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1 NAME:____ANSWER KEY____________________________ Health Economics Second Test, Georgia State University, Rashad Thursday, February 26 th , 2009, 4:30 – 6:00pm Please put all answers on the question sheet. You have two hours to finish the test. You may use your textbook, notes, and handouts in answering. Please use full sentences when answering. Best of luck. 1. Tom and Nancy decide to pool risk. Each individually faces a 15% probability of losing \$100 and an 85% probability of losing nothing. a) (4 points) What is the expected value of the outcome for each individually? (Show work.) 0.15*100 + 0.85*0 = \$15 each b) (4 points) What is the variance equal to? The standard deviation? (Show work.) Variance = 0.15*(100-15) 2 + 0.85*(0-15) 2 = 1275 Standard deviation = (1275) 0.5 = 35.71 c) (4 points) What is the expected value if they decided to pool risk? (Show work.) 0.0225*100 + 0.1275*50 + 0.1275*50 + 0.7225*0 = \$15 each d) (4 points) What is the variance equal to? The standard deviation? (Show work.) Variance = 0.0225*(100-15) 2 + 0.1275*(50-15) 2 + 0.1275*(50-15) 2 + 0.7225*(0-15) 2 = 637.5 Standard deviation = (637.5) 0.5 = 25.25 e) (4 points) Comment on the difference in standard deviations in (b) and (d). What implications does this have? The standard deviation is lower in part (d) due to the reduced uncertainty associated with lower risk, in line with the law of large numbers. 2. (4 points) Employer-based health insurance is currently fully exempt from federal and state income tax. If the price of health insurance is \$1000 and the marginal tax rate is 30%, what is the user price of health insurance equal to? What would be the user price if employer-based health insurance were not exempt at all from income tax? The user price would be (1-0.3)*(1000) = \$700 if health insurance were exempt. The user price would be (1-0)*(1000) = \$1000 if health insurance were not exempt. 3. (4 points) How would the following factors affect the quantity of health insurance purchased? a) A decrease in the degree of risk aversion This would decrease the quantity of health insurance purchased. b) An increase in the amount of medical expenses paid if sick This would increase the quantity of health insurance purchased. 4. (4 points) What can you say about the price elasticity of demand for health care, based on empirical studies? Comment on the implications this has for the moral hazard argument. Based on empirical studies, the price elasticity of demand for health insurance is

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