Question

QUESTION 3

1. Politicians are considering a policy that would fully privatize Medicare. From an economics perspective, what would be the likely effect? (Think of moral hazard, adverse selection, prices, and number of people who have insurance)

QUESTION 4

1. What is adverse selection? What are three different policies that reduce or eliminate adverse selection?

QUESTION 5

1. What is moral hazard? What are three different policies that reduce or eliminate moral hazard?

Please help with these questions with detailed explanations by your own words rather than copy and paste from other websites.

Answer 1

Question 3. If the health benefit (that is, Medicare) is fully privatized. Then such a scenario is different from the government provided Medicare service. A government willing to extend the health benefits whether the individual has a high risk (that is, high chances of getting ill) or low risk (that is, comparatively lower probability of getting ill). But, in the case of privatization of Medicare service provider would less willing to extend the benefits to high-risk type (as they are the profit maximisers and not the social welfare maximiser) which is why they would likely to charge a premium which is different low-risk type in the case when the insurer could distinguish the type of customer is dealing with.

But, in the case of incomplete information with the insurer about the type of the insuree whether a low-risk type or high-risk type. Thus, a private insurer is willing to charge an average premium which is less than companies willing to charge from the high-risk type and more than the willingness to charge from low-risk type. And the average premium is more than the premium that the low-risk type willing to pay which is why the low-risk type exits from the insurance market and the insurer deals only with the high-risk type, that is, the case of adverse selection.  

And once the high-risk type is insured then the individual has less incentive to take necessary action to minimise the loss. This is because the burden of loss (that is, treatment payments) are reimbursed by the insurance company which is why the policyholder has no incentive to take actions to reduce loss. That is the case of moral hazard.

Question 4. The adverse selection is defined as the situation of incomplete information either with the buyer about the seller or about the seller with the buyer. Which results in the inefficient outcome that would not exist if there is complete information with both the buyers and sellers. As in the example of insurance, the insurance company end up dealing with only high risk type which they wouldn't have in the case of complete information which is why the said outcome is inefficient (that is, adverse selection) in the case of asymmetric information.

Three different solutions of adverse selection are as follows-

1) Signalling - when the buyers have incomplete information on the quality of products that the seller are selling. The consumer's willingness to pay is different for a different quality product. The incomplete information with the buyer the consumer is willing to pay the average price which is less than the marginal cost of the good quality seller to provide a good quality product. Thus, good quality seller exits from the market and only bad quality sellers participate in the market. Thus, by signalling about the quality of product good seller can charge his marginal cost and is able to sell their good quality product. The good quality product seller can provide the warranty for the product. The extending warranty is possible only if the product is of good quality. Thus, the buyer can distinguish the good quality from the bad quality product and thus willing to pay price different from the average price and good quality of product seller can charge his marginal cost and is able to sell their good quality product. Thus, the problem of adverse selection is reduced.

2) Screening - when the employee is unaware of the productivity of the employee whether the highly productive worker or low productive worker. Then the employee is willing to pay the average wage rate, that is the average wage rate that the employee willing to pay the good and low-risk type employee. And the average wage rate is less than the reservation wage of a highly productive worker. Thus, they choose not to offer their services and the employer only employs a low productive worker. The employer can screen the employees on the basis of a certain standard like minimum educational qualification (linking it with the productivity of worker). Thus, screening could help the employer employing a highly productive worker.

3) The government can produce the information to reduce the incomplete information with the buyer and seller and can allocate it at no price. Thus, complete information with agents dealing in the market could reduce the problem of adverse selection. Just like standardised products like gold, LPG cylinders are sold in the market meeting the minimum standards that the government lays down regarding the quality of the product, which assures the buyer about the quality.

Question 5. The moral hazard is defined as the situation under which the insurer changes his behaviour regarding minimising the loss. As the loss, it occurred will be reimbursed by the company. Thus, the burden of loss is not bear by the insuree. Therefore, no incentive to take necessary action to minimise losses which is an inefficient outcome.

Three different solutions of adverse selection are as follows-

1) Try to set up the incentive for the insurance policyholder to act in the desired manner, that is, to minimise the risk. The insurance company can charge deductibles, that is, the losses are reimbursed by the insurance company only when a certain proportion of losses are paid by the policyholder. That is the burden of loss is also bear by the policyholder and thus policyholder has every incentive to take necessary action to minimise risk. Thus, the problem of moral hazard is reduced.

2) The moral hazard also exists in the labor market. The permanent employees have no fear of losing the job once they are recruited. Thus, they have no incentive to work hard to increase the return to the firm, that is, case of moral hazard that the employee is not taking necessary action (that is, working hard) because of no fear of losing the job. The employee can link their remuneration with performance in terms of output. Thus, the employee has every incentive to work hard and this reduces the problem of moral hazard.

3) The policyholder could be penalized for the action if the necessary action is not undertaken by the policyholder. Thus, the cost of not taking necessary action to minimise risk and it will increase the incentive for the policyholder to minimise risk and it will reduce the problem of moral hazard.