Lec6_Dem_Ins_handout

Lec6_Dem_Ins_handout - The Demand for Medical Insurance The...

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Unformatted text preview: The Demand for Medical Insurance The Demand for Medical Insurance Professor Vivian Ho Health Economics Fall 2009 These slides draw from material in Santerre & Neun, Health Economics: Theories, Industries and Insights, Thomson, 2007 Topics to cover: Topics to cover: ● A theoretical model of health insurance ● When theory meets the real world... Logic Logic ● The consumer pays insurer a premium to cover medical expenses in coming year – For any one consumer, the premium will be higher or lower than medical expenses ● But the insurer can pool or spread risk among many insurees ➨ The sum of premiums will exceed the sum of medical expenses Characterizing Risk Aversion Characterizing Risk Aversion ● Recall the consumer maximizes utility, with prices and income given – Utility = U (health, other goods) – health = h (medical care) ● Insurance doesn’t guarantee health, but provides $ to purchase health care ● We assumed diminishing marginal utility of “health” and “other goods” ● In addition, let’s assume diminishing marginal utility of income Utility Income ● Assume that we can assign a numerical “utility value” to each income level ● Also, assume that a healthy individual earns $40,000 per year, but only $20,000 when ill $20,000 $40,000 70 90 Income Utility Sick Healthy Utility Income $20,000 $40,000 90 70 Utility when healthy Utility when sick A B ● Individual doesn’t know whether she will be sick or healthy ● But she has a subjective probability of each event – She has an expected value of her utility in the coming year ● Define: P = prob. of being healthy P 1 = prob. of being sick P + P 1 = 1 ● An individual’s subjective probability of illness (P 1 ) will depend on her health stock, age, lifestyle, etc. ● Then without insurance, the individual’s expected utility for next year is: ● E(U) = P U($40,000) + P 1 U($20,000) = P •90 + P 1 •70 ● For any given values of P and P 1 , E(U) will be a point on the chord between A and B Utility Income $20,000 $40,000 70 90 A B ● Assume the consumer sets P 1 =.20 ● Then if she does not purchase insurance: E(U) = .80•90 + .20•70 = 86 E(Y) = .80•40,000 + .20•20,000 = $36,000 ● Without insurance, the consumer has an expected loss of $4,000 Utility Income $20,000 $40,000 90 70 A B $36,000 C • 86 ● The consumer’s expected utility for next year without insurance = 86 “utils” ● Suppose that 86 “utils” also represents utility from a certain income of $35,000 – Then the consumer could pay an insurer $5,000 to insure against the probability of getting sick next year – Paying $5,000 to insurer leaves consumer with 86 utils, which equals E(U) without insurance Utility Income $20,000 $40,000 90 70 A B $36,000 C • • 86 $35,000 • D ●...
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Lec6_Dem_Ins_handout - The Demand for Medical Insurance The...

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