Question 1.
What will be the consumer and producer surplus in this market? (Note: If you round off the intermediate results, those rounding errors may be amplified in your final result. We suggest finding exact solutions.) CS: PS: Adwoa's friend tells her that 2001:A Space Odyssey is good. Adwoa is trying to decide between reading the book and watching the movie. Assume that the movie yields an immediate utility of 1 in the single period (single day) during which Adwoa watches it, and a utility of 0 thereafter. Assume that the book yields a utility of 0.1 for each of 100 periods during which she reads it, and a utility ofO thereafter. Adwoa's utility function at time t is Ut = u (ct) + 2;\" 6iu (ct), representing the fact that she discounts the utility of future consumption. First, suppose that = 0.5 and 6 = 0.92. What is Adwoa's present value of seeing the movie today? What is Adwoa's present value of reading the book, starting today? Compared to when insurers could weigh people prior to offering them a contract (in P51 1.2.2), what is the deadweight loss from this policy change? (Enter a positive number for a loss.) DWL = In order to increase fairness and equity, in 1996 lawmakers in Massachusetts enacted a requirement that insurers utilize "community rating\": they must charge everyone the same price. Consider the impact ofthis policy change. If all individuals purchase insurance, at what price would the insurer break even? p: Who will purchase insurance at this price? (Select each correct answer.) C] Normal weight individuals C] Overweight individuals C] Neither Given this, what price will insurers actually set? p: Now suppose that ' = 0.92 and 6 = 0.5. What is Adwoa's present value of seeing the movie today? What is Adwoa's present value of reading the book, starting today? Type II Diabetes is a costly and potentially debilitating disease. The total costs incurred over a lifetime by a person with Type 2 diabetes were recently estimated to be $85,000 from treating the disease directly, and complications like nerve damage, amputations, and stroke. Consider a simplified model ofthe market for health insurance, where diabetes is the only future health risk people face. Assume that there are 1,000 people classified as "normal weight" and 1,000 people classified as "ovenNeight." Normal weight people face a 20% chance of developing Type II diabetes in their lifetime, and overweight people a 30% chance. Assume an individual can expect to earn $2,000,000 over the course oftheir lifetime. Additionally, assume individuals spend all their money on consumption, and u (c) = \\/E. Ignore any intertemporal considerations of interest rates, inflation or discount factors, i.e. r = 0. What is the amount, x, that each type of individual would be willing to pay for an insurance contract that fully insures them against the lifetime costs of developing diabetes? x (normal weight) = x (overweight) = Which does she actually choose tomorrow? She is indifferent The book The movie This utility function is time inconsistent. Did this particular example actually demonstrate time inconsistency? Yes NOSuppose insurance companies may measure the weight of an individual prior to offering them an insurance contract, and price their contract based on the result. Assume the only costs the insurance company faces are payments for medical costs if a person develops diabetes, that insurance companies are risk-neutral, and that the market for providing insurance is perfectly competitive. What prices for insurance contracts will be offered? p (normal weight) = p (overweight) = Who will purchase insurance? (Select each correct answer.) C] Normal weight individuals C] Overweight individuals C] Neither Which does she plan to choose tomorrow? OShe is indifferent The book O The movieWhat is happening in this market? O Moral hazard Adverse selection Time-inconsistent preferences Loss aversion ONone of the above What will be the consumer and producer surplus in this market? CS = PS =Which will she choose today? She is indifferent O The book The movieWhat is Adwoa's present value of seeing the movie tomorrow (one period from now)? What is Adwoa's present value of reading the book, starting tomorrow (one period from now)? Which does she plan to choose tomorrow? O She is indifferent The book The movieWhich does she actually choose tomorrow? O She is indifferent The book The movie This utility function is time inconsistent. Did this particular example actually demonstrate time inconsistency? OYes ONOWhich will she choose today? She is indifferent The book The movieIn 2006, Governor Mitt Romney enacted "Romneycare,"which mandated that all individuals purchase health insurance. Assuming community rating is still in effect, what will be the price of insurance? p: What will be the consumerand producer surplus in this market? CS: Compared to when insurers could measure an individual's weight prior to offering them a contract (in PS1 1 2.2), what is the deadweight loss from this policy change? (Enter a positive number for a loss.) DWL = What is Adwoa's present value of seeing the movie tomorrow (one period from now)? What is Adwoa's present value of reading the book, starting tomorrow (one period from now)
