Essentials

Question 1

First Best Economy Assumptions

Answer 1

1. COMPETITIVE MARKETS (price=marginal cost)
2. GOODS ARE PRIVATE (excludable and rivalrous)
3. PERFECT INFORMATION (quality of good, preferences/indifference curves, budget constraints, perfect foresight
4. NO EXTERNALITIES
5. No behavioural bias (rational actors)

Question 2

Human Capital Model of Education

Answer 2

1. Benefits are long lived
2. Education increases future earnings relative to previous level of education
3. rational cost-benefit approach
4. Time dimension: benefits accrue in future so discounted - are worth less when converted to present value

Question 3

Human Capital Model Limitations

Answer 3

1. No role for external benefits
2. Children can’t make rational decisions
3. Assumes perfect info about cost and benefit
4. Investing in human capital requires borrowing but young people don’t have collateral so lending is risky

Question 4

Grossman Model of Health

Answer 4

Healthcare is DERIVED DEMAND
1. Health is viewed as capital stock that depreciates over time
2. People invest in health through time (exercise) market goods (medication)
3. Health increases utility and productivity
4. We invest in our health until MC = MB

Question 5

Market Failures in Healthcare

Answer 5

1. Information Asymmetry
2. Uncertainty
3. Adverse Selection
4. Moral Hazard
5. Externalities
6. Merit good
7. Third party payment problems

Question 6

Market Failures in Education

Answer 6

1. Positive externalities
2. Credit constraints
3. Information failure
4. Merit good
5. Inefficient Competition
6. Intergenerational Externalities