Public Microeconomics Spring 2020
Problem Set 4
Due Thursday Feb 18
Please exercise discipline in the answers, more text isn’t necessarily better. This is meant to help
you practice being concise yet clear.
1. There are two types of drivers on the road today, Speed Racers with a 5% chance of an accident
per year, and Low Riders with a 1% change per year. There are an equal number of Speed Racers and
Low Riders. The cost of an accident is $12,000.
a. Suppose an insurance company knows with perfect information each person’s type. What premium would they charge each type?
b. Now suppose there is asymmetric information, so the insurance company doesn’t know each
driver’s type, would insurance be sold if:
1) Drivers self report their types to the company?
2) No information is known about types?
If you are not sure about the answer, say why.
2. What is the empirical evidence about the consumption-smoothing benefits of UI indicate about
the degree to which individuals are on average, insured against the income losses associated with unemployment?
3. Name 2 examples of moral hazard that has been found by researchers with the Unemployment
Insurance social insurance program.
4. Describe what would happen if we raised the maximum benefit level for unemployment insurance to the savings rate of high income workers. How big are the consumption-smoothing benefits of
this policy change likely to be? Are there other potential benefits of raising this maximum benefit level?
5. Matt works at a large university, where his insurance premium for health insurance is $120 per
month and his pre-tax pay is $300 per month. He discovers if he quit his job his insurance premium
would be $600 per month for the same quality of job. Why is there a difference in the premium?
6. Many privately purchased health insurance plans have stringent “preexisting conditions” exclusions, which deny coverage to insured persons for any health conditions that were known at the time
of enrollment.Why does this exclusion reflect a market failure in the insurance market?
7. Possibly moved to PS 5. Describe the empirical evidence about the effects of the Oregon Health
Experiment on health of low income adults. Given this, what do you expect to be the impacts of the
Medicaid expansion of eligibility up to 138% of poverty via ACA on costs? On health?
8. Possibly moved to PS 5. Mr. J has three kinds of medical spending: contact lenses, prescription
drugs for a condition he has, and accidents and acute illnesses (such as broken bones or pneumonia). He
has been paying for all of his medical expenditures out of pocket and he is now considering purchasing
health insurance. Different plans he is considering offer coverage for different types of expenditures.
Describe in detail the consumption-smoothing benefits and moral hazard costs of coverage for contact
lenses, prescription drugs, and accidents and acute illnesses.