7550 Final Exam (May 4, 2004) Page 1

7550 Final Exam (May 4, 2004) Page 1

Economics 7550 – Winter 2004

Final Exam

Dr. Goodman

You are to do all 7 questions. Each question receives equal credit and each part of each question receives equal credit within the question, so allocate your time accordingly. Partial credit will be given as appropriate. Set up each problem as carefully as you can, and show the steps to solution if you cannot actually solve it in the short time that the test takes.

I am unlikely to give any help during the exam unless a question is clearly misleading, so you should make clarifying assumptions and proceed with your analysis. Any incidents of cheating will result in a 0 on the exam. Good luck!

1. Consider the market demand for care, described by the accompanying chart.

PriceQuant. DemandedQuant. Supplied

40016

35214

30412

25610

208 8

1510 6

1012 4

514 2

016 0

In all parts of this problem, a graphical solution will be perfectly acceptable.

a. If there is no insurance, calculate the equilibrium price, quantity, and level of expenditures.

b. If a 25% coinsurance rate were instituted, calculate the new equilibrium levels of price, quantity, and total expenditures?

c. Calculate the welfare gain to the individual to increased consumption of medical care due to excess consumption brought about by the fractional coinsurance rate.

d. Calculate the welfare loss to society of the excess consumption brought on by fractional coinsurance.

2. Care for the elderly in “assisted care” settings (like apartments or nursing homes) can be very expensive so many policy makers have proposed “home care.” Assume that people either live in their own homes, which are entirely paid for, or in assisted care. As an analyst, you are asked to prepare a cost-effectiveness analysis.

a. Sketch out the major categories of costs for each setting, recognizing both explicit costs, and opportunity costs.

b. What measures of effectiveness would you use? Why?

c. Discuss briefly Pezzin and colleagues’ findings about how publicly provided home care may substitute for family care.

3.

Suppose that Albert’s utility function is Ua = 0.6 ln z + 0.4 ln m

Suppose that Betty’s utility function is Ub = 0.2 ln z + 0.8 ln m.

The economy has 100 units of medical care and 40 units of other goods, and Albert and Betty both start with equal amounts of both medical care and other goods.

a. Plot the initial allocations for each person. Are their total utilities equal? Why or why not?

b. Sketch out a contract curve for Albert and Betty if they can trade. Sketch out a new equilibrium if trade occurs.

c. If the allocation in part (a) is considered to be equitable, what can we say about equity and efficiency in a market in which trading is permitted?

4. Dr. Goodman ran time series regressions on health expenditures per capita v. GDP/capita for the UK and the US. He found:

ln expenditures/person (UK) = 2.148 + 0.897 ln (GDP/person)

ln expenditures/person (US) = 1.538 + 1.395 ln (GDP/person).

a. Provide a brief interpretation for each of these equations.

b. In the context of luxury goods or necessities, are health expenditures considered necessities or luxuries in the UK and the US?

c. Provide explanations regarding technology as to why the coefficient for the US is higher than for the UK.

d. How would you use these equations to explain the trends in expenditure shares in the two countries?

5. In discussing the impacts of policies, we considered the concepts of “take-up” and “crowd-out.”

a. Briefly, define each term.

b. Using indifference curve analysis, show how one would measure the “take-up” and “crowd-out” effects of the expansion of a health policy initiative.

c. How did Currie and Gruber use these concepts to measure the impacts of improved Medicaid coverage?

6. Suppose that a monopoly hospital faces the following demand curve:

P = 480 – 5Q, and the following cost function

TC = 100 + 20Q

a. Calculate the monopoly’s profit maximizing price, quantity, and profit.

b. What would society’s optimal production be? Why?

c. Suppose that for a fixed cost investment of $200 per period, the monopolist could

reduce marginal cost by $1 per unit. Sketch out a graphical depiction of this

possibility.

d. Suppose now that the “yardstick” price facing the hospital was $19.00 per unit

output. Sketch out in as much detail as possible the hospital yardstick

optimization, using all of the information you have been given.

7. We introduced you to the economics of “bads” this year.

a. Discuss briefly the economics of “rational addiction,” why anyone would ever rationally choose to use an addictive substance.

b. Using the economic analysis, demonstrate why the long-run responses to items such as cigarette price changes may be larger than the short run responses.

c. Alcoholism and drug abuse constitute major substances that are abused. What types of costs are similar for the two categories? Which types of costs differ for the two categories?