Suppose there are two types of people, Healthy and Unhealthy. It\'s expensive to

Question

Suppose there are two types of people, Healthy and Unhealthy. It's expensive to insure unhealthy people for obvious reasons. It's relatively inexpensive to insure healthy people because they are unlikely to have large medical bills. Suppose the marginal cost of providing an insurance policy to a Healthy person is $1000 per year and the marginal cost of providing an insurance policy to an Unhealthy person is $4000 per year. Once you have a policy, it covers any medical expenses that you incur (i.e. the company can't withhold coverage if you turn out to be more expensive to insure than they expected). Assume that insurance companies set P=MC. Healthy people are willing to pay $1500 per year for health insurance. Unhealthy people are willing to pay $5000 per year for health insurance. Will an insurance market exist? Explain. Assume 20% of the population is unhealthy. If everyone buys insurance, what will insurance companies charge for a policy? Show your work. Now assume people can choose whether to buy insurance or not. Who will buy insurance now? As a result, what will happen to the price of insurance in equilibrium? Show your work. How could government lower the price of health insurance? Evaluate the following possibilities. Impose a mandate that makes everyone buy health insurance. Provide healthcare subsidies Impose a price ceiling of $1200

Explanation / Answer

1.

(a) Yes, insurance market will exist as person's willingness to pay for the insurance is greater than the price insurance company charge from them.

(b) Expected price charged by the insurance company = 20% of $ 4,000 + 80% of $ 1,000

= $ 800 + $ 800 = $ 1,600

(c) When insurance company charge $ 1,600 then healthy people will not buy while all unhealthy people will buy the insurance as healthy people are willing to pay $ 1500 which is less than the price demanded by the insurance company.

(d) Government can provide healthcare subsidies or impose a price ceiling of $ 1200.

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