Econ 344
Problem Set #3
Assigned:Tu. Feb. 22, 2011
Due:Tu. Mar. 1, 2011
Corresponding Chapters:Gruber 11-13
Part I Multiple Choices (3*12=36 points)
1.When people behave in ways that involve increased risk because they have insurance, this is known as
a)adverse selection.
b)moral hazard.
c)asymmetric information.
d)a HMO.
2Health care markets may be inefficient because of
a)poor information.
b)adverse selection.
c)moral hazard.
d)all of the above.
e)none of the above.
3An actuarially fair return means
a)returns on investments are indexed to the stock market.
b)returns on investments have to be positive.
c)benefits received, on average, would be equal to the premiums paid.
d)premiums for insurance are generally paid by the government.
e)none of the above.
4When the average buyer of an insurance policy is likely to have higher risk than others in his class, this is known as
a)adverse selection.
b)moral hazard.
c)asymmetric information.
d)a HMO.
e)none of the above.
5.Asymmetric information generally implies
a)information between parties is not equal.
b)all parties are fully informed.
c)information is costless.
d)information is too costly to transmit.
e)a and c.
6.Which of the following is a moral hazard effect of Social Security?
a.Retirees die sooner than they would without Social Security.
b.Workers retire sooner than they would without Social Security.
c.Retirees buy less health insurance than they would without Social Security.
d.Workers work longer and become more unhealthy than they would without Social Security.
e.Retirees suffer on-the-job injuries more as a result of Social Security.
7.Which of the following was a recommendation or action of the Greenspan Commission in 1983?
a.Social Security benefits should be cut.
b.Social Security benefits should be means-tested to a greater degree.
c.Individuals should be able to put their taxes into private retirement accounts.
d.Both a and b are correct.
e.Both b and c are correct.
8.Vouchers allow students to
a.get free lunches at public schools.
b.go to public schools at reduced rates.
c.receive discounts on school supplies like pens and paper.
d.all of the above
e.none of the above
9.A pay-as-you-go system means
a.you pay for your dinner as you go to the table to eat.
b.current working citizens pay for current retired citizens.
c.there is no need for taxes since current workers pay for current retirees.
d.retirees are paid from accounts that have accumulated with interest over their working lives.
e.all of the above.
10.By providing a fixed level of education, the government intervention can lead to which of the following?
a.crowding out of private spending
b.an increase in total spending on a child’s education
c.a reduction of total spending on a child’s education
d.all of the above are correct
e.both a and b are correct
11.If a politician were to suggest that Social Security benefits should be means-tested, which of the following approaches is that politician suggesting?
- Raising taxes
- Extending the base of taxable wages
- Raising the retirement age
- Lowering benefits for all recipients
- Lowering benefits for higher-income groups
True/False/Uncertain----explain if uncertain or false
12.TFUHaving a Social Security program makes people less inclined to save for their own retirement.
III. Open questions
1.Ch 13. (8pts) What are the political and economic ramifications of investing a large part of the Social Security trust fund in the stock market, as has been recently proposed?
2.Ch13#4. (8 pts.) Suppose the Social Security payroll tax were increased to 16.4%in order to solve the pending fiscal imbalance in the program. Explain the effect of this change on the value of the Social Security program for people of different ages, earning levels and gender.
3.Expected utility of insurance. (18 pts.) Johnny is considering whether to buy health insurance. His utility is given by U(I)= √I where I is his yearly income equal to $25,000. However there is a 5% chance that he’ll fall sick with a avian flu virus which will cost him $5000.
a.What is his expected utility of not buying any insurance?
b.What is the actuarially fair premium for the health insurance in this case?
c.Assuming that the premium is actuarially fair, what is the expected utility associated with buying full insurance (ie insuring all $5,000 of potential loss)? What is the expected utility associated with insuring only half of the loss ($2500)? Is Johnny going to choose full insurance or partial insurance?
4.Social Security Reform (12 pts.)
a.What is the difference between pay as you go and fully funded social security systems? What is the reason Social security may be in trouble?
b.Name at least three incremental reform proposals
c.Name at least two fundamental reform proposals and briefly discuss the problems associated with each.
d.Do you think making social security voluntary will work? Explain
.
5.13. Ch11. (18 pts) The town of Greenville has three families, each with one child, and each of which earns $20,000 per year (pre-tax). Each family is taxed $4,000 per year to finance thepublic school system in the town, which any family can then freely attend. Educationspending is $6,000 per student in the public schools. The three families differ in theirpreferences for education. Though families A and B both send their children to thepublic school, family B places a greater value on education than family A. Family Cplaces the greatest relative value on education and sends its child to private school.
a.Graph the budget constraints facing each of the three families and draw a possibleindifference curve which could correspond to the choice each family makes. Notethat family B’s indifference curve is steeper than Family A’s, reflecting theirgreater preference for education (even though they make the same choice).
The town is considering replacing its current system with a voucher system. Under the new system, each family would receive a $6,000 voucher for education,and families would still be able to send their children to the same public school. Since this would be more costly than the current system, they would also raisetaxes to $6,000 per household to pay for it.
b.Draw the budget constraint the families would face under this system.
Suppose that, when the new system is introduced, family A continues to sendtheir child to public school, but family B now sends their child to private school(along with family C’s child).
c.Explain how you know that family C is made better off and family A is made worseoff by the voucher policy.
d.Show, using diagrams, that family B could be made better or worse off by the
voucher policy.