Question

1. Suppose Joe Sixpack would like to make a decision about how much he should invest in his health based on the Grossman’s model (1972) and human capital theory.

a. Fill out the table above by assuming the initial wage level (W1) of $100. Given total cost of (health) capital (C) of $2,500 (including visits to doctor’s office, medicine, daily exercise, and vitamin supplements) and 7 percent depreciation rate (?) and 5 percent real interest rate (r), calculate the optimum level of health stock and demonstrate your results in graph (as in Figure A2-3 in your associated readings). (Please do not forget to fill out the table-if necessary- and demonstrate your results in the same graph in the following steps)

Health Stock(H)	Illness Days(TL)	Healthy Days(365-TL)	Marginal Product of Health(MPH)	Marginal Efficency of Capital(Mec1=Mph*W1)	Marginal Efficiency of Capital Mec2=Mph*W2)
10	112	253	0	0	0
11	72	293	40	4000	0
12	47	318	25	2500	0
13	32	333	15	1500	0
14	22	343	10	1000	0
15	16	349	6	600	0
17	7	358	4	400	0
18	4	361	3	300	0
19	2	363	2	200	0
20	1	364	1	100	0

B. Suppose there was an economic crisis and the real interest rate (r) fell down to zero percent (as it happened recently right after the Great Recession). Everything else is being constant; calculate the optimal level of health stock for the same person. Explain the rationale for the difference between the new level of health stock and the previous one (calculated in part a)? Why?Do not forget to mention what happened to the cost first and why).

C. Given total cost of (health) capital (C) of $2,500 (including visits to doctor’s office, medicine, daily exercise, and vitamin supplements) and 7 percent depreciation rate (?) and 5 percent real interest rate (r), calculate the optimum level of health stock if Joe loses his job (W2=$0). Compare the new result with the ones in part (a) and (b) above. Provide an explanation according to human capital theory.

Answer 1