RBC with Endogenous Health

Abstract: The purpose of this paper is to contribute to the limited literature on RBC models with endogenous health accumulation. To this end, we develop an infinitely lived agent model with endogenous health, productivity shocks, and health shocks. Health is conceptualized as a capital stock in accordance with the Grossman model. Unlike previous literature, we assume that investments in health are made using medical expenditures and exercise, where time spent on health-improving physical activity is separate from utility-generating leisure. The model successfully replicates key relationships observed in the data - it predicts pro-cyclical medical expenditures, counter-cyclical physical activity, and a negative correlation between health status and medical expenditures. By simulating impulse response functions, we find that the agent responds to a temporary positive shock by reallocating their resources such that more consumption or more leisure can be enjoyed, whilst holding health state constant. This is achieved by substituting between medical expenditures and exercise in the production of health, suggesting that RBC models with endogenous health accumulation should account for a more complex health production than has previously been used.