Discuss the below:
Question 1
Two types of drivers: half are slow riders (1% chance of an accident) and half are speed racers (5% chance)
Cost of accident: $12,000
a) If insurers have full information about drivers' types, what actuarially fair price will they charge each type? Is the market outcome efficient?
Now suppose there is asymmetric information: insurers do not know drivers' types and therefore must charge a single price to all drivers.
b) At what price do insurers break even?
c) How do the two types of drivers respond to this price? Does insurer break even?
The utility functions are:
For the more risk averse: U = ln(C)
For the less risk averse: U = C1/2
Question 2
Your utility function is U = ln(2C) where C is the amount of consumption you have in any given period. Your income is $40,000 per year and there is a 2% chance that you will be involved in a catastrophic accident that will cost you $30,000 next year.
a. What is your expected utility?
b. Calculate an actuarially fair insurance premium. What would your expected utility be were you to purchase the actuarially fair insurance premium?
c. What is the most that you would be willing to pay for insurance, given your utility function?
Question 3
Matt is an employee at a large university, where he pays $120 per month in insurance premiums and his employer pays $300 per month. He finds that if he quits his job, the same quality of insurance would cost him $600 per month. Why is there a difference in the premium?
Question 4
An individual's demand for physician office visits per year is Q = 10 - (1/20)P, where P is the price of an office visit. The marginal cost of producing an office visit is $120. a. If individuals pay full price for obtaining medical services, how many office visits will they make per year?
b. If individuals pay only a $20 copayment for each office visit, how many office visits will they make per year?
c. Compute the DWL to society associated with not charging individuals for the full cost of their health care?Also, show DWL graphically.