There are fifty low-risk people in a town and fifty high-risk ...

[kamilo84]

There are fifty low-risk people in a town and fifty high-risk people. A low-risk person has an average of 1,000 in medical expenses each year and is willing to pay 1,200 for medical insurance (this person is risk averse).
 
  A high-risk person has an average of 2,000 in medical expenses each year and is willing to pay 2,400 for medical insurance. Insurance companies are unable to tell who is high-risk and who is low-risk. a. Show that an insurance company would lose money if it offered medical insurance at a price of 1,600 b. Show that if the insurance company offered medical insurance at a price of 2,200, low-risk people would not be insured. Calculate total surplus if the price is 2,200 c. Now suppose the government in this town passes a law that requires everyone to purchase medical insurance and sets the price of insurance at 1,600 . Calculate total surplus under this law. d. The 2010 Patient Protection and Affordable Care Act (commonly called the Affordable Care Act, or Obamacare) includes an individual mandate that requires everyone to have health insurance. Does this question suggest that there is an efficiency argument in favor of the individual mandate? Defend your answer carefully.

Question 2

Torrie is thinking of starting up a small business selling hand-painted wine glasses. She is considering setting up her business as a sole proprietorship. What is one advantage to Torrie of setting up her business as a sole proprietorship?
 
  A) As a sole proprietor, Torrie would have the ability to share risk with shareholders.
  B) As a sole proprietor, Torrie would face limited liability.
  C) As a sole proprietor, Torrie would have both ownership and control over the business.
  D) All of the above would be advantages of setting up her business as a sole proprietorship.

[kilada]

Answer to Question 1

a. Low risk people would be unwilling to buy insurance if the price is above 1,200 and so only high-risk people would be insured. The insurance company would have  on average  claims of 2,000 for each of its customers, which is more than the 1,600 price.
b. Low-risk people would be unwilling to buy insurance at a price of 2,200, but high-risk people would. Total willingness to pay will be 50 x 2,400 = 120,000, total producer cost will be 50 x 2,000 = 100,000 and so total surplus will be 120,000 - 100,000 = 20,000
c. Total willingness to pay will be (50 x 1,200) + (50 x 2,400) = 180,000, total producer cost will be (50 x 1,000) + (50 x 2,000) = 150,000 and so total surplus will be 180,000 - 150,000 = 30,000
d. We have shown that total surplus is higher if everyone is required to purchase health insurance (part c) than if people can decide for themselves whether or not buy insurance (parts a and b). Given asymmetric information in the health insurance market, government intervention can be justified on efficiency grounds.

Answer to Question 2

C