AP1. [19 points total] Insurance plan death spiral. A large employer provides insurance to employees and charges them any premium it chooses. However, the employer must try to cover the expected medical expenditures of those who it insures. The employer offers one insurance contract to all employees, and charges them an initial premium at time T = 1 equal to P = 10. After T = 1, for all subsequent periods the employer charges employees a premium that equals the average cost of the people who buy insurance in the previous year. Think about the graphical framework for adverse selection we studied in Class 6. Assume that consumer demand is characterized by: P = 25 0.8 Q and assume that marginal and average cost are characterized by: MC = 25 1.2 Q AC = 25 0.6 Q Suppose that there are 20 consumers, and that demand exceeds marginal cost there, so that: Qmax = 20 (If you like, imagine Q indexing thousands of consumers.) Recall that the welfare loss in a given year is the area below the demand curve and above the marginal cost curve, measured over the slice extending from the equilibrium quantity Q to Qmax. When these \"curves\" are linear, it is the area of a trapezoid, which you can calculate as the average willingness to pay (the average of the two levels on the demand curve) minus the average marginal cost, times Qmax Q. Note that Qmx = 20. c) [6 points: 5 numbers and 1 statement] Compute the welfare loss from adverse selection in the market for each year. Is this welfare loss increasing or decreasing over time? T=1 T=2 T=3 T=4 =5 Welfa re loss AWeIfare loss