Lesson 6

Question 1

meaning marginal utility of income

Answer 1

People are typically risk-averse, meaning they prefer a guaranteed outcome over a risky one with the same expected monetary value.
Diminishing marginal utility of income:
- Each additional dollar gives you less extra satisfaction (utility) than the one before.
So losing €80,000 hurts you more than gaining €80,000 helps you

Question 2

all the point in the graph

Answer 2

Utility curve= Shows diminishing marginal utility of income (concave shape)

Iᴴ (High income)= Income if you’re healthy: €100,000

Iˢ (Sick income)= Income if you’re sick: €20,000 (after medical expenses)

E(I)= Expected income: E(I) = 0.8 × 100,000 + 0.2 × 20,000 = €84,000.

U(E(I))= Utility from receiving €84,000 for sure (no risk).

E(U)= Expected utility from the risky situation: 80% chance of U(100k), 20% chance of U(20k).

I꜀ (Certainty equivalent)= The income level that gives you the same utility as E(U). It’s less than €84,000. (based on income calculations, not utility).

Question 3

What does the graph show?

Answer 3

U(E(I)) (No risk income) > E(U) expected utility in risk behavior) → You’re better off with a guaranteed income than the risky situation.
That gap is due to your risk aversion.

The difference between E(I) and I꜀ is called the risk premium, it’s the maximum you’d pay to avoid the gamble.
= max amount the risk-averse is willing to pay to avoid risk because she’s trying to max utility

Question 4

so why is it logical for people to buy health insurance?

Answer 4

–> because the marginal utility of income is decreasing
–> risk aversion
–> willingness to pay to avoid income fluctuations

The expected payout is the same as their expected loss,
Or the insurer makes zero profit.
They’re not paying to make money — they’re paying to avoid risk and protect their utility.

Question 5

meaning risk-pooling

Answer 5

one person taking on multiple risk, therefore diversifying risk

Question 6

asymmetric information

Answer 6

one party in a transactions knows more than the other

Question 7

the case of asymmetric info of health insurance

Answer 7

–> lead to adverse selection for consumers

hi offer policy only to cover their costs –> price will be too high for some and too low for others
–> price too high (won’t get it)
–> price too low (will take advantage of it)
–> company ends up paying more than bringing in

–> results: death spiral

Question 8

adverse selection definition

Answer 8

market proces that makes it so that “bad” types are more likely than “good” types to be selected

Question 9

meaning moral hazard

Answer 9

occurs when having insurance changes a person’s behavior in a way that increases costs, typically because they are shielded from the full consequences of their actions.

Question 10

solutions for moral hazard

Answer 10

• copayment
• coinsurance rates
• deductible

Question 11

results from uninsured and emergency care use

Answer 11

1. insured individuals are therefore paying for uninsured individuals additional expensive care
2. uninsured are over-consuming emergency care from a societal standpoint (and under consuming preventative care)

Question 12

efforts to insure more people in society

Answer 12

• distributional preferences of society
• efficiency improvement

trough:
- mandate or subsidize