LECTURE9/11/14

ConsumerChoice(Assumesarationalconsumer)
Individualdemandcurve(Figure2)
Whenthepriceoffoodgoesup,consumer(she)consumeslessfood
LawofDemand
Ifthepriceofsomethinggoesup,aconsumerwillwantlessofit
Curvewillalwaysslopedownward
Difficulttofindcounterexamples
Expensivesushivscheapsushi
Notdisprovingthelawofdemandotheraspectsof
thegoodarechanging(quality)
Highfashionexample
Expensivepurseshighpricesignifiesasenseof
socialstatus,notnecessarilyrelatedtothelawof
demand
Potentialscenariowherehealthcareissoimportanttoa
consumerthatpricedoesnotaffecttodemand
Consumerhasanindividualutilitysetandabudgetsetthatallowsthe
figuretobeformed
Marketdemandcurve(Figure3)
Horizontalsumofallindividualagentdemandcurves
Describeshowconsumersreacttopriceandpricechanges
Shiftstotherightifconsumerhasmorecapitaltospendshiftsto
theleftifconsumerhaslesscapitaltospend
Consumerwillwantmorequantityiftheycanaffordit
CompetitiveFirmsChoice
Afirmsgoalistomaximizeprofits
Profit=pricexquantitycost(quantity)
Profit=pxqcost(q)
Costscaneitherbefixedorvariable
Fixedcostsdonotdependonquantity
Rentforofficespaceisafixedcost(doesnotdependon
quantityofgoodproduced)
Foranimagingcenter,theimagingunitisafixedcostthat
doesnotmatteronhowoftenitisused
Variablecostsvarywithoutput
Foraphysician,themorepatientsyouseethemore
needles/tonguedepressorsyouneedtobuy
Foraprimarycarephysician,timeisavariablecost
Averagecostvs.Marginalcost
Averagecost=total/goodsproduced
Avg.Cost=total/g
Marginalcostistheadditionalcostofproducingthenextgood
Inanimagingcenter,marginalcostwouldbetimespent
withareceptionistoragownthattheyneedtowearduring
anMRI
Couldbehighorlow
Leadstoadebateoverconsumerresponsibilityin
healthpolicywithbusinessesthatoperatewitha
largefixedcostandsmallmarginalcost
Areconsumersresponsibleforcoveringthe
fixedcost?
Foraphysician,themarginalcostforseeinganadditional
patientishigh
Problemfacedbyfirms(Figure4)
Marketpricevs.quantityproduced
Marginalcost(MC)isanupwardslopingline
IntersectsACatitsminimum
Averagecost(AC)isUshaped
Iftoolittleortoomuchisproduced,ACremainshigh
Costofproduction
Economiesofscale(downwardslopeofAC)
Asyouincreaseproductionandproducemore,averagepricegoes
down
Linkedtohigherefficiencyinmassproduction
Reasonwhyhospitalsareverylarge
Diseconomiesofscale(upwardslopeofAC)
Averagecostbeginstorisetoaccountforoverproduction
Firmwillgraphthepricewithahorizontalline(BC)
UntilthepriceintersectsMC,afirmwillwanttoproducemore
quantity
Atthatintersection,thefirmbecomesindifferenttowards
increasingproduction
Maximizingprofitsonthemargin
Individualsupplycurve
Determinestheamountproducedbythefirmbaseduponmarket
price
Basedonmaximizingprofitsonthemargin
SupplyvsDemand(Figure5)
Competitiveequilibrium
Intersectionbetweensupplyanddemand
Describesthecompetitivepriceandcompetitivequantity
Atthispriceandquantity,thereisnothingwasted
Justasmanyproducerswanttosellthegoodas
consumerswanttobuythegood
Consumersgetricher(Figure6)
Startoutwithacompetitiveequilibriumandthentheconsumers
gainmorecapital
Curveshiftstotherightaspriceofproductincreaseswith
higherincomelevels
Producersbecomemoreefficient(Figure7)
Atanygivenprice,supplierscanproducemoreofthegoodand
leadstolowerpricesandhigherquantity
Thinkoftechnologicaladvancementsforfarmers(tractors,
pesticides,betterseeds,etc)
FoodinZimbabwe(Figure8)
Beforechangesweremade,Zimbabwehadacompetitivemarket
Rulecomesinthatcreatesapriceceiling
Leadstoashortageingoods(food)
Winners:Consumerswhocanfindfood
Losers:
Producers
Consumerswhocannotfindfood
Misallocationproblem?
Underafreemarket,allocationofresourcesisbasedupon
awillingnessandabilityofconsumerstobuygoods(pay)
InalowincomecountrylikeZimbabwe,thepriceceiling
installationwasputinplacewiththehopethatthehungriest
hadaccesstofood
Endedupbeingmorerandomwhereallocationofa
scareresourceledtonotenoughpeoplehaving
access
Canleadtoablackmarketwhereproducerssellgoodsbasedona
normalsupplyanddemandcurve
ApartmentsinNYC
NewYorkCityinthe1950shadapolicyofrentcontrol(eventuallybecamerent
stabilization)
Governmentcappedrentbecauseofrisingprices
Winners:Consumerswhocouldfindapartments
Abletobuygoodforalowprice
Losers:
Producers(landlords)
Consumerswhoareunabletofindapartments
Leadstoashortageofapartments
Stillsuffersfromthepossiblemisallocationissue
Policyinplacemaynothelptheconsumergroupthat
needsit
WallStreetJournalarticleaboutrentcontrolinMumbai
Applicationsrelevanttohealthcare
Themarketforcrystalmethamphetamine
Maybeacompetitivemarketwithoutmuchfriction
Locallyproducedbysmallfirms
Displaysanormalsupplyanddemandcurve
IftheDEAweretoraiseregulationsagainsttheavailabilityof
chemicalsneededtomakemeth
Supplywoulddecreaseandpriceswouldincrease
Studyoncrystalmethsales
Reliedondealerarreststographthegoingrateofmethpergram,
formingacomparativepurityvspricecomparison
Priceandsupplywentdownimmediatelyafterthenewregulations
wereinstitutedbuteventuallyreturnedbacktonormallevels
Foodsupplyandobesity
Pricesbeforeahurricane
Gasstationsarepreventedfrompricegougingorraisingthepriceofgas
baseduponanincreaseindemandinLongIsland
Pricesremainthesame,supplyeventuallyisdepleted
Governmentimposedpriceceilingleadstodistinctwinnersand
losers
Normally,priceswouldincreasebeforeahurricaneaccordingtosupply
anddemandcurves
FamineinBangladesh(Riceprices)
Before1974famine,priceincreasesaccordinglywithwages
After1974famine,priceskyrocketsunlessmoreproductisaddedtothe
system(viaforeignaid)
NPRstoryonhowforeignaidhurtspatientfarmers
Discussionquestions
1. TheACAmoreorlessprovidescomprehensivehealthinsurancetoeveryone.
Howwouldthisaffecttheamountofhealthcareconsumed?
a. Willincreasetheamountofhealthcareconsumed.Demandcurvewillbe
shiftedtotheright.
2. Supposethatmoreundergraduatesdecidetobecomephysicians.Whathappens
tothepriceofhealthcare?
a. Willincreasetheamountofsupply.Supplycurvewillbeshiftedtothe
right.
Economicrentseeking
Artificialprofitsthatoccuronlywhencompetitionisrestricted
Suppliersinamarketconvincethegovernmenttolimitcompetition
NYCYellowCabsandtheirsilvermedallions
Medallionisworthexponentiallymorethanthecabitself
Governmentsellsalimitedamountofmedallions
Currentcabownerswithamedallionseekoutthe
governmenttoensurethatfewermedallionsaresoldand
lesscompetitionisavailable
Liquorlicenseswithincitylimits
Healthcareisfilledwithrentseekingbehavior

LECTURE9/18/14

Positiveexternality
Publicgoods
Nonrival
Nonexcludable
Vaccines
Negativeexternality
Pollution
Figure1(Review)
Firmdecidinghowmanybicyclestoproduce
Maximizeprofitsonthemargin
Determininghowmuchrevenueonemakesfromsellingaunitandthe
costtoproduceoneunit
Eventuallyreachesapointofindifferencewhereitcostsmoretoproduce
agoodexceedstherevenueitbringsinforsellingagood
Letssayproducingabicycleproducespollutionaswell
Thereisawaytopriceouthowmuchpollutioniscreated
Accountsforsocialcosts(healthissues,cleanup,etc)
Priceisaddedtothemarginalcosttothefirm
Shiftsthemarginalcosttotheleft
Thereisadifferenceincurveswhensocialcostisaddedtotheequation
Anegativeexternalityleadstooverproductionintheprivatemarket
Thisfirmisignoringacost,leadingittoproducetoomuchrelativetoifit
facedthatcost
Governmentisutilizingamethodtoensurethatthefirmaccountsforitssocial
externalities
Figure2
Apositiveexternalityleadstounderproductioninthefreemarket
Thefirmandtheconsumerareignoringsocialbenefitsandwill
consume/producetoofewofthegoodsthatcausepositiveexternalities
Governmentisutilizingamethodtoensurethatthefirmaccountsforitssocial
externalities
Whatarethesolutionstoexternalities?
Fornegativeexternalities,therearethreesolutions:
Quantityregulation(Fig.1)
Governmentcomesinandtellsfirmstoproduceless
Usedintheregulationofpowercompanies
Governmentwillcomeinandtellfirmtoproduceq
e
insteadofq
c
Pigouviantaxation
Ifyouchargefirmspreciselytherighttax,youcanleadfirmsto
maketherightdecision(whichhappenstobethesociallyoptimal
decision)
Lowerseffectivepricethatthefirmsees,causingittolowerthe
amountitproducesitself
Cap&Trade
Governmentinstitutesamandateclaimingthatanareacanonly
handlesomuchpollution
Createsalimitednumberofpermitsthatallowafirmto
polluteaspecifiedunitofpollutionandthenhascompeting
firmsbidforthatpermit
Forpositiveexternalities
Subsidizeproductions(Figure2)
Providingincentivesforcompaniesthatproducepositive
externalities
FirmisatpointDandisgivenanincentivesothattheymoveupto
pointE
Townfishingexercise
Applicationstohealth
Vaccines
Seenasapositiveexternality
Governmentsubsidizesclinicstopromoteincreasedvaccinationaccess
andsupply
Formsanargumentthatgovernmentshouldbemoreinvolvedin
healthcare
Maynotbeapplicableforwealthycountries,wheremostspending
goestowardsnoncommunicablediseases
Autopsies
IntheUS,lessthan10%ofdeathsreceiveautopsies
Issueofunderproduction
Epidemiologistsbelievethatpositiveexternalitiesassociatedwith
autopsiescouldbeutilizedtohelpformabetterunderstandingofdiseases
Costassociatedwiththeactualautopsy,butalsoaprivatecostforthe
familytoemotionallygrapplewiththeirdeceasedsbodybeingdissected
Whatifthephysicianmadeamistake?
Whatifthepatientwasmisdiagnosed?
Caraccidents(PoundsthatKill)
Twomainnegativeexternalities:
Gasconsumption/pollutiongreaterinlargerSUVs
Largersizeleadstogreaterdangerduetoaccidents
ConcludeswiththebeliefthatAmericansarepayingtoolittleatthegas
tank
Economicepidemiology
Wearingacondom
Privatebenefits
LowersriskofobtainingHIV
Privatecosts
Hassle
IfHIVweretoberareinaregion,theprivatebenefitofwearingacondomis
loweredandtheprivatecostdoesnotchange
UltimatelyleadstoHIVcomingback
Selflimitingincentiveeffectofepidemics
Tendstohappeninreality
Vaccinationpolicies
Twomodelsofthoughts
Parentsarestupid:Peopleareconfusinganecdotewithscience
coincidencethatautismsymptomsshowuparoundthetimethat
somevaccinationsaregiven
MaybeJennyMcCarthyisright?
Antibioticusage
Shouldberegulatedbythegovernmentbecauseofthepossibilitythatantibiotic
resistancecouldoccurthroughoveruseandpossiblycauseanepidemic
Antibioticresistantstrain
Uniquenegativeexternality
Knowledge(awareness)
JohnSnowdiscoversthatcholeraiswaterborneandnotairborne
Treatingwatersupplyisthecorrectwaytogo
Knowledgeisapublicgood
Nonrivalling(everyonecanknowit)
Nonexcludable(onceitsoutthereitdoesnotmatterwhoknowsit)
Fordrugdevelopmentthatrequiresalotofcapitalinvestmenttoproduce,the
governmentcanprovideincentivessuchaspatentprotectionforthedrugsothat
thepharmaceuticalcompanycanmaintainaprofit
Smoking(TheTaxesofSin)
Whyaretherecigarettetaxes?
About$13/packinManhattanwouldbe$4/packwithouttaxation
IsitaPagouviantaxtojustifyitsnegativeexternalities?
Majornegativeexternalitiesassociatedwithit:
Causesmuchpropertydamageduetofires(+tax)
Medicalcare(+tax)
SIckleave(+tax)
Grouplifeinsurance(+tax)
Nursinghome(tax)
Retirementpension(tax)
Deathbenefitofsmoking
Smokersdiebeforetheyareabletocapitalizeonpensionornursinghome
benefits
Behavioraleconomics
Accordingtosurveys,theaveragesmokertriestoquitevery8months
ofsmokersbeginasteenagers
Behavioraleconomistswouldarguethatsmokersareignoringfuture
costs
Alsohaveaselfcontrolproblem
Actionsarenotinlinewiththeirutility
Utilitymaximizationdoesnotapplyinthesecases
Internalities(madeupword)
Termtodescribetrueinternalcoststowardsapersonsactions
Peopleareinherentlyirrationaltowardsmostfuturecosts
Economistsarguethattheyneedregulationsimilartoexternalities
Commitmentcontract
Storyoftwograduatestudentswhobeteachotheraboutlosing
weight
Madearealbetthattheyheldeachotherto
Plugforstickk.com
Verycontroversialaspectofeconomicresearch
Referredtoaspaternalism
Slipperyslopeargumentthatregulationcouldbecome
excessiveandfixallissueswithinapersonslife(starts
withcigarettesandextendstofood,webbrowsing,etc)
Utilitymaximizers,nothealthmaximizers
Peopledonotlivetomaximizehealth,butrather
maximizeutility(makesunhealthydecisions
rational)
Exploitingdefaultbias(Asymmetricpaternalismorlibertarianpaternalism)or
nudging
Discusses401kassignments
Whetherpeopledecidetooptinoroptouthasanaffecton
everyone
Evidenceinfavorofbehavioraleconomics
Peoplewillhaveatendencytotakethedefaultoption
Ifitisthenormtopay,thenpeoplewillpayifnot,thenpeoplewill
not
Peoplewillfollowthepathofleastresistance

LECTURE10/2/14Uncertainty

Insuranceallowsustotrademoneyacrossuniverses
StoryofMattbettingmoneyagainsttheRedSoxintheworldseriestoanonlinebetting
companyinIreland
Notionofinsuringyourselfwhenyourfavoriteteamloses
Ifyourteamloses,youreceivecompensationiftheywin,youreceivethe
satisfactionofknowingtheywon
HealthInsurance(Themodelforexpectedutility)
Themarketforhealthinsurance
Probability
Numberbetween01
Describestherelativefrequencythataneventoccurs
Bets
Flippingacoin
HeadsIget$1000,TailsIgiveyou$900
Expectedvalueofthatbet:+$50
50%chancethecoinlandsheads,50%chancethe
coinlandstails
Notagoodbettotakeifitsonlyperformedonce
Employsthenotionthatpeopleareriskaverse
Despitebeingapositivebetforyou,itstillinvolvesa
highdegreeofrisk
Rationalconsumersdonotmakedecisionsbased
onexpectedvalue,butratherexpectedutility
Figure1(Consumerutilityoverallthemoneytheycouldhave)
Upwardsloping(morewealthisalwaysbetter)
Accountsforaconsumerstendencytoberiskaverse
Measuresutilitybaseduponhowmuchwealthisaccumulated
Assumesthatmorewealthisalwaysbetter
Exhibitstodiminishingmarginalutility
Goingfrom$0$1000isamuchhigherslopethangoing
from$1000$2000
Diminishesasyougetwealthier
Losingmoneyleadstoagreaterlossofutilitythangainingthe
sameamountofmoney
Example:ConsumerstartsatpointBwitha10%chancethatshe
endsupatpointA
Facestwostatesoftheworld:pointBorpointA
10%ofthetimeshewillhaveautilityof$1000,90%ofthe
timeshewillhaveautilityof$2000
Expectedutilityis194(pointC)
.9(200)+.1(140)
Insuranceexample
Badstate:
10%thatconsumerstartsoutwith$2000andends
with$1000
Pays$100premiumtoinsurancecompany,but
insurancecompanywillpayher$1000ifsheends
upinbadstateendsupwith$1900
Goodstate:
Shewakesupwith$2000andpaysher$100
premiumandnothingelsehappens
PointCisherexpectedutilityifshesuninsured,pointDis
herexpectedutilityifshesinsured
Herexpectedutilityishigherwhenshesinsured
GapbetweenpointDandpointCisthebenefitofbeinginsured
Figure2(sameconsumer)
Supposethattheconsumerfacesabigriskoflosingallofher
wealth
HerexpectedutilitywillbetheaverageofpointAandB(pointC)
PointEisherexpectedutilitybeinguninsured,pointDisher
expectedutilitybeinginsured
Peoplegetinsurancefortheirhomes,butnotfortheircalculators
Highlyvaluableitemvs.lessvaluableitem
Gainfromgettinginsuranceforabigshockismuchlargerthan
gettinginsuranceforasmallshock
Heterogeneityininsurance
Figure3
Describestwoconsumers
Consumer1islessriskaversethanconsumer2(lesscurved)
Consumer2
10%chanceofbeingatpointEandbeingsickanda90%
chanceofbeingatpointGandbeinghealthy
IfIminsured,ImatpointH(whichishigherthanpointG)
WillchoosetobeinsuredtobeatpointH
Consumer1
10%chanceofbeingatpointAandbeingsickanda90%
chanceofbeingatpointCandbeinghealthy
IfIminsured,ImatpointD(whichisbelowpointC)
Insuranceistooexpensivewillchoosetoremain
uninsured
Completelyrationalchoice
Themoreriskaverseyouare,themorelikelyyouaretobuy
insurance
Articleonbehavioralheterogeneity
Peoplewhohavehealthinsurancearemoreriskaversethan
peoplewhodonothavehealthinsurance
Peoplewhoarelessriskaversetendtoparticipateinriskier
actionsandnothavehealthinsurance
Figure4
Bothconsumershavethesamedegreeofriskaversion(same
slope)
Consumer1
10%chanceofbeingsick(pointA)and90%chanceof
beinghealthy(pointB)
ExpectedutilityofpointE
Makessenseforhimtonottaketheinsurance
Consumer2
90%chanceofbeingsick(pointC)and10%chanceof
beinghealthy(pointD)
ExpectedutilityispointF
Makessenseforhertotakeinsurance
Greaterdemandforhealthinsurance
InsurersPerspective
Expectedprofits:E(profits)=P(sick)x(+premiumbenefits)+P(healthy)x
(+premium)
WhenE(profits)=0,thereisactuariallyfairinsurance
Willwanttochargehighriskconsumersahigherpremium
Makesmoneyonhealthy(lowrisk)consumerslosesmoneyonhighrisk
consumers
Healthysubsidizethesick
LawofLargenumbers
Instatistics,ifIflipacoin10,000times,Imprettysuretherewillbe5,000
heads
Maynotbeexact,butitshouldbeprettyclose
Ifyouflipacoinonce,theresamuchgreaterdegreeofvariance
Largeemployerswilltendtoselfinsure
IBMknowshowmuchitneedstopayininsurancebecausethere
isamuchlowervarianceduetosize
Communityrating
Alawwherethegovernmentforcesinsurerstochargethesame
premium,regardlessofrisk
Bothstartwith$2000
Young:10%chanceoflosing$1000
Actuariallyfairprice:.1(+P$1000)+.9(P)=0
P=$100
Old:90%chanceoflosing$1000
Actuariallyfairprice:.9(+P$1000)+.1(P)=0
P=$900
Oldpersonismoreexpensivetoinsurethanyoung
(.5)(.1)(P$1000)+(.5)(.9)(P)+(.5)(.9)(P$1000)+(.5)(.1)(P)=0
P=$500
Experienceratedinsurance
Involvesanexternalitywherethedecisionsofapersongreatlyaffects
otherpeople
Carinsurance
Ifyougetintoanaccident,yourpremiumincreasesasyou
becomelabeledintoahigherrisk
Samepolicydoesntapplytohealthinsurance
Graphdescribingaveragecostbaseduponage,drivershistory,
occupation,etc
Notallowedtodiscriminatebaseduponrace,ethnicity,religion,
socioeconomicstatus,etc
Gendercanbedescribedthough
Healthinsuranceisallowedtochangeratesbaseduponincome,age,
(sometimes)gender,education,andsmokingpreference
ProblemswithHealthInsurance
Reclassificationrisk(JohnCochranearticleandAmyFinkelsteinarticle)
Contractstendtobewrittenfromyeartoyear
Ifhealthissuesoccurduringthemiddleofyourcontract,youre
covered
Ifhealthissuesoccurclosertotheendofyourcontract,you
becomeahigherriskconsumerandarechargedahigher
premiumacrosscontracts
Insurancecompanydoesntprotectyoufromthatrisk
Issuebecauseitimposesalargerriskforconsumers,whichinturnposes
ariskforinsurancecompaniestolosehealthyconsumers
JobLock(MarkZuckerbergexampleandMadrainarticle)
Problemwhenpeopleprimarilygethealthinsurancefromtheiremployer
andfeellockedintotheirjobtoavoidtheriskofnotbeingcoveredbytheir
employerinsurance
Issuewithentrepreneurs
Forcesyoutoleaveyourinsuranceplanandgouninsured
IfMarkZuckerbergweretohavediabetes,wouldhehavebeen
abletogouninsuredonhisownandleftHarvard?
Economistsarguethatstrongeconomiesneedentrepreneurial
ambition
TheGoodSamaritanProblem(Herringarticle)
ExampleofProfessorGrossfriendwhodoesnothaveinsuranceand
dependsonalocalCatholichospitaltoprovidecharitycare
ThereareGoodSamaritanswhowillhelpyounomatterwhat
Whyshouldyoubuyinsuranceifyouknowyoucanreceivecarewhenyou
needit?
Therearelawsthathospitalsareobligatedtofollowwheretheymust
providecaretostabilizeyouregardlessofyourabilitytopay
Implicithealthinsuranceinregardstobankruptcy
Longtermhealthinsurance
Whenyougetolder,youhavemanyoptionstowardshealth
insurance(Medicare,familyassistance,etc)
TaxSubsidy
Supposeyouwant$100fromyouremployertobuyagood
Theyneedtogiveyou$120or$130toaccountfortheamount
takenoutbytaxesbythegovernment
Thegovernmentchoosestosubsidizeemployerhealthinsurance
CounterpartyRisk
Goingaboutatransactionbetweentwopeoplewhereonepartypasses
awayduringthetransaction
Hugerisk
Canbecontinuedinttomoralhazard

LECTURE10/9/14MoralHazard

IssueoftheBritishsendingprisonerstoAustralia
Shippingprisonerswasadeadlytasknearly30%ofprisonersweredyingduring
thetripduetoovercrowding
Lowpercentageevenforthattime
Howtosolvethisissuewithovercrowding?
FliptheincentivedontpayshipsfortransferringXamountofprisoners,
paythemforsuccessfullybringingXamountofprisoners
Mortalitydroppedfrom30%to1%
AsymmetricInformation
Moralhazards(hiddenactions)
Foremployeesthatarenotunderdirectsupervision,thereisnowayto
ensurethattheyaredoingtheirjobandnotplayingcomputergamesall
day
Tosolvethis,itsimportanttoprovidefinancialincentivesto
promotehigherwork(bonusesforsalesorproductivity)
Untilthe1960s,economistsfocusedprimarilyonsymmetricinformation
Figure1(Elasticity)
Twodemandcurvesfortwodifferenttypesofpeople
Whendemandgoesup,theconsumerswantlessofthegood
Group1ismoresensitivegroupforprice
WhenpricegoesdownfromAtoB,group1increasesconsumptionfrom
CtoD
Elasticity(Pricesensitivity)E
D
Priceelasticityofdemand
Percentchangeinquantitydemandedgivenapercentchangeinprice
Wheatelasticity
E
D
=0.35
Anincreasein10%ofthepriceisgoingtoleadinadecreaseof
3.5%ofthedemandforquantity
Americanshavearelativelyelasticdemandcurvewhenitcomestothe
marketforwine

Figure2(Perfectlyinelastic)
E
D
=0(realistically,approaching0)
Notsensitivetopriceatall
E
D
=%changeQ
D
/%changeP
Examplecouldbeinsulinprices
Peopleabsolutelyneedittosurvivearewillingtopaywhatevertogetit
Figure3(Perfectlyelastic)
E
D
=INF
Highlysensitivetoprice
Examplecouldbeanonessentialitem(Texacogas)
Ifonegascompanychangestheirprices,thenconsumerswilleitherstop
drivingifitstheironlyoptionorgotoanothersourcetofindgas
Thingstendtobesurprisinglyelastic
HealthInsurance
CostSharingMechanisms
Theconsumerissharingtheircostswiththeinsurer
Theconsumerhassomeskininthegame
Premium
Priceofinsurance
Paidinbothworlds(whetheryouaresickorhealthy)
Copayment
Priceyoupayforagivenencounterwithahealthsystem
Payforatreatmentorprescription
Tendtoberoundnumbers
Deductible
Amountaconsumerhastopaybeforetheinsurancebenefitskick
in
Ifmydeductibleis$500formycarinsuranceandIgetintoan
accidentthatcosts$1000,Ihavetopay$500beforemyinsurance
willcovertherest
CoinsuranceRate(rarenowadays)
Percentpaidbytheinsureruntilyouhitsomemaximum
MoralHazard
ExAnteMoralHazard
Backintheday,fireswereaverycommonoccurrence(wooden
houses,candlelighting,coalovens)
FireinsurancemapforManhattanin1909
Dependingonthebuildofhouses,insurerswouldsurvey
theircustomerstodeterminehowlikelyahousewouldbe
tocatchfire
Foundimmoralcharacterinclientswithfireinsurance
Theseclientstendedtonottakecareoftheiryard,
letivygrowalongtheirhouse,etcbecausethey
knewthatiftheirhousecaughtfiretheywere
insuredtogetanewone
Behaviorthatoccursbeforetheuncertaintyisresolved
Runningafterthetrainexample
Runningtothetrainwhenyoureworriedyoullmiss
itisjustified,butifyouarriveandfindyoureearly
thenitswitchesandtherunningisnolonger
justified
Hugeissueregardingcarinsurance
DaveandKaestnerPaper
Describeexantemoralhazard
Anecdoteaboutsomeonedroppingtheirhealthinsurance
andadoptingahealthierlifestyle
Posesaninterestingscenariodoesinsuranceleadpeople
toleadlesshealthylifestylesbecauseconsumersknow
theyhavecoverage?
Nothingdecisive,butcompellingnonetheless
ExPostMoralHazard
Behaviorthatoccursaftertheuncertaintyisresolved
Figure4(MyindividualdemandcurveforhealthcarewhenIm
sick)
WhenImsickanduninsured,mypriceishighsoIwont
purchasethatgood
WhenImsickandinsured,mypriceislowsoIwill
purchase/consumethatgood
InsurancelowersthepriceofhospitalvisitsfromP1toP2
Insteadofconsumingq1hospitalvisitsIamgoing
toconsumeq2hospitalvisits
Ifyourdemandisperfectlyinelastic,thenthereisnomoral
hazard
Addingcostsharingmechanismssuchascopayments
leadtolessconsumptionbyraisingthepricesomewhere
betweenP2andP1
Figure5(Review)
Copaymentsimposeriskonconsumers
Downsideofprocess
PointEissomeonewhoinsured,buthastofacealotof
copayments
Fundamentaltradeoff
Wanttopreventmoralhazardwhileprovidingrisk
protection
Wewantcopaymentstobereallyhightodealwith
moralhazard,buthighcopaymentswillraiserisk
forconsumersandleadthemtounderconsumeor
droptheirinsurance
Empiricaldebateregardingwelfarecompensationand
motivationtoseekoutajob
Doconsumersonwelfarepaymentshaveless
incentivetogetajobandstabilizetheirfinancial
situationwhentheyareabletoreceivewelfare
benefits?
RandHie
HealthInsuranceDemandRandomizedExperiment
Polledsixrandom,typicalcitiesandpolledcitizensondifferent
typesofplans
Usedafreeplan,25%,50%,95%,andindividualdeductible
Allrandomizedtothosefivegroups
Ranforroughlyfiveyearsfrom19761981
Knewpeopleshealthbeforeandafter
Peopleonthefreeplantendedtospend25%moreonhealthcare
thanthoseonthedeductible
Forcingcopaymentshasamajoreffectonhealthcare
consumption
0.2
Anincreaseinhealthcarecostisgoingtodecreaseyour
healthcareconsumptionby20%
Costsharingleadstoadecreaseinbotheffectiveandineffectivecare
Peoplecutbackoneverythingwhencostsharingisimposedupon
theirplans
Effective,necessarycareislessutilized,whichiswhatinsurance
istryingtomaximize
Onaverage.noeffectonhealth
Difficulttomeasurehowhealthysomeonereallyis
Createindicestotryandgaugeoneshealth
Costsharinghurtthehighriskconsumers
Manypeoplegoingintothisstudyhadapreexistingcondition
Labeledaselevatedriskpatientsgoingintotheexperiment
Costsharingraisedtheriskofdyingforthatperson
SomearguedthatthedatafromtheRandHieexperimentwereconvinced
thattherewerenotenoughcostsharingimplementsineffect,causing
Americanstopaytoomuchforhealthinsurance
Theinsuredvs.theuninsured(Anderson,Dobkin,Grosspaper)
AlotofAmericansbecameuninsuredatage19afterbeingdroppedfromtheir
parentsplans
Fig.2(shareofpeopleinsuredvs.uninsured)
Ifallofthesuddenpeopleturn19andloseinsurance,howdoestheir
behaviorchange?
Consumersbecomelesslikelytogototheemergencydepartment
Dropinutilizationafterlosinginsurance
Insuranceappearstoincreaseutilization
Finkelsteinpaper
StoryinOregonwheregovernmenthadrunoutofmoneyanddidnthave
enoughslotstoprovidemedicaidforthosewhoneededit(10,000people
vyingfor1,000slots)
Decidedtorunalotteryonwhoreceivedit
Comparedhealthbehaviorforpeoplewhoreceivedmedicaidcomparedto
thosewhodidnot
Thoseonmedicaidconsumedmorehealthcarethanthosewhowerenot
Higherutilizationbyconsumerswhenhavinginsurance
Problemswithsolutionstomoralhazardproblems
VanHalenexample
Oneofthemostpopularbandsinthe1980s
VanHalenwouldtravelthecountryperformingandwouldmakerequests
forpreparationsatvenuesfortheirconcerts
RumorthatVanHalenintentionallyrequestednobrownM&Msintheir
dressingrooms
AddedthisstipulationtoensurethatiftheM&Mswerenttaken
careof,theywereconcernedthatotherdemandswerentmetas
well
IfthevenuedidnottakethetimetotakeoutthebrownM&Ms,they
maynothavetakenthetimetoreinforcethestage
Interestingsolutiontowardsmoralhazard
OffsetEffect
Argumentagainstcopaymentsanddeductibles
Ifyouraisecopaymentsonsmallissuestoreducemoralhazards,the
subsequentcostofadoctorvisitoffsetsthereducedconsumptioncost
Chandra,Gruber,McKnightpaper
Physicianvisitsbefore2002hadacopaymentof$0.00andraised
itto$10.00
Atpharmacies,wentfrom$0.00to$5.00to$15.00
Figuresdescribetheeffectsincreasingcopaymentprices
Ascopaymentpricesincrease,utilizationdecreasesfordoctor
visits(Fig.1)
ConfirmedRandHiefordoctorvisits
Fig.2continuesthistrendforpharmaceuticalutilization
Fig.3describeshospitalvisits
Peoplearecuttingbackondoctorvisitsanddrugs,butend
upstillgoingtothehospital
NotconsistentwithRandHiedata
Raisingcopaymentsstillsavemoneyfordoctorvisitsanddrug
consumptiondespiteincreasinghospitalvisits
Offseteffectcomesintoplay
Nooffseteffectforhealthypeoplebutlargeoffseteffectfor
elevatedriskconsumers
Atriskconsumerscancontainalargeoffseteffectthatleadstoan
insurerlosingmoney
ValueBasedInsurancedesign
Hotideainhealthpolicy(VBid)
Letstakehighriskconsumersandlowertheircopaymentssothat
theyarenotdiscouragedfromutilization
Ensurethatcertaintypesofconsumptionhavenocopaymentfor
everyone(controversial)
Raisecopaymentsforwastefulconsumption
Multitasking
Notabigdealnow,butlaterinthesemester
Supposeyouhireacontractortofixyourroof,costs$40,000
Presentsamoralhazardproblemgiventhatyoucannotwatchhimdohis
work
Provideabonusforhimtofinishbyacertaindate
Hefinishesbythatdate,butroofeventuallycavesinduetopoor
quality
Quantitybeingstressedoverquality
Immunizationissuewithdoctorswhoalsodealwithobesity
StrategicDelay
Cabralpaper(Dentalinsurancecare)
Dentalinsurancepaysforfirst$1000care,butthenyouhaveto
payfortherest
Oppositemodelofinsurancesmallshocksyouarecovered,but
shocksyouarenotcovered
Plottingweeklydentalcarecoverage
Consumersarewaitingforrenewedcoverageinorderto
accommodatetheirneeds
Usedtheir$1000foroneyearandthenwaiteduntilitwas
renewedtousetheirnext$1000
Certaintypesofhealthcareconsumptioncanbedelayedsoit
becomescheaperforapersontoconsume
Closingceremonies
Definedinelasticity
Goodtoolforcomparisons
Exantemoralhazard
Doesntmatterasmuchinhealthinsurance
Expostmoralhazard
Mattersinhealthinsurance
Randismajorexperimentforhealthpolicy
EdwardSnowdenexampleofmoralhazardintheCIAwithrecruitingdouble
agents

LECTURE10/16/14AdverseSelection

LECTURE10/23/14Demand

FeldsteinisaconservativeprofessoremeritusofeconomicsatHarvard
ProposedthisplaninthehopesthatRepublicanswouldadoptthisplanasa
countertotheAffordableCareAct(ACA)
Howdoeshethinkaboutadverseselection?
Inthecurrentsystem,somehealthierindividualshavedroppedout
Hisplanisthateveryonegetsavoucherthatensuresthateveryonehas
healthinsurance
Everyonewouldbecovered
ManydetailsnotdiscussedjustanOpEd
Healthcarecreditcarddealswithmoralhazard
FrontPageGraph(PercentofNHISRespondentsWhoHaveEverHadaColonoscopy)
Gradientpatternexistsbaseduponlevelofeducation,unrelatedtocost
Whydomoreeducatedpeopleconsumemorehealthcareandarehealthierthan
lesshealthypeople?
HumanCapitalRevolution
Ifyougobackbeforethe1960seconomistsfocusedprimarilyonstereotypical
economictrends(boring)
Economistsstartedtoapproachnewtopicsfromothersocialsciencestoapply
aneconomicbasistohumanbehavior
Startedthinkingabouteducationandthemotivationpeoplehavebehind
receivinganeducation
C
D
stockofapersonsabilitytoproducegoods
Becomingeducatedisaninvestmentinyourhumancapital
Analogy:Firmsinvestintheirequipmenttoincreaseprofitability
Ideally,investingononeseducationleadstoareturnonthat
investment
Peoplewithaneducationshouldmakemoremoneyonaverage
Onaverage,educatedpeoplemake7%morethanuneducated
peopleforeveryyearofeducation
Standardtermineconomics
Mirrorssocialcapitalfromsociology
Politicianswilltalkaboutpoliticalcapital
GrossmanModel(1972)
Wroteapapertotryandexplainhealthcapital
Comesupwiththisterminthemidstofeconomicadvancesinthenotion
ofhumancapital
Healthcapitalisastockofhealthrelatedwellness
Investmentsincreasehealthcapital(exercise,doctorvisits,eatinghealthy,
avoidingunhealthybehavior,etc.)
Depreciationcanoccurifyoudonotinvestinyourhealthcapital
Healthcapitalcandisappear
Careabouthealthydays
Thehigheryourhealthcapital,themorehealthydaysyouhave,thelonger
youlive,thelessyoullbesick,etc.
Figure1(GrossmanHealthProductionFunction)
Famousamonghealtheconomists
Horizontalaxisisyourhealthcapital
StartsatH
min
(minimumamountofhealthcapitalyouneedtostay
alive)
Verticalaxisistheamountofhealthdays
Thereisamaximumamountofhealthydaysyoucanhaveper
year(365)
Therearediminishingreturnsinthatthegaininhealthydaysisfurtherout
asyouincreaseyourhealthcapital
Initialgainsinhealthcapitalresultinalotofhealthydays
AtpointA,theresahugereturnfrominvestmentatpointC,
theresmuchlessofareturn
Figure2(Graphingreturntoinvestmentforeveryamountofhealthcapital)
Derivativeoffigure1
Graphingthereturnofinvestmentfromfigure1
ThereisamuchhigherreturnatpointAcomparedtopointC
Allowspeopletomakedecisionsonthemargin
Graphscostasahorizontalline
Priceittakestogotothegym,gotothedoctor,orpayforvitamins
ConsumersstartatH
min
anddecidewhetherornottheywanttogo
forwardwithinvestments
h*isarationalchoicefortheamountofhealthcapitalthataperson
needs(intersectionofreturnoninvestmentandcost)
Peopleareutilitymaximizers,nothealthmaximizers
Figurestellusthatsomeonecanmakearationalchoicetonotbeinperfect
health
Grossmanmakestheassumptionthateducationincreasesthereturnon
investment
Investmentshiftsthecurveinfigure2upwardreturnincreasestomore
healthcapitalforagreaterinvestmentineducation
Educationincreasesyourabilitytointerpretyourdoctorsdirections
Betterabletofollowdirections
Goingtoschooljustallowsyoutobemoreefficientininvesting
Paperisincrediblyboring
FuchsThirdVariables
Healtheconomistfromthewestcoast
Thereisarelationshipbetweeneducationandhealthbehavior(association,
correlation)
Grossmanarguesthatitsacausaleffect
Fuchdisagrees
Fuchinsteadarguesthattherearethreevariables
Education
HealthBehavior
Persistence,attitude,selfcontrol
Thesevariablesworktogethertodeterminehealthcapital
TheMarshmallowTest(ProfessoratColumbia)
Attemptstounderstandthewillpowerofpeople
Placesamarshmallowinfrontofchildrentoseeiftheycanresisteatingit
whenleftalone
Promisedasecondmarshmallowiftheycanwait
In1972,itwasdiscoveredthatofchildrencouldnotresistdelaying
gratification
FolloweduptodeterminetheirSATscoresin1990andfoundthatthose
whowereabletoresisthadhigherSATscoresonaverage
RegressionDiscontinuityDesign
Figure3
DiscussingtheNationalMeritScholarship
Curiouswhetherthescholarshiphasacausaleffectonones
futurewages?
Ifyoucouldrandomlyassignascholarshipwouldthosepeopledo
betteryearslater?
Everyonewhoscoresabovea700receivesthescholarship
Ifyoucomparesomeonewhoscored100andsomeonewhoscored900,
theyareverydifferent
Butwhataboutcomparingscoresbetween699and701
Ifwelookverycloseatthisdiscontinuouschangewecan
seeifthereisatrend
Leadstotheformationoffigure4
Figure4
Thegapbetweenthesetwobestfitlinesshowsusthecausaleffectofthe
scholarshiponthewages
Differencebetweenthecutoffisthatcausaldifferencedespitenot
havingarandomizedcontroltrial
McCraryandRoyerPaper
Interestedintherelationshipbetweeneducationandhealth
Whenlookingatbirthdata,thereisthissamegradient
Educatedwomenhaveahigheraveragebirthweightfortheirchildren
Educationisheldtobeakeydeterminantoffertilityandinfanthealth
CiteGrossmanaboutwhetherthereisacausalrelationshipbetween
educationandbirthweight
Claimthatcausalityisunclearunsureofthedirectionofcausality
Inmanystates,thereisathresholdforwhenstudentscangotoschool
InCalifornia,youmustbe5yearsoldbyDecember1sttoattendschool
alsoillegaltodropoutofschoolbeforeyour16thbirthday
Supposewehavetwogirlswithdifferentbirthdays:November30thand
December2nd
WhenDecember1stcomesaround,onegoestoschoolandthe
otherdoesnot
Thefirstgirlisgoingtobe16in10thgradeandimmediatelydrops
outthesecondgirlisgoingtobe16in9thgradeandimmediately
dropsout
Thefirstgirlhasanextrayearofschoolingbecauseshe
wasbornrightbeforethecutoff(December1st)
FourPicturesComparingCaliforniaandTexas
CaliforniaandTexashavesimilarsystems,butdifferentcutoffdates
Showsthatthereisquasiexperimentalcorrelationbetweenproximityto
cutoffdayandeducation
Peoplebornbeforethecutoffdatehaveahighereducationlevel
thanthosebornafter
Thereisnodifferenceinbirthweightthough
Determinethatthereisnoeffectonhealthbecauseofeducationonceyou
eliminatequasivariation
ClarkandRoyerPaper
EstablishmentofmandatoryeducationlawsintheUK(cantleaveschool
untilyour15ifbornpastApril1st,1947and16ifbornpastSeptember1st,
1957)
Createtwodiscontinuitiesineducation
MIDTERM
Firstday:Maximization
Cameupwithamodelofconsumerchoice
Pricesinincomeweremodelledwithabudgetset(triangle)
Utilityfunctions
Indifferencecurves
Combinedthesetoformchoice
Modelforhowaconsumerbehaves
ThePeltzmanEffect
Crowdout
Raisesthepriceofcoveringtheuninsured
Keyterms
Opportunitycosts
Onthemargin
Competition
Secondday:Markets
Demandcurves
Profitmaximization
Costfunctions
Variablecosts
Fixcosts
Marginalcosts
Averagecosts
Economiesofscale
Price=marginalcost
Determinesthefirmsindividualsupplycurve
Supplycurves
Equilibrium
Priceceilings
Watermelonstory,rentcontrol,gasolinepricesafterthe
hurricaneinNY,foodsupplyinZimbabwe
Rentseeking
Thirdday:Externalities
Definedpositive,negative,andnonrival
Consequencesofunderproductionandoverproduction
Solutionsfromthegovernment
Applicationsintherealworld
Internalitiesandbehavioraleconomics
Smokersdeathbenefit
Cantjustifycigarettetaxesbaseduponexternalities,butrather
mustlookatinternalities(controversialnotion)
Defaultbias
Fourthday:Uncertainty
Introducedtheconceptofinsurance
Riskaversion
Expectedutility
Riskoflittlecopaymentsissmallpeoplearemoreconcerned
aboutlargefigures
Comparisons
Biggerrisksimplyhigherdemandforinsurance
Moreriskaversionincreasesdemand
Insurersperspective
Actuariallyfair
Lawoflargenumbers
Actuariallyfairinsurancehasamathematicaldefinition
Insurersareattractedtobigpoolscomparedtosmall
Communityrating
Problems
Reclassificationrisk
Insurancecontractstendtogoyeartoyear
Joblock
GoodSamaritanproblem
Taxsubsidy
Fifthday:MoralHazard
Elasticity
Exantemoralhazard
Expostmoralhazard
Relevanttohealthinsurance
RANDStudy
Fourkeyconclusions
0.2
Whenpriceofhealthinsurancegoesup10%,
usagegoesdown2%
Peoplecutbackoneverything,botheffectiveand
ineffectivecare
Onaverage,therewasnoeffectonhealth
Peoplewhowerehighriskwereimpacted
Offseteffect
VBID(Valuebasedinsurancedesign)
Weneedcomplicatedcopaymentsdependentonhealth
status
Multitasking
Sixthday:AdverseSelection
Akerlof'slemons
Asymmetricinformationcanskewdata
Deathspirals
Decisionofbeinginsuredvs.uninsured
Mandate(ProsandCons)
AdverseSelectionacrossplans
Medicareadvantage
Riskclassification
DebateofprivatizationofMedicare(Creamskimming)
Takeawayallofthegoodcandidates,raisingprices
SeventhDay:Grossmanvs.Fuchs
Knowhowtointerpretelasticityandhowtousesupplyanddemandcurvesknow
actuariallyfairpremiums(usingtheequations)
Haveafamiliaritywitheverygraph
Wontneedtodraweachone
Dontmemorizenamesorobscurefacts
Examresemblespracticequestionsfromhandout(butlonger)
Studyrecommendations:
Gothroughoutlineandensurethatyouunderstandthebasicconcepts
Understandtheargumentwhysupportone
Gooverhomeworksolutions
Closedbook
Onlyusetopicsthathavebeendiscussedinclass
Paperbasedexam