For each question, please highlight the correct answer in bold and type a detailed justification for selecting that answer in the space provided below.

1. John has a 40% chance of becoming ill and having to pay $10,000 for medical care, and a 60% chance of being healthy and not having to pay anything for medical care. He is just indifferent between taking this risk and paying a $5,000 premium for health insurance that will give him exactly $10,000 for health care when he is sick. Based on this we can say that:

a) John risk averse

b) John is risk neutral

c) John is a risk lover

d) There is not enough information to say.

e) This problem has nothing to do with risk aversion.

Explain Your Answer:

2. Using the above example, John is given another option for the structure of his health insurance plan. He can choose between the plan above, or choose a high deductible plan with a deductible of $2000, and a premium of $3000. He still has a 60% chance of being healthy (assume he will have no medical expenses in this case). If he becomes ill, his plan will provide exactly $8,000, and he will contribute $2,000 from the deductible.

Leaving aside other factors, which of the two plans is most advantageous financially?

Explain Your Answer:

3. Which of the following is NOT a good reason why health care markets differ from other important markets that economists study?

a) Health care demand is highly uncertain

b) Health care prices are opaque

c) Health care has experienced dramatic technological change

d) Health care is paid for indirectly through insurance

e) Health care markets are especially vulnerable to moral hazard, behavioral hazard, and adverse selection

Explain Your Answer:

4. Which of the following statements is FALSE as a description of how co-insurance affects demand and consumption by consumers?

a) As the co-insurance rate drops, the demand curve becomes more inelastic

b) As the co-insurance rate drops, consumption increases

c) Co-insurance allows consumers to know the actual cost of the intervention

d) The lower the co-insurance rate, the greater the financial risk for consumers

Explain Your Answer:

5. Medicare enrollees can purchase prescription drug coverage through the Medicare Part D program. Prior to passage of the Affordable Care Act, the general coinsurance structure of Medicare Part D was as follows (the specific dollar amounts shown are for 2009):

a) There was an initial $295 out of pocket deductible before insurance began to pay anything.

b) Between $295 and $2700 in total costs, the coinsurance rate was 25%.

c) After $2700 in total costs, coinsurance rates increased to 100%,

d) Once out of pocket costs reached $4350, the coinsurance rate fell to 5%.

Use the above specifics of the Medicare Part D prescription drug plan and graph a senior's out of pocket expenses for prescription drugs (vertical axis) versus the total expenditures on prescription drugs (horizontal axis). Limit the x-axis to $5000.

6. Which of the following situations is NOT a (potential) example of adverse selection for individuals choosing a health insurance plan? Assume the insurance company is unaware of any of these factors.

a) An individual who has lost 25 pounds over 6 months because of abdominal pain and poor appetite

b) An individual who has smoked for 30 years, but stopped 3 months ago and has a negative nicotine screening test.

c) A woman with a genetic predisposition to breast cancer

d) An individual who has just changed jobs and must select a new health insurance plan

e) None of the above

Explain Your Answer: