Consider a market for health insurance similar to the one below.
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Suppose individuals have different health levels H, where H is distributed uniformly between 0 and 9. The marginal cost of medical care depends on an individual’s health H, and is characterized by the function MC=1000+1000*H (notice that a higher value of H corresponds to a sicker person, with higher marginal costs, so the left edge of the graph corresponds to the sickest person with H=9, and the right edge of the graph corresponds to the healthiest person with H=0). Individuals are risk averse, there is a single insurance plan available for purchase (as in the Akerlof model, NOT the R-S model), and individuals have utility functions for this insurance plan that result in a risk premium equal to RP=1000*H.
Now suppose an individual insurance mandate is imposed that forces all consumers to purchase insurance or else pay a tax of $3000.
a) What will the insurance mandate do to the
b) What is the effect of the mandate on the
c) What is the smallest mandate tax penalty that will completely eliminate the deadweight loss from adverse selection in this market?
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