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 doesnt guarantee health, but provides $ to purchase health care We assumed diminishing marginal utility of health and other goods In addition, lets 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 doesnt 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 individuals subjective probability of illness (P 1 ) will depend on her health stock, age, lifestyle, etc. Then without insurance, the individuals 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) = .8090 + .2070 = 86 E(Y) = .8040,000 + .2020,000 = $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 consumers 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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