Gary’s demand for doctor visits depends on his health. Half the time his health is good and his demand is D1 in the figure. When his health is poor, his demand is D2. Gary is risk averse. Without medical insurance, he pays $50 a visit. With full insurance, he pays a fixed fee at the beginning of the year, and the insurance company pays the full cost of any visit. Alternatively, with a contingent contract, Gary pays a smaller premium at the beginning of the year, and the insurance company covers only $20 per visit, with Gary paying the remaining

$30. How likely is a moral hazard problem to occur with each of these contracts? What is Gary’s risk (the variance of his medical costs) with no insurance and with each of the two types of insurance? Compare the contracts in terms of the trade-offs between risk and moral hazard.