Medigap is a private insurance product that causes governmentexpenditures through Medicare to be higher than...

Medigap is a private insurance product that causes government expenditures through Medicare to be higher than otherwise. Let’s see how we can estimate just how much more the government spends as a result. 70 yr old Mr. Smith has frequent need for doctor-administered injections that improve his hip functioning. His demand for these treatments is given by P=30-0.60Q where P is the full market price of the service (if Mr. Smith had no insurance), and the supply of these treatments is given by P=15.

Lets see what happens if the government tries to get people to stop buying Medigap. Suppose that Medicare consists of 10 million people like Mr. Smith (and that is it). The elasticity of demand for Medigap is -1.5 and a Medigap policy costs $100 a year. The government imposes a 20% tax on Medigap plans. How much government revenue would be raised by the tax, and how much government spending on Medicare would be saved through the effect the tax has on people’s purchases on Medigap plans?

Expert Solution

Answer : Tax revenue = 20% on $100 = $20 per policy

$20 × 10 million = $200 million

Total Tax revenue will be $200 million by government.

Elasticity of demand is 1.5 that means it is elastic which means rise in prices will have major negative impact on quantity demanded.

Quantity demanded will be decreased 1.5 times then rise in prices.

People will reduce their demand with rise in prices due to imposing of taxes by government for Medigap plans as price elasticity of demand for Medigap plans is elastic.

Rahul Sunny answered 2 years ago

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