Let's consider the health insurance market. Suppose there are two types of consumers: those with existing conditions and those without. Those with pre-existing conditions make up 10% of consume All consumers are risk-averse with utility function, U(X)=√√X. Those with pre-existing condition require medical care 50% of the time. Those without require medical care 5% of the time. Assume each consumer has an initial wealth of $1000 and medical care costs $500. If the insurance companies are allowed to sell insurance at different prices to the two types of consumers and competition forces them to charge the fair insurance premium, consumers without existing conditions ✓ insurance at a price of $ Consumers with pre-existing conditions
Let's consider the health insurance market. Suppose there are two types of consumers: those with existing conditions and those without. Those with pre-existing conditions make up 10% of consume All consumers are risk-averse with utility function, U(X)=√√X. Those with pre-existing condition require medical care 50% of the time. Those without require medical care 5% of the time. Assume each consumer has an initial wealth of $1000 and medical care costs $500. If the insurance companies are allowed to sell insurance at different prices to the two types of consumers and competition forces them to charge the fair insurance premium, consumers without existing conditions ✓ insurance at a price of $ Consumers with pre-existing conditions
Managerial Economics: A Problem Solving Approach
5th Edition
ISBN:9781337106665
Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Chapter19: The Problem Of Adverse Selection
Section: Chapter Questions
Problem 7MC
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Transcribed Image Text:Let's consider the health insurance market. Suppose there are two types of consumers: those with pre-
existing conditions and those without. Those with pre-existing conditions make up 10% of consumers.
All consumers are risk-averse with utility function, U(X)=√X. Those with pre-existing conditions
require medical care 50% of the time. Those without require medical care 5% of the time.
Assume each consumer has an initial wealth of $1000 and medical care costs $500.
If the insurance companies are allowed to sell insurance at different prices to the two types of
consumers and competition forces them to charge the fair insurance premium, consumers without pre-
existing conditions
✓ insurance at a price of $
✓. Consumers with pre-existing conditions
✓ insurance at a price of $
Now suppose the government passes a law that bans discrimination on the basis of pre-existing
conditions. In this case, the insurance companies can no longer offer insurance at two different prices
(they can only charge a single price). In this case, in equilibrium, consumers without pre-existing
conditions
insurance at a price of $
. Consumers with pre-existing conditions
✓ insurance at a price of $
Relative to before the law is passed, consumers without pre-existing conditions are
✓ off. Consumers with pre-existing conditions are
✓ off.
Transcribed Image Text:0
10
25
47.50
100
125
227.50
250
buy
don't buy
are indifferent between buying and not buying
better
neither better nor worse
worse
SL
e
of
ne
ira
le
m
a
-e
of
e the law is passed, consumers without pre-existing condit
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