Microeconomics – Insurance and social policy30

Economics 103Professor FriedmanFall 2015Your Name:__________________________________________Your TA:____________________________________________Your Section Time and Day:_____________________________Problem Set 3Due Date: December 14 at 5PMHand in hard copy in your TA’s mailbox, 8th floor of ThompsonDo not submit answers on line through MoodleNote that there are two types of problems. You are encouraged to work with someone else inyour TA section on the quantitative problems (1, 2, 3); hand in one set of answers to theseproblems with both your names. You should do the essay question (4) individually and appendseparate answers with each person’s name for these to your group answers to the quantitativeproblems. Type your answers; hand-written answers will be accepted only by specialarrangement. Staple pages together. Be sure to keep a copy of your answers in case of problem.Total 20 points.1) (7 points) Insurance and social policyYou are making a movie with a 20% chance of making a ton-load of money, and 80% chance ofearning nothing. Your utility is the square root of income (Utility = Y1/2); you will have$1,000,0001/2 happiness if your movie succeeds but 01/2 happiness if it fails.a) (1 point) What is the expected value of your movie? What is your utility at that income?Note that in EXCEL, the square root function is “=X^.5” for the number Xb) (1 point) What is your expected utility from your movie? (Note: this is the weightedaverage of utility when the app succeeds and when it fails where the weight is theprobability of success.)c) (1 point) What would be the price, P, of a risk-neutral insurance plan where you have aguaranteed income of a successful movie and the insurance company breaks even withoutmake profit?d) (1 point) What is the maximum price you would be willing to pay? (Hint: what is theexpected utility with and without insurance? The premium is the maximum amount thatyou would sacrifice to be guaranteed as much utility as without insurance.)e) (1 point) Considering your answer to part A, in general, why do people buy insurance?How can insurance companies profit? What happens to expected utility when people canbuy insurance at a fair market price?f) (2 points) How else can insurance companies make profits? What is moral hazard andwhat is adverse selection. How do these affect insurance markets? Give examples fromthe marketing of automobile insurance. Would you expect markets with moral hazardand adverse selection to provide the optimal amount of car insurance at an efficient price?2) (5 points) Equilibrium discrimination and crowding. Suppose there are two occupations,nurses and doctors.a) (2 points) Draw hypothetical supply and demand graphs for men and women to bothoccupations assuming that some of each gender prefers each job. Now, assume that1discriminatory actions take place preventing men from becoming doctors. Show theeffects of discrimination on your graph.b) (1 point) Who benefits and who loses from this discrimination? Show the effect ofdiscrimination on wages and employment in both occupations and on total output in each.(Hint: have one graph for nurses, and a separate for doctors.)c) (1 point) Wanting higher wages, nurses successfully lobby government to crack down ondiscrimination practices. If discrimination is eliminated, show the changes that will takeplace in the labor markets for nurses and doctors. Who benefits and who loses from theban on discrimination?d) (1 point) Are there circumstances where the government should not preventdiscrimination?3) (4 points) Long-run competition. Most of the cost of a new phone is in the research anddevelopment and in building production facilities. By contrast, the marginal cost ofproducing another phone is relatively low, even minimal.a) (1 points) You have been hired by Samsung to recommend pricing and marketingstrategies for a new phone. On one graph: Draw a hypothetical Average Total Cost (ATC)curve, the Marginal Cost curve, and a Demand (MU) curve for the phone. (Hint: Thepoint where Demand intersects MC should be below the ATC curve.)b) (1 point) Show the area of net profit (or loss) under perfect competition for phones as thedifference between average total cost and the average revenue (or the price). (Note thatSamsung’s profit is the number of phones sold times price minus ATC.) What will happento the price of IPhones and Apple sales and profits when Samsung comes out with a newphone? What happens to the industry and the number of companies under competitiveconditions? Why?c) (1 point) Duplicate the ATC, MC, & MU graph from part b, but this time, show whathappens if Samsung can charge a monopoly price. Show the area of net profit as thedifference between average total cost and the price multiplied by the number of cars sold(Profit = (P – ATC)*Q). How does this change consumer, producer, and total surplus?d) (1 point) Discuss at least three strategies Samsung could follow to give it moremonopoly power and allow it to raise prices.4) (4 points) Health insurance. Read Gerald Friedman, “Universal Health Care: Can we affordanything less?” (Real World Micro, 8.6):a) What has happened to the cost of health care in the United States since the early 1970s?What has happened in other countries, countries who do not have private healthinsurance?b) Why would people expect private, for profit health insurance companies to be moreefficient than a government system? Why has private health insurance led to highercosts?c) Why has private health insurance led to worse health outcomes for Americans?2

 

 

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