On the Anatomy of Medical Progress Within an Overlapping Generations Economy

Abstract

We study medical progress within a two-sector economy of overlapping generations subject to endogenous mortality. Individuals demand health care with a view to lowering mortality over their life-cycle. We characterise the individual optimum and the general equilibrium, and study the impact of a major medical innovation leading to an improvement in the effectiveness of health care. We find that general equilibrium effects dampen strongly the increase in health care usage following medical innovation. Moreover, an increase in savings offsets the negative impact on GDP per capita of a decline in the support ratio. Finally, we show that the reallocation of resources between the final goods and health care sector, following the innovation, plays a crucial role in shaping the general equilibrium impact.