Health Economics WS 2012/13

Problem Set 1 - 18.12.

Exercise 3.1: Check your understanding of the Grossman model by answering the following questions:
1. How does the equilibrium change when
a) the wage increases?
b) the price for medical services drops?
2. What happens if the individual becomes wealthier?
3. What happens when health care technology improves?
4. What is the role of education in the model?
Exercise 5.1: Consider an individual with income utility function u(y) =
ln y. The probability of illness is = 0.5. In the case of illness the individual
needs health care treatments that cost L = 9 monetary units. His initial
income is 12 monetary units.
a) Determine
1. the expected income
2. the expected utility
3. the certainty equivalent
4. the risk premium
Illustrate these measures in the income-utility diagram and in statecontingent income diagram.
b) Now assume there is an insurance available with a premium per unit
cover p. Calculate the optimal insurance cover for p = 0.4, p = 0.5
and p = 0.75. Illustrate your results in the state-contingent income
diagram. Determine the profit of the insurance company that sells this
optimal contract.

Exercise 5.2: Assume that = 0.5, M = 25, 000 and Ymin = 2, 500. Individuals derive utility u(y) = y 0.5 from disposable income y.
a) Calculate the critical income level Y below which an individual will
choose no insurance coverage.
b) An individual earns gross income Y = 20, 000. Show that compulsory
insurance in combination with a state-independent transfer can
(i) raise expected utility of the individual and
(ii) lower the expected transfer payment by the government.
Explain your result.
Exercise 5.3:
a) Show that with the Wilson modification, an equilibrium always exists.
When is it a separating, when a pooling equilibrium?
b) Why is the assumption of price-quantity contracts crucial for the model? What would happen if insurers were not able to control the total
amount of insurance purchased by their customers?
c) What kind of tax-subsidy policy could replace partial social insurance
as a means of government intervention?
Exercise 5.4: In the German private health insurance system, insurers must
charge a constant premium over the life-cycle.
a) Use the premium risk model of Section 5.6.2. to calculate the constant
premium Pconst which yields zero profits under the assumption that no
individuals switch in period 2.
b) Compare the constant premium to the premiums of a guaranteed renewable contract and show that P1GR > Pconst > P2GR . What are the
implications of this result for a contract which guarantees a constant
premium Pconst ?
c) Suppose that everybody experiences a deterioration of the health status
in period 2. With probability , individuals have a probability of M >
L of becoming ill, with probability 1 the probability is H > M .
Show that for a sufficiently high value of M , we must have Pconst <
P2GR . Comment on your result.
2

Exercise 6.1: Consider the following situation: The utility function is given
by u(x) = 40x x2 . The income before uncertainty resolves is y = 20 and
the loss is L = 16. There are two prevention levels (measured in money)
V = 0 (no prevention) and V = 2 (prevention). Without prevention the
probability of illness is (0) = 0.75. With prevention the probability of illness
is (2) = 0.25.
a) Calculate the expected utility with and without prevention when no
insurance is available. Will the individual engage in prevention?
b) Calculate the expected utility with and without prevention when insurance is available and insurers can observe prevention activities. Will
the individual invest in prevention?
c) Now assume that the level of prevention is private information of the
individual. Show that the equilibrium is one with prevention and that
it has insurance coverage 12.
Exercise 6.2: Consider the marginal willingness to pay for health care services is p(x) = 10 x and the marginal cost is 4. Let denote insurance
coverage so that the co-payment of the individual is 4(1 ). Calculate demand and welfare loss as a function of and interpret your result.