Let’s consider the health insurance market. Suppose there are
two types of consumers: those with pre-existing conditions and
those without. Those with pre-existing conditions make up 10% of
consumers. All consumers are risk-averse with utility function, U
left parenthesis X right parenthesis equals square root of X. Those
with pre-existing conditions require medical care 50% of the time.
Those without require medical care 5% of the time. Assume each
consumer has an initial wealth of $1000 and medical care costs
$500. If the insurance companies are allowed to sell insurance at
different prices to the two types of consumers and competition
forces them to charge the fair insurance premium, consumers without
pre-existing conditions ___________ insurance at a price of
$__________. Consumers with pre-existing conditions insurance
____________ at a price of $ _______________.
Now suppose the government passes a law that bans discrimination
on the basis of pre-existing conditions. In this case, the
insurance companies can no longer offer insurance at two different
prices (they can only charge a single price). In this case, in
equilibrium, consumers without pre-existing conditions insurance
_______________ at a price of $______________. Consumers with
pre-existing conditions insurance ________________ at a price of $
________________. Relative to before the law is passed, consumers
without pre-existing conditions are _________________ off.
Consumers with pre-existing conditions are ________________
off.
DROP DOWN OPTIONS:
0
10
25
47.5
100
125
227.5
250
BUY
DONT BUY
INDIFFERENT BETWEEN BUYING AND NOT BUYING
BETTER
NEITHER BETTER OR WORSE
WORSE