Transcript
Chapter 8 – Demand and Supply of Health Insurance
Key Ideas
We buy insurance only if we have decreasing marginal utility. To know that marginal utility is decreasing (or increasing for that matter) requires that we be able to measure utility. This is a cardinal concept, because not only must we measure the utility, we must determine that the marginal utility is decreasing, as contrasted to simply knowing that more wealth brings more utility, an ordinal concept. This is one of the few places in microeconomics some form of cardinal utility is essential to the analysis.
We use insurance to eliminate the costs attendant to risk.
Insurance premiums relate directly to the probability of the damage.
Teaching Tips
This is one of the few places in the book where we depend on algebra for certain derivations. Without using calculus, algebra helps to demonstrate, with some rigor, the implications of competitive insurance markets. Although the algebra is simple, the logic is complex, so instructors must go through the derivations slowly.
The television show “Deal or No Deal” provides an interesting way of showing risk. It is easy to calculate the expected return, and the contestants’ choices provide indications of risk aversion (none, a little, or a lot), or, on occasion, non-rational behavior.
The insurance “worksheets” are a useful example that can take advantage of spreadsheet programs. Students may wish to recreate them on spreadsheet programs.
Students should distinguish “moral hazard” from “adverse selection.” Moral hazard involves any behavior that occurs because of contractual arrangements, here insurance. Adverse selection involves the sorting of individuals into groups, based on risk status. Students (and professionals) sometimes mix the two up.
Over the years, students have seemed intrigued by viatical insurance markets in which insurance holders “cash in” the present value of their expected death benefit. When HIV/AIDS was almost certainly fatal, patients could use the cash to alleviate their (often substantial) costs of care. Such arrangements are now also common among the elderly. Asking students whether viatical arrangements are ethical or whether the students would participate in such markets promotes a good discussion.
John Nyman views certain types of insurance as income transfers. This interpretation is omitted in the more conventional moral hazard analysis, which ignores income effects, thus ruling out income transfers.
Chapter 8 – Demand and Supply of Health Insurance - Multiple Choice
All but one of the following features characterizes desirable aspects of insurance arrangements.
the number of insured should be large, and they should be independently exposed to the potential loss.
the chance of loss should be measurable.
the insurer should be guaranteed positive economic profits.*
the losses should be accidental from the viewpoint of the person who is injured.
Coinsurance refers to:
a fixed dollar or percentage fee per treatment.*
an amount that the insured must pay out-of-pocket, before the insurer will pay.
the price of insurance to the insured.
the cost of insuring one’s family.
Consider a consumer with a medical bill of $1,000. He has a $250 deductible and a 10 percent coinsurance rate on all expenses over $250. His “out-of-pocket” liability for this bill is.
$100.
$250.
$325.*
$500.
Calculate the expected return in a game where Sam wins $1 with the probability of , $5 with the probability of , and $0 with the probability of
$0.
$.*
$.
$3
In “Deal or No Deal” what is the fair amount that one should be willing to pay for the following set of suitcases with equal probability:
$1, $5, $10,000, $20,000, $500,000
$1
$20,000
$75,000
$106,000*
In Figure 8-1 of the text, the expected wealth if the probability of illness if ¼ equals
$12,500.
$15,000.
$17,500*
$19,000
In Figure 8-1 of the text, the expected utility if the probability of illness is equals
140.
160.
180.*
200.
In Figure 8-1 of the text, the certainty level of utility if the probability of illness is equals (approximately)
140.
160.
180.
195.*
In Figure 8-1 of the text, the certainty level of utility if the probability of illness is 1. equals (approximately)
140. *
160.
180.
195.
In the accompanying diagram (above), George _____.
will purchase insurance because he wishes to avoid risk.
will not purchase insurance, because the utility function pictured indicates a constant marginal utility of wealth.*
will purchase insurance because it is not expensive.
will purchase a limited amount of insurance to avoid some risk.
In the accompanying diagram (above), George _____ purchase insurance because ______.
will purchase a limited amount of insurance to avoid some risk.
will not purchase insurance, because the utility function pictured indicates a decreasing marginal utility of wealth.
will not purchase insurance, because the utility function pictured indicates a constant marginal utility of wealth.
will not purchase insurance, because the utility function pictured indicates an increasing marginal utility of wealth.*
In the accompanying diagram (above), George _____ purchase insurance because ______.
will purchase a limited amount of insurance to avoid some risk.*
will not purchase insurance, because the utility function pictured indicates a decreasing marginal utility of wealth.
will not purchase insurance, because the utility function pictured indicates a constant marginal utility of wealth.
will not purchase insurance, because the utility function pictured indicates an increasing marginal utility of wealth.
The fundamental rule for insurance coverage is:
if one is ill, he or she doesn’t need insurance.
one should equate expected marginal benefits with expected marginal costs.*
one should equate expected average benefits with expected average costs.
one should carry as much insurance as one can afford.
In competitive long run equilibrium insurance premiums reflect the:
monopoly power of insurers.
probability of the event’s occurring, multiplied by the expected loss.*
amount that the employer negotiates.
amount mandated by the government.
Moral hazard refers to:
illegal behavior by insurers.
illegal behavior by consumers.
behavior that occurs solely because of the contractual insurance arrangement.*
consumers’ choosing particular plans based on their health statuses.
Moral hazard with respect to insurance refers to:
the insured person’s buying prescription shampoo because it is covered.
the insured person’s not using preventive care, because he/she is insured against illness.
the insured person’s getting teeth whitened because it is covered.
All three refer to moral hazard.*
Increased insurance premiums may:
cause people to buy more insurance
cause people to buy less insurance.
cause people to self-insure.
answers (b) and (c) are correct.*
If the probability of the insurable event is 0.2, and the insurer’s loading costs are 12% of the policy value, then in a competitive insurance market, each dollar of insurance will cost:
$0.10.
$0.20.
$0.26.
$0.32.*
In Figure 8-4 of the text (recreated below) suppose that Q0 = 10 visits, Q1 = 20 visits, P0 = 10, and P1 = 2. The increased expenditures due to insurance are:
$50.
$100.*
$200.
$300.
In problem (19) the consumer’s increased benefits (area under the demand cure) are:
$120.
$90.
$60.*
$30.
In problem (19) the consumer’s welfare loss is:
$100.
$60.
$40.*
$20.
In problem (19), suppose that visits were “free”, that is zero copayments. As a result quantity would be ________ visits with total expenditures of ______.
25; $250.
22.5; $225.*
220; $200.
0; $0.
In the Figure above, the decreased coinsurance rate leads to __________ total health care expenditures from _______ to _______.
increased; $8,000; $12,000.*
decreased; $12,000; $8,000.
increased ; $80; $100.
increased; $8,000; $10,000.
In the Figure above, the decreased coinsurance rate leads to a(n) ________.
deadweight loss of $20
deadweight loss of $800.
increase of 20 visits.
answers (b) and (c) are correct.*
When coinsurance is extended to a market with upward sloping supply, the welfare losses per unit increase because:
more units are sold.
more units are demanded.
resources are supplied that would not otherwise have been supplied.*
answers (b) and (c) are correct.
For an entire economy the optimal coinsurance rate balances the marginal gain from increased protection against risk against the marginal loss from increased moral hazard. Manning and Marquis find this optimal rate to be approximately ____ percent.
10.
25.
45.*
60.
(Difficult) Suppose that the demand for labor is summarized by the equation:
wD = 40 – 10 LD.
The supply of labor is summarized by the equation:
wS = 10 + 5 LS.
The equilibrium wage is ___ and the equilibrium labor force is ____:
$5; 4.
$10; 3.
$15; 3.
$20; 2*
(Difficult) Suppose that the employer in problem (27) provides an insurance benefit at a cost of $2 per hour of labor. It is worth $1 per hour to the workers. The new equilibrium gross wage (money wage + benefit) will be _________ and the new equilibrium employment will be _______.
$20 2/3; 29/15.*
$20; 2.
$19 2/3; 29/15.
$18; 3.
In Nyman’s insurance formulation:
some portion of the income transfer is welfare increasing, but there can also be moral hazard which is welfare decreasing.*
there is no income transfer
none of the insurance transfer is welfare increasing.
all of the insurance transfer is welfare increasing.
In Figure 8-10, section BZ is steeper than the original demand curve because in order for Elizabeth to purchase an insurance contract with successively lower coinsurance rates:
she must pay successively greater premiums
insurance providers must charge successively greater premiums to remain competitive.
federal laws mandate that the insurers provide this insurance.
Answers (a) and (b) are correct.*
