Journal of The Financial Economics

Running Head: ECONOMICS
ECONOMICS
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ECONOMICS 2
1.) Consider a competitive health care firm providing a hip surgery with a standard
downward sloping demand curve and a constant marginal cost (i.e horizontal supply curve)
(Refer figure 9.2 in Module 9 for this question).
a. [2 points] Assuming that no one in the market has insurance, draw a demand and supply curve
on your graph and show an equilibrium price and quantity of a market for the hip surgery.
Remember to label your axis clearly.
Equilibrium is reached when MC= P
In the short run, the market will not be competitively efficient and hence; MC= AC. However, in
the long run, MC= P

ECONOMICS 3
b. [3 points] Suppose that health insurance is made available that covers 100% of all health care
expenditure on hip surgery. Draw the demand curve which results from this insurance plan on
the same graph, and indicate the new equilibrium price and quantity. Show the deadweight loss
(welfare loss) under this insurance scheme on your graph. What do you observe?
A shows the deadweight loss
P2 shows the new equilibrium price while Q1 is the new equilibrium quantity. With the increase
in the equilibrium quantity, the marginal cost also rises from C to C1.
c. [5 points] now supposes an insurance plan covers only 50% of all health care expenditure.
Draw supply and demand under this insurance plan on a new graph. Indicate the new equilibrium
price and quantity. Also, indicate the deadweight loss caused by this insurance scheme on your
diagram. What do you observe?

ECONOMICS 4
The new equilibrium price is P* and the new equilibrium quantity is Q*. The new
deadweight loss is L*.The difference between the deadweight loss in between B and C is that the
deadweight loss in C is lesser in size than the deadweight loss in B (Moscati, 2016).
d.[5 points] How does your answer to the deadweight loss in part (c) compare with part (b)?
The deadweight loss in B is lesser than the deadweight loss in B. This is because, with a
reduction in the insurance cover payment, lesser people will stop visiting the hospital.
e. [5 points] Do you think moral hazard arises only in private insurance markets? Why or why
not?
Moral hazard arises in all health insurance markets. This is because when people are
insured, they will consume care that is worth less to the consumers that the cost of production
(Kostovetsky, 2015).