A patient with arthritis of the knee is planning to have a replacement. He has a

Question

A patient with arthritis of the knee is planning to have a replacement. He has applied for a loan for this surgery; the loan has an annual interest rate of 6 percent. The artificial knee can function for 10 years before it needs to be replaced. Fees for knee replacement surgery are expected to grow at 5 percent annually.

a) Why is an artificial knee a form of health capital?

b) Assume the artificial knee depreciates at a constant rate every year until the time of

replacement, which is 10 years hence. What is the cost of capital?

c) Suppose that instead of a loan, the patient plans to pay for the surgery from his or her own

savings. Assume that the bank

Explanation / Answer

a. Why is an artificial knee a form of health capital?
An artificial knee could serve as a part of body function for
several years, which is similar to capital stock that could yield
the flow of return annually in the sense that artificial knee could
help a person to work normally every day.
b. Assume the artificial knee depreciates at a constant rate
every year until the time of replacement, which is 10 years
hence. What is the cost of this capital?
As noted in this chapter, cost of capital (COC) = i+?+a, where i
indicates the cost of obtaining a dollar of capital for a period, ?
is the depreciation rate on the capital stock, and a is the
appreciate rate of a unit capital. In this case, i = 0.06, ? = 0.1, a =
0.05. Thus, COC = 0.06+0.1+0.05 = 0.21. 5
c. Suppose that instead of a loan, the patient plans to pay the
surgery from his or her own savings. Assume that the bank

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