marginal utility of consumption varies with health. To do so, we develop a simple model in which the impact of health on the marginal utility of consumption can be estimated from data on permanent income, health, and utility proxies. We estimate the model using the Health and Retirement Study’s panel data on the elderly and near-elderly, and proxy for utility with measures of subjective well-being. We find robust evidence that the marginal utility of consumption declines as health deteriorates. Our central estimate is that a one-standard¬deviation increase in the number of chronic diseases is associated with an 11 percent decline in the marginal utility of consumption relative to this marginal utility when the individual has no chronic diseases. The 95 percent confidence interval allows us to reject declines in marginal utility of less than 2 percent or more than 17 percent. Point estimates from a wide range of alternative specifications tend to lie within this confidence interval. We present some simple, illustrative calibration results that suggest that state dependence of the magnitude we estimate can have a substantial effect on important economic problems such as the optimal level of health insurance benefits and the optimal level of life-cycle savings.

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Bibliographic Info

Paper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number rwp08-036.

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Date of creation: Jun 2008
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Handle: RePEc:ecl:harjfk:rwp08-036

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