1. Define adverse selection. Give two examples of adverse selection in markets other than health insurance and explain the rationale for each choice. (5 pts)
2. In what ways is medical care different from other commodities? In what ways is it the same? (5 pts)
3. Preventative care refers to care taken to prevent future diseases rather than to treat current ones. Compared to emergency room care, preventative care is rarely urgent, and benefits can be difficult to measure – if you had the flu vaccine this year but did not catch the flu, it is impossible to tell if it was the shot or assiduous hand washing that preserved you. (10 pts)

(a) Given this description of preventative care, would you expect preventative care to be more or less price sensitive compared to inpatient care? Why?

(b) The Table below shows evidence on preventative care from the RAND HIE. Summarize the data in the table and note any interesting patterns. Was your prediction correct?

Table : Percentage with preventative care in the last 3 years from the

RAND HIE study

Males 17-44 Males 45-64 Females 17-44 Females 45-64

Any care Any care Any care Pap test Any care Pap test

Free 27.2% 39.1% 83.7% 72.2% 76.9% 65.0%

Copay 23.1% 27.4% 76.9%** 65.8% 65.3%** 52.8%**

**indicates statistically significant difference from the free at the p = 1% level.

Source: Newhouse (1993).

Here is a selection from an abstract of a recent study entitled “The Effect of Health Insurance Coverage on the Use of Medical Services” by Michael Anderson, Carlos Dobkin, and Tal Gross:

Substantial uncertainty exists regarding the causal effect of health insurance on the utilization of care. Most studies cannot determine whether the large differences in healthcare utilization between the insured and the uninsured are due to insurance status or to other unobserved differences between the two groups. In this paper, we exploit a sharp change in insurance coverage rates that results from young adults “aging out” of their parents insurance plans to estimate the effect of insurance coverage on the utilization of emergency department (ED) and inpatient services. [In the United States, children are eligible for insurance coverage through their parents’ insurance only up to their 23rd birthday, at which point they lose eligibility.] Using the National Health Interview Survey (NHIS) and a census of emergency department records and hospital discharge records from seven states, we find that aging out results in an abrupt 5 to 8 percentage point reduction in the probability of having health insurance. We find that not having insurance leads to a 40 percent reduction in ED visits and a 61 percent reduction in inpatient hospital admissions.

(a) What two groups are being compared in this study? (15pts)

(b) Identify at least one important methodological differences between the design of this study and the RAND HIE. Give a hypothetical reason that this difference would bias the results.

(c) Are the findings of this study generally consistent with the findings from the Oregon Medicaid Experiment?

Munchausen’s syndrome. Munchausen’s syndrome is a psychiatric disease first recognized by doctors in the 1950s. Sufferers will feign unusual medical symptoms and seek out the most complicated treatments and procedures, typically out of a desire to gain the sympathy and attention of family, friends, and medical professionals. In some sense, we could say that health care enters into the utility function of the afflicted. As much as most people viscerally dislike sitting in a doctor’s waiting room or undergoing surgery at a hospital, people with Munchausen’s often cannot get enough.

Imagine an individual in the Grossman model who suddenly develops Munchausen’s syndrome. How would this affect her optimal level of H’’? Explain your answer, and make sure your explanation discusses the three roles of health in the model. (15 pts)

What is asymmetric information? How does it present a problem to medical providers and health insurers? (5 pts)

Assume that Gabriel discovers, to his dismay, that his 2020 healthy-state income will be lower than his 20119 healthy-state income, but that his sick-state income IS is unchanged from 2019 to 2020. Assume that his healthy-state income in 2019 is IH, and his healthy-state income in 2020 is IH -∆. Assume 0 < p < 1. (15pts.)

(a) What is the difference between Gabriel’s expected income in 2020 E [I20], and his expected income in 2019, E [I19]?

(b) Assume that a local insurance firm designed an ideal insurance contract for Gabriel in 2019 – that is, one that was actuarially fair and full that year. They now want to adjust the contract so that it remains ideal for Gabriel in 2020. How will the premium r change, if at all? How will the payout q change, if at all? Interpret these changes in terms of the concepts of price and quantity.

(c) Suppose Gabriel finds a stipulation in the fine print of his contract that the premium and payout cannot change for five years. The firm gnashes its teeth and admits it cannot legally change the contract set in 2019. Describe how full and fair this contract will be for Gabriel in 2020. Would Gabriel prefer to be healthy or sick, assuming he buys the contract and that his utility is determined only by his income level?

Health insurance is normally seen as a good that is most valuable to sick people, since health expenditures are highest for the sick. Yet, in the basic insurance model we have discussed, actuarially-fair health insurance is worth nothing to people who are certain to become sick (p = 1).

Why does the standard model produce this result? How is this different from the way real-world insurance markets work? (10 pts)

(a). Draw an analogy between health insurance and taxi leasing in terms of moral hazard. In each case, highlight the price distortion, the behavior change due to price sensitivity, the information asymmetry, and the form of the social loss. (15 pts)

(b). The researchers find that moral hazard is reduced when lessor and lessee share a country of birth (most lessors and lessees in the NYC taxi industry are immigrants to the US, so participants in the market come from many different countries). Come up with a mechanism by which country-of-birth effects could reduce moral hazard.