HCMG LATEST QUESTIONS AND ANSWERS UPDATE: A
MASTERING A+ MATERIAL!
Rothschild-Stiglitz Model: 2 Constraints
1) incentive compatibility (IC)
2) firm's participation
1) incentive compatibility (IC) constraint
- We don't want high-risk individual to "disguise" themselves as low-risk.- We do that by
choosing a contract that lies on UH, the indifference curve for the high-risk individual
2) Firm's participation
- We want to allow the firm to break-even while not making abnormal economic profits.
- We do that by placing the firm on the zero-profit line for the low-risk individuals
When we combine both constraints we obtain a single point (E sub L) -- the pair is stable.
Why?
Each of the risk-types strictly prefers a different insurance contract, each type self-select into
one of the two contracts
Pooling Equilibrium
It is an actuarially fair insurance for all. Assume that gamma is the proportion of low-risk
individuals and the insurance company knows this gamma
if gamma = 0 -- everyone is high risk (approach zero profit line for HR)
Contract is great for insurance company but bad for patient
Separating Equilibrium
equilibrium separates high and low risk
Cream skimming
contract only attracting LR individuals
-- above LR zero profit line
Why would a monopolist offer full insurance (with one risk type)?
there is no moral hazard, no selection problem
What would a monopoly do differently?
, A monopoly would elicits the entire Consumer Surplus (i.e. the price that makes the individual
exactly indifferent between purchasing insurance and self insuring)
Indifference curve represents
set of premium/coverage pairs which include no insurance (0,0)
Monopoly vs competition
Monopoly -- maximizing profit s.t. some underlying utility level (U = 0)
Competition = maximizing expected return s.t. zero profit
Insurers process ____ and engage in ______ _____ __________
Insurers process claims and engage in risk bearing activities
Faced with many risk types, one type of insurance would lead to an ....
unstable insurance market
Results from the Rothschild & Stiglitz Model
- High-risk individuals purchase full coverage.
- Low-risk individuals purchase partial coverage at lower premium
- High-risk individuals are indifferent between the two types ofpolicies
It is hard to maintain a _________ equilibrium
"pooling"
Insurance companies with monopoly power cannot ....
extract the entire consumer surplus from high-risk individuals when faced with adverse
selection
Division of labor
an economic concept which states that dividing the production process into different stages
enables workers to focus on specific tasks
Hospitalists:
physicians whose primary professional focus is the general medical care of hospitalized patients
Limits of the division of labor
MASTERING A+ MATERIAL!
Rothschild-Stiglitz Model: 2 Constraints
1) incentive compatibility (IC)
2) firm's participation
1) incentive compatibility (IC) constraint
- We don't want high-risk individual to "disguise" themselves as low-risk.- We do that by
choosing a contract that lies on UH, the indifference curve for the high-risk individual
2) Firm's participation
- We want to allow the firm to break-even while not making abnormal economic profits.
- We do that by placing the firm on the zero-profit line for the low-risk individuals
When we combine both constraints we obtain a single point (E sub L) -- the pair is stable.
Why?
Each of the risk-types strictly prefers a different insurance contract, each type self-select into
one of the two contracts
Pooling Equilibrium
It is an actuarially fair insurance for all. Assume that gamma is the proportion of low-risk
individuals and the insurance company knows this gamma
if gamma = 0 -- everyone is high risk (approach zero profit line for HR)
Contract is great for insurance company but bad for patient
Separating Equilibrium
equilibrium separates high and low risk
Cream skimming
contract only attracting LR individuals
-- above LR zero profit line
Why would a monopolist offer full insurance (with one risk type)?
there is no moral hazard, no selection problem
What would a monopoly do differently?
, A monopoly would elicits the entire Consumer Surplus (i.e. the price that makes the individual
exactly indifferent between purchasing insurance and self insuring)
Indifference curve represents
set of premium/coverage pairs which include no insurance (0,0)
Monopoly vs competition
Monopoly -- maximizing profit s.t. some underlying utility level (U = 0)
Competition = maximizing expected return s.t. zero profit
Insurers process ____ and engage in ______ _____ __________
Insurers process claims and engage in risk bearing activities
Faced with many risk types, one type of insurance would lead to an ....
unstable insurance market
Results from the Rothschild & Stiglitz Model
- High-risk individuals purchase full coverage.
- Low-risk individuals purchase partial coverage at lower premium
- High-risk individuals are indifferent between the two types ofpolicies
It is hard to maintain a _________ equilibrium
"pooling"
Insurance companies with monopoly power cannot ....
extract the entire consumer surplus from high-risk individuals when faced with adverse
selection
Division of labor
an economic concept which states that dividing the production process into different stages
enables workers to focus on specific tasks
Hospitalists:
physicians whose primary professional focus is the general medical care of hospitalized patients
Limits of the division of labor
