Chapter 6 - Chapter 6 Why purchase health insurance o...

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Chapter 6 09/09/13 Why purchase health insurance? o Utility of income: o SEE HANDWRITTEN NOTES FOR GRAPH o Buy healthcasre? o Two choices: You can buy insurance, but if you buy it then some of your income cannot be spent on another thing (and you may or may not use that insurance) You can take a change and not buy insurance, but if you need medical care you will have to pay out of your own pocket o Risk averse: the pain of losing a dollar is much worse than the pleasure you get from gaining a dollar Most of us are risk averse (prefer not to take a risk, guarantees are better) EX: if our stock goes down by 5% it feels worse than the happiness you get when it goes up by 5% We will always take the guaranteed 09/11/13 Utils: measure of utility that varies from individual to individual o EX: SEE HANDWRITTEN NOTES FOR GRAPH If healthy, receive $40000 per year which yields 90 utils of happiness Contingent on the person being healthy and able to work If sick, pay (out of pocket) $20000 for health care, meaning they are only left with $20000 to spend which yields only 700 utils of happiness Expected utility: the weighted average of all possible outcomes weighted by their respective probabilities o E(U) = P r0 x U 0 + P r1 x U 1 EX: (see above) If this person has a 20% chance of getting sick in any year, then E(U) = .8(90) + .2(70) = 86 Expected income is the possible income outcomes weighted by their respective probabilities o E(Y) = .8(40000) + .2(20000) = $36000 o Loading fee: o The amount you are willing to pay, over and above, the expected cost you are expecting to incur so that you can guarantee o Price of insurance, basically Subsidy from government—when your employer withholds some of your income to pay for your healthcare, that is nontaxable so the government is losing a lot of money from that
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Factors that influence insurance demand: o Price of insurance (loading fee) (LISTEN TO RECORDING 25:00) How much you are paying for someone to absorb the risk o Probability of illness You are less likely to insure against things that are highly unlikely or also highly likely EX: you are less likely to have insurance against a meteor hitting your head—it could happen, but the likelihood is very small; we are more likely to have a hospital insurance that will cover you us in the case of an accident or rare illness o Magnitude of loss
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