Question

The U.S government wants to determine whether immigrants should be tested for a contagious disease, and it is planning to base this decision on financial considerations. Assume that each immigrants who is allowed to enter the United States and has the disease costs the country $100,000. Also, assume that each immigrants who is allowed to enter the United States and does not have the disease will contribute $10,000 to the national economy. Finally, assume that x percent of all potential immigrants have the disease. The U.S government can choose to admit all immigrants, or test immigrants have the disease before determining whether they should be admitted. It costs T dollars to test a person for the disease, and the test result is either positive or negative. A person who does not have the always tests negative. However, 10% of all people who do have the disease test negative. The government’s goal is to maximize the expected net financial benefits per potential immigrant.

a. If x=5, what is the largest value of T at which the U.S government will choose to test potential immigrants for the disease?

b. How does your answer to the question in part a if x increases to 10?

c. If x=5 and T=$500, what is the government’s optimal strategy?

Answer 1