Question 1

What is moral hazard?

Accepted Answer

Moral hazard occurs when one party takes risks because they do not have to bear the full consequences, often after a transaction has been made, potentially harming the other party involved.

Question 2

Which of the following is not an advantage of risk pooling?

Accepted Answer

The statement in option D is not an advantage, but rather a disadvantage of risk pooling. Individuals may overuse health care services if they are insured and do not have to pay the full cost, leading to an increase in overall health care costs. The other options list advantages of risk pooling.

Question 3

Adverse selection occurs in the market for used cars because used car buyers

Accepted Answer

Adverse selection occurs in the market for used cars because used car buyers have less information than used car sellers. This is because sellers have more knowledge about the condition of the car, while buyers can only observe the car's current state. As a result, sellers are more likely to sell low-quality cars, taking advantage of buyer's lack of information. This can lead to a situation where only low-quality cars are available in the market and buyers are unwilling to pay the price demanded by the sellers, leading to market failure.

Question 4

The cost of group health insurance is lower than if an individual buys a policy on his own because

Accepted Answer

Group health insurance spreads the risk among a larger group of people, reducing the likelihood of adverse selection where only those with higher medical risks purchase insurance. As a result, insurers can offer lower premiums to groups than to individuals.

Question 5

If a doctor knows that an insurance company will pay for most of a patient's bill, the doctor has more of an incentive to require additional medical procedures and tests, even if the patient may not require them.This is an example of

Accepted Answer

The answer of If a doctor knows that an insurance...

Question 6

What is the principal-agent problem?

Accepted Answer

The principal-agent problem arises when an agent (person who has been hired by the principal to perform a task on their behalf) acts in their own interest rather than the principal's interest. This can occur due to asymmetric information (where the agent has access to more information than the principal) or due to misaligned incentives. The agent may prioritize their own interests over the principal's, which can lead to inefficiencies, conflicts of interest, and other issues.

Question 7

Suppose a large firm allows its employees to choose whether to participate in its health insurance plan.The firm is trying to decide between two plans: Plan I has a low monthly premium but a high deductible, and Plan II has a high monthly premium but a low deductible.Under which plan is adverse selection likely to be a bigger problem?

Accepted Answer

Plan II is likely to draw participants who expect high medical costs as they would prefer low deductibles, which may result in adverse selection as healthy individuals who do not expect to consume much health care services will not be willing to pay the high premiums. This can result in insurance companies paying out more claims than the premiums they collect.

Question 8

Automobile insurance companies have a problem with people who buy insurance and then drive recklessly or take less care to avoid losses after being insured.In other words, the automobile insurance market is subject to

Accepted Answer

Moral hazard occurs when individuals alter their behavior in a way that increases the likelihood of a loss occurring after being insured. In the case of automobile insurance, individuals who engage in reckless driving or take less care on the road after being insured are creating more risk for the insurance company. This is a classic example of moral hazard. Asymmetric information refers to situations where one party has more information than the other, and adverse selection refers to the tendency for high-risk individuals to be more likely to seek insurance. Market signaling refers to the use of certain behaviors or actions to communicate information to the market. None of these concepts accurately describe the situation with automobile insurance and reckless driving.

Question 9

Figure 7-1
  
Figure 7-1 represents the market for vaccinations. Vaccinations are considered a benefit to society, and the figure shows both the marginal private benefit and the marginal social benefit from vaccinations.
-Refer to Figure 7-1.Marginal private benefit is represented by which curve?

Accepted Answer

Marginal private benefit is the benefit that an individual receives from consuming an additional unit of a good or service. In this case, it is represented by the demand curve D₁, which shows the willingness of individuals to pay for vaccinations based on the marginal benefit they receive.

Question 10

Health insurance companies impose deductibles on policies and co-payments on claims

Accepted Answer

Health insurance companies impose deductibles and co-payments to reduce moral hazard problems, which occur when individuals may make riskier healthcare decisions or overuse healthcare services because they are insulated from the financial consequences. By requiring customers to pay a portion of the cost, the insurance company encourages individuals to make cost-conscious decisions and avoid unnecessary medical expenses.

Question 11

In the principal-agent relationship, the agent is

Accepted Answer

In the principal-agent relationship, the agent is typically the person who is put in control of some resources (such as money, property, or decision-making power) that belong to someone else, with an obligation to use those resources in the best interests of the owner. This is what is meant by being an "agent" - acting on behalf of someone else. Option A is incorrect because it suggests that the agent owns the resources being used; option C is incorrect because it suggests that the agent is compensating the resource owner for poor outcomes rather than being compensated by the resource owner for their services; option D is somewhat accurate but not as clear as option B, which specifically references the principal-agent relationship.

Question 12

The Pre-Existing Condition Insurance Plan is a federally administered part of the Affordable Care Act, and is designed for people with pre-existing medical conditions to obtain insurance.By offering health insurance to all U.S.citizens with pre-existing medical conditions, the Pre-Existing Condition Insurance Plan eliminates ________ for both the insurer and the insured, and eliminates ________ for the issuer of the insurance policy.

Accepted Answer

The Pre-Existing Condition Insurance Plan tackles the issue of asymmetric information, where the insurer may not have access to all relevant information about the insured's medical history, by offering insurance to all those with pre-existing conditions. This eliminates adverse selection for both the insurer and insured parties. The plan does not directly address the principal-agent problem (where the actions of the agent - the insurer - may not align with the interests of the principal - the insured), or moral hazard (where insured parties may take on risky behaviors due to being insured).

Question 13

If a fire insurance company requires firms buying fire insurance to install automatic sprinkler systems, the insurance company is trying to reduce

Accepted Answer

By requiring firms to install automatic sprinkler systems, the insurance company is reducing the moral hazard problem. Moral hazard occurs when the insured party takes more risks because they are protected by insurance. By installing automatic sprinkler systems, the insured party is less likely to take risks that could lead to a fire, reducing the likelihood of the insurance company having to pay out a claim.

Question 14

If a state requires all drivers to purchase auto insurance, insurance companies still face the problem of

Accepted Answer

The answer of If a state requires all drivers to...

Question 15

When people who buy insurance change their behavior after the purchase because they are protected from loss by the insurance, the insurance market is said to face the problem of

Accepted Answer

Moral hazard is the problem faced by insurance markets when insured parties change their behavior to take on more risk because they are protected by insurance. For instance, individuals may engage in riskier behavior or neglect to take precautions against potential losses because they feel that they are protected from the consequences of their actions by their insurance policy. This can lead to increased claims and higher costs for insurers, which can negatively impact premiums and profitability in the market. Therefore, option A is the correct answer.

Question 16

If a buyer in an economic transaction has more information than the seller, the buyer benefits at the expense of the seller.This phenomenon is due to

Accepted Answer

This phenomenon is known as adverse selection, where the buyer has more knowledge or information than the seller, leading to an unfair advantage and potentially resulting in the seller receiving less value for their product or service. Adverse selection can occur when one party to a transaction has better information or greater knowledge than the other party, resulting in an imbalance of power or knowledge.

Question 17

Which of the following is not an advantage to an insurance company of insuring a large group of people for health insurance?

Accepted Answer

Moral hazard is not reduced by all group members paying the premium; it relates to the behavior of insured individuals who may take more risks because they are covered.

Question 18

In markets with asymmetric information,

Accepted Answer

In markets with asymmetric information, there is a lack of information symmetry between buyers and sellers.
This can lead to adverse selection, where buyers or sellers with better information make decisions that are detrimental to those with less information. As a result, less informed participants may choose to opt-out of the market. This is adverse selection.
To counteract adverse selection, firms and individuals may engage in moral hazard. This means that some may alter their behavior in such a way that they become riskier, knowing that they can shift the risk to the other party, who is less informed. Because of asymmetric information, the less informed party may not be aware of these additional risks.
Thus, asymmetric information causes adverse selection, which, in turn, causes moral hazard.

Question 19

One reason why adverse selection problems arise in health insurance markets is that

Accepted Answer

Adverse selection occurs when those who are more likely to use insurance (in this case, sick people) are also more likely to purchase it. This leads to higher costs for insurers, which are then passed on to consumers through higher premiums.

Question 20

Figure 7-1
  
Figure 7-1 represents the market for vaccinations. Vaccinations are considered a benefit to society, and the figure shows both the marginal private benefit and the marginal social benefit from vaccinations.
-Refer to Figure 7-1.Marginal social benefit is represented by which curve?

Accepted Answer

Marginal social benefit is represented by D₂, which is located to the left of the demand curve (D₁) and takes into account the positive externalities (benefits to society) of vaccination. Supply represents the marginal private cost of production, which does not consider the benefits to society beyond the individual receiving the vaccine. Therefore, it does not represent marginal social benefit. While both D₁ and D₂ represent the total benefit to individuals from vaccinations, only D₂ represents the additional benefit to society as a whole.

Quiz 7: The Economics of Health Care