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ECON 157: Health Economics Midterm 2 Solutions Dr.

Snider

Question 1 (55 points)

Consider the case of a competitive health insurance market, similar to what we studied in
the graphical framework in Week 3B and after. Assume that, as in the Affordable Care
Act, the government allows many insurers to compete (perfect competition) to offer the
one kind of insurance contract allowed. (This is just the same as the framework we have
discussed all along, starting in Week 3B.)

Consumer demand for insurance is described by:

P = 500 − 4Q
Qmax = 80

As is typically assumed, demand represents both willingness-to-pay for insurance as well as


how much consumers value insurance from a social perspective.

Assume that marginal and average costs are characterized by:

MC = 380 − 2Q
AC = 380 − Q

Throughout all parts of this question, where possible, if you show a very clearly labeled
graph that shows how to solve for an answer, but don’t get the right numerical answer, you
will get 50% of the possible points.

1. (6 points) Compute the competitive market price Peqm (3 points) and quantity Qeqm
(3 points) in this market (under the usual assumptions about competitive equilibrium
we’ve maintained in class).
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

Answer:
Set demand (willingness to pay) equal to average cost:

500 − 4Q = 380 − Qeqm


120 = 3Qeqm
Qeqm = 40

Substitute the equilibrium quantity into demand to determine the equilibrium price.
(You could alternatively substitute into AC.)

Peqm = 500 − 4(40)


Peqm = 340

Grading: Half credit for correct equation but wrong number. OR half credit for a
correct, clearly labeled graph.

2. (4 points) Compute the socially efficient quantity of insurance Qef f , under the usual
assumptions we maintain.

Answer:
Set demand (willingness-to-pay) equal to marginal cost:

500 − 4Q = 380 − 2Qef f


120 = 2Qef f
Qef f = 60

Grading: Half credit for correct equation but wrong number. OR half credit for a
correct, clearly labeled graph.

3. (10 points) Compute the welfare loss from adverse selection in the competitive market,
relative to the socially efficient benchmark you just calculated. You can report your
answer as either a negative number (welfare impact of adverse selection) or a positive
number (welfare loss of adverse selection).
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

Answer:
The welfare loss from adverse selection is calculated as the difference between the
efficient and the equilibrium quantities, multiplied by the difference between average
willingness to pay (WTP) and average MC among people between the efficient and
equilibrium quantities (i.e. the people who should have insurance but did not buy in
equilibrium).
We calculate each of these pieces and then plug them into the formula.
Average WTP at equilibrium quantity: W T P (40) = 500 − 4(40) = 340.
Average WTP at efficient quantity: W T P (60) = 500 − 4(60) = 260.
Average WTP among those who should have insurance but did not buy in equilibrium:
340+260
WTP = 2 = 300
Average MC at equilibrium quantity: M C(40) = 380 − 2(40) = 300.
Average MC at efficient quantity: M C(60) = 380 − 2(60) = 260.
Average MC among those who should have insurance but did not buy in equilibrium:
300+260
MC = 2 = 280

welfare loss = (Qef f − Qeqm )(W T P − M C)


= (60 − 40)(300 − 280)
= 20(20)
= 400

It’s also OK to write ”welfare impact = -400.”


Grading: Half credit for correct equation but wrong number. OR half credit for a
correct, clearly labeled graph.

4. (10 points) Now assume that the government imposes a tax penalty t on consumers
who do not buy insurance. Solve for the tax penalty which will yield a competitive
market equilibrium at the efficient quantity you found in part (2).

Answer:
The market equilibrium occurs where demand equals average cost. The tax penalty
for not buying has the effect of increasing demand by t. (A tax penalty for not buying
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

functions similarly to a subsidy for buying in this model.)


Demand = AC implies 500 + t − 4Q = 380 − Q.
Substitute in the efficient quantity from part (2) for Q:

500 + t − 4(60) = 380 − 60


500 + t − 240 = 320
260 + t = 320
t = 60

Grading: Half credit for correct equation but wrong number.

5. (10 points) Forget about the tax for not purchasing insurance. Now assume that
the government imposes a mandate so that all consumers must purchase insurance.
Assume that this mandate is perfectly enforced so that the quantity of consumers
purchasing insurance becomes Qmax = 80. What is the welfare impact of this man-
date relative to the competitive equilibrium in part (1) (8 points)? Indicate clearly
whether social welfare has improved, worsened, or remained the same compared to
the competitive equilibrium in part (1) (2 points).

Answer:
The welfare impact equals the welfare gain from insuring people from Qeqm to Qef f ,
who should be insured, minus the welfare loss from insuring people from Qef f to
Qmax , who should not be insured.
We know the welfare gain from part (3). So now we need to calculate the loss.

The welfare loss equals the difference between the maximum and the efficient quan-
tities, multiplied by the difference between average MC and average WTP among
people between the maximum and efficient quantities (i.e. the people who should
have not have insurance but buy due to the mandate).

Note: M C > W T P among people who should not have insurance. You could al-
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

ternatively subtract MC from WTP to get the welfare impact of mandating insurance
among those who shouldn’t have it. You would get a negative number, indicating a
welfare loss.

Average WTP at efficient quantity: W T P (60) = 500 − 4(60) = 260.


Average WTP at maximum quantity: W T P (80) = 500 − 4(80) = 180.
Average WTP among those who should not have insurance but buy due to mandate:
260=180
WTP = 2 = 220
Average MC at efficient quantity: M C(60) = 380 − 2(60) = 260.
Average MC at maximum quantity: M C(80) = 380 − 2(80) = 220.
Average MC among those who should not have insurance but buy due to mandate:
260+220
MC = 2 = 240

welfare loss = (Qmax − Qef f )(M C − W T P )


= (80 − 60)(240 − 220)
= 20(20)
= 400

Welfare gain from insuring those who should be insured minus welfare loss from in-
suring those who should not be insured = 400 - 400. The welfare impact is 0, i.e.
welfare is the same with the mandate as under the competitive equilibrium.

Grading: Half credit for correct equation but wrong number. OR half credit for
a correct, clearly labeled graph.

6. (15 points) Now assume that demand is the same as indicated at the beginning of this
problem, but marginal cost and average cost are now specified as follows:

MC = 200 + 2Q
AC = 200 + Q
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

What is the competitive equilibrium quantity in this market (3 points)? What is the
efficient quantity in this market (3 points)? What kind of selection is observed in this
market (3 points)? Name an example of a real-life market which has been observed to
have this type of selection (2 points). What is the welfare impact of selection in the
competitive equilibrium in this market compared to the efficient outcome (3 points)?
Indicate clearly whether this is a welfare loss or gain (1 point).

Answer:
Equilibrium occurs where demand equals average cost:

500 − 4Qeqm = 200 + Qeqm


300 = 5Qeqm
Qeqm = 60

The efficient quantity occurs where demand equals marginal cost:

500 − 4Qef f = 200 + 2Qef f


300 = 6Qef f
Qef f = 50

This market features advantageous selection. The individuals with lower marginal
cost have greater willingness to pay for insurance.
Empirical studies have found evidence of advantageous selection in the following mar-
kets: life insurance, Medigap coverage (i.e. supplemental private coverage to pay for
what Medicare does not), long-term care insurance. (Just one example is needed.)

The welfare impact is the difference between the equilibrium and efficient quantities,
multiplied by the difference between average WTP and average MC among people
between the equilibrium quantities.
Average WTP at efficient quantity: W T P (50) = 500 − 4(50) = 300.
Average WTP at equilibrium quantity: W T P (60) = 500 − 4(60) = 260.
Average WTP among those between the equilibrium and efficient quantities:
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

300+260
WTP = 2 = 280
Average MC at efficient quantity: M C(50) = 200 + 2(50) = 300.
Average MC at equilibrium quantity: M C(60) = 200 + 2(60) = 320.
Average MC among those between the equilibrium and efficient quantities:
300+320
MC = 2 = 310

welfare impact = (Qeqm − Qef f )(W T P − M C)


= (60 − 50)(280 − 310)
= 10(−30)
= −300

This is a welfare loss. Due to advantageous selection, more people buy insurance in
equilibrium than is socially optimal.

Grading: Half credit for correct equation but wrong number. OR half credit for
a correct, clearly labeled graph.
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

Career Income Period 0 Income Period 1 Income Period 2 Income Period 3

Doctor -10 5 20 40

Football Player 10 20 5 3

Question 2 (40 points)


In this problem we are going to explore the net present value / internal rate of return model
for career choice discussed in class and in Bhattacharya Chapter 5. Consider someone
choosing between career paths with the time path of income payoffs described in the table
at the top of this page.

Answer the following questions for someone choosing between these two career paths.
Throughout, assume that period zero is the present, so no discounting is applied to period
0 income, while future income is discounted at δ t where t is the period being considered.

1. (6 points) Assume the individual’s discount rate is δ = 1. Write down the individ-
ual’s present discounted income from each career and clearly state which career the
individual would pick.
Answer:
If δ = 1, we simply sum up income in each period to obtain the present discounted
income (or alternatively, you can call it net present value, NPV):
N P V (doctor) = −10 + 5 + 20 + 40 = 55
N P V (f ootballplayer) = 10 + 20 + 5 + 3 = 38
55 > 38. Choose doctor.
Grading: 2 points each for correct present discounted income of a given career. 2
points for the correct career choice.

2. (12 points) Assume the individual’s discount rate is δ = 0.8. Write down the indi-
vidual’s present discounted income from each career (3 points each) and clearly state
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

which career the individual would pick to maximize present discounted income (3
points). Is the internal rate of return for being a doctor relative to a football player
greater than or less than 33% (3 points)?
Answer:
If δ = 0.8, we now need to discount income in each period to obtain the present dis-
counted income (or alternatively, you can call it net present value, NPV):
N P V (doctor) = −10 + 0.8 ∗ 5 + 0.82 ∗ 20 + 0.83 ∗ 40 = 27.28
N P V (f ootballplayer) = 10 + 0.8 ∗ 20 + 0.82 ∗ 5 + 0.83 ∗ 3 = 30.74
27.28 < 30.74. Choose football player.
We know that the discount factor that makes the individual indifferent between doc-
tor and football player is in between 1 and 0.8 because with δ = 1 the individual
chooses doctor, but when δ drops to 0.8, the individual chooses football player.
Recall that the discount factor δ can be expressed in terms of the discount rate r as
follows:
1 1
δ= 1+r , or equivalently, r = δ −1
Therefore, δ = 1 corresponds to r = 0 and δ = 0.8 corresponds to r = 0.25. So the
individual chooses doctor when r = 0 and football player when r = 0.25. Therefore
we know that the internal rate of return is less than 33% (or 0.33).
Grading: Count the answer as correct if it is within +/- 0.1 of the answer in the key.

Now forget about the first two parts of this problem. Assume that there are only
two periods where each career accrues income (periods 0 and 1) and that, as before,
discounting occurs in period 1 but not period 0. Now individuals have uncertainty
about the income they will earn in period 1, and evaluate which profession they want
to choose according to their discounted expected income.

Income in each period for each profession is given in the table above.

3. (8 points) Assume that the individual has a discount factor of 0.5. Calculate the
present discounted income for each career path (3 points each). Which career will the
individual choose (1 point)? What does the fact that the individual chooses a career
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

Career Income Period 0 Income Period 1

Doctor 1 25, Pr = 0.2


100, Pr = 0.8
Football Player 16 9, Pr = 0.1
16, Pr = 0.9

based on expected income tell us about the individual’s risk preferences (1 point)?
Answer:
N P V (doctor) = 1 + 0.5[0.2(25) + 0.8(100)] = 43.5
N P V (f ootballplayer) = 16 + 0.5[0.1(9) + 0.9(16)] = 23.65
43.5 > 23.65. Choose doctor.
Because the individual is choosing based on discounted expected income alone, the
individual is risk neutral.

Grading: Count the answer as correct if it is within +/- 0.1 of the answer in the key.

Now assume that the individual evaluates which profession to choose according to
the individual’s discounted expected utility.

Assume that their utility function for income I in each period (not factoring in dis-
counting) is:


U (I) = I

4. (14 points) Assuming that income is still determined as given in the table in part
(3), and continuing to assume a discount factor of 0.5, calculate the individual’s dis-
counted expected utility for each career path (4 points each). Which profession will
the individual choose (2 points)? What does the utility function tell you about the
individual’s risk preferences (1 point)? Did your answer on the career choice change
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

compared to part (3) (1 point)? Intuitively explain your answer (2 points).


Answer:

√ √ √
N P V (doctor) = 1 + 0.5(0.2 25 + 0.8 100)
= 1 + 0.5(0.2(5) + 0.8(10))
= 5.5

√ √ √
N P V (f ootballplayer) = 16 + 0.5(0.1 9 + 0.9 16)
= 4 + 0.5(0.1(3) + 0.9(4))
= 5.95

5.95 > 5.5. Choose football player.


The increasing, concave utility function indicates that the individual is now risk averse.
Yes, the answer changed compared to part (3) in which the individual was risk neutral.
In part (3) with risk neutrality, the choice was doctor; now it’s football player. The
individual now chooses football player because it’s less risky (i.e. the good outcome
is more likely, and the difference between the good and bad outcomes is smaller).
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

Question 3 (35 points)

Assume that all consumers in a given population are enrolled in an insurance contract that
requires them to pay 25% of any medical expenditure at any point in the year. This contract
is thus a 25% coinsurance contract where the consumer pays 25% of the total cost of every
medical expenditure they have.

Assume that this particular population has high cholesterol that has been unresponsive
to statins (a common class of cholesterol-lowering drugs). This population is therefore at
high risk of heart attacks. Suppose that a new drug has been introduced to treat high
cholesterol in this population with a total cost of $4, 000 per year. This is the amount the
consumer pays if uninsured, and the amount the consumer and insurer pay combined when
the consumer is insured.

Assume the actual yearly benefit to consumers from taking the new drug is uniformly
distributed across the entire population, with values spanning the range 0 to 8,000. Assume
that the number of consumers in the population is some large number P OP .

Answer the following questions related to consumer purchases of this new drug.

1. (5 points) What proportion (or percentage) of consumers buys this drug if all con-
sumers are uninsured?
Answer:
Buy if benefit exceeds cost. That is true for the following share of consumers:
8000−4000 1
8000 = 2
50% buy if uninsured.

2. (15 points) What proportion (or percentage) of consumers buys this drug if all con-
sumers are insured with the 25% coinsurance contract described above (5 points).
What is the welfare impact of moral hazard when all consumers are insured with this
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

contract, relative to the case where they are uninsured (10 points)? For this welfare
calculation, you can assume the population has total size 1, so that, e.g., if 30% of
consumers purchase the drug, the quantity purchasing the drug equals 0.3. If welfare
impact of moral hazard is negative, e.g. a welfare loss from moral hazard, please state
your answer as a negative number.

Answer:
With insurance the out-of-pocket (OOP) cost now drops to $1000.
8000−1000 7
8000 = 8 = 0.875
87.5% buy if insured with 25% coinsurance.
The welfare impact due to moral hazard is the share buying due to moral hazard
times the difference between average benefit and cost.
welfare impact = (0.875 − 0.5)(2500 − 4000) = −562.5
This indicates a welfare loss from moral hazard.

3. (5 points) Continue to assume the actual yearly benefit to consumers from taking the
drug is uniformly distributed with values spanning the range 0 to 8,000. However,
now assume that consumers mis-perceive the actual benefit of the drug. They are not
well informed about the long-run benefits of the drug and, as a result, underestimate
its benefit. Assume that all consumers in the population perceive the drug’s benefit
to be 75% of the true benefit. Assume that all consumers are insured with the 25%
coinsurance contract described earlier in this question. What proportion (or percent-
age) of consumers in the population buys the drug?
Answer:
Perceived benefit is distributed uniformly in the interval [0, 6000], while actual benefit
is still distributed in the interval [0, 8000].
Consumers will buy if the perceived benefit exceeds the OOP cost.
0.25(4000) <perceived benefit
1000 < perceived benefit
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

6000−1000 5
6000 = 6 = 0.833
83.3% of consumers buy the drug.

4. (10 points) Continue to assume that consumers mis-perceive the benefit of the drug as
described in part (3). Now further assume that the drug is very effective at preventing
heart attacks in this high-risk population, which saves the insurer money from avoided
hospitalizations, and improves the insurer’s quality rating. Because of these effects,
the insurer would like to encourage this high-risk population to take the drug. What
coinsurance rate should the insurer set on the insurance contract so that all consumers
in this population will take the drug (5 points)? What coinsurance rate should the
insurer set if the insurer wants 90% of the consumers in this population to take the
drug (5 points)?
Answer:
Let the coinsurance rate be x.
Buy if 4000x < perceived benefit.
6000−4000x
6000 =1
The whole population will buy if x = 0, i.e. there is zero coinsurance, or equivalently,
no cost sharing, for the drug.
90% of the population will buy if:
6000 − 4000x 9
=
6000 10
60, 000 − 40, 000x = 54, 000
6000 = 40, 000x
6000
x=
40, 000
= 0.15

90% of the population will buy with a coinsurance rate of 15%.


Grading: For each question in this part, 2 points for the correct equation but wrong
number.
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

Plan Feature Plan 1 Plan 2


Yearly Premium $2,000 $8,000

Yearly Deductible $3000 $0

Post-Deductible Coinsurance 30% 10%

Out-of-Pocket Maximum $9,000 $1,200

Question 4 (30 points)

Consider a consumer choosing between two yearly insurance contracts offered by their em-
ployer. Assume that the two plans being offered give the consumers the exact same access
to doctors and medical treatments, such that the only difference between the two contracts
is financial. The details of the two plans are given in the table at the top of this page.
Answer the following questions related to this consumer’s choice.

1. (10 points) Assume that the consumer knows that their total medical spending for
the next year will be $2,000. This is the total amount that they plus their insurer
will spend on health care, not including the yearly insurance premium. Compute how
much the consumer will spend if they choose plan 1 including spending on the up
front premium and out-of-pocket spending on medical care during the year (5 points).
Compute the same statistic if they choose plan 2 (5 points).
Answer:
Under Plan 1, spending will be the $2000 premium plus $2000 (since the $2000 in
medical spending is less than the deductible). So total consumer spending (counting
the premium and OOP) will be $4000.
Under Plan 2, spending will be the $8000 premium plus 10% of $2000, which is $200.
(Note that 10% of $2000 is less than the OOP max of $1,200.) So total consumer
spending (counting the premium and OOP) will be $8200.
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

2. (10 points) Again, define total medical spending as the total amount that the con-
sumer plus their insurer spend on health care during the year, not including the yearly
insurance premium. Assume the consumer knows what this total medical spending
will be at the time they choose their insurance plan. What is the amount of total
medical spending for a consumer that makes them indifferent between enrolling in
plan 1 and enrolling in plan 2 (8 points)? If the consumer’s total medical spending is
more than this amount, which plan will the consumer prefer (2 points)?
Answer:
The consumer’s spending, counting the premium and OOP, as a function of medical
spending x is as follows:



2000 + x, 0 ≤ x ≤ 3000

consumerspend(P lan1) = 2000 + 3000 + 0.3(x − 3000), 3000 < x ≤ 23, 000



11, 000, x > 23, 000


8000 + 0.1x, 0 ≤ x ≤ 12, 000
consumerspend(P lan2) =
9, 200, x > 12, 000

If x is less than 3000, Plan 1 is clearly better. If x is greater than 23,000, Plan 2
is clearly better. So the point of indifference must occur between 3000 and 23,000
in medical spending. If x=12,000, Plan 1 is better, so the point of indifference
must occur between 12,000 and 23,000 in medical spending. Therefore, we set con-
sumer spending under plan 1 equal to consumer spending under plan 2, assuming
12, 000 < x < 23, 000. This yields:

2000 + 3000 + 0.3(x − 3000) = 9200


4100 + 0.3x = 9200
0.3x = 5100
x = 17, 000
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

If the consumer’s spending is more than $17,000, the consumer will prefer Plan 2.

Grading: 3 points each for the correct equation for consumer spending under Plan
1 and Plan 2, but wrong number for indifference between the two plans.

3. (10 points) Now assume the consumer has an 80% chance of being healthy, with to-
tal medical spending (i.e. the amount paid by the consumer plus their insurer, not
counting the yearly premium) of $2000, and a 20% chance of being sick, with total
medical spending of $50,000. Assuming the consumer seeks to minimize their own
expected spending (including both the yearly premium and out-of-pocket spending
on medical care), which plan will the consumer choose (5 points)? What plan would
the consumer choose if the consumer knew they would be healthy for sure (2 points)?
Which plan would the consumer choose if they knew they would be sick for sure (2
points)? How does the consumer’s knowledge of their likelihood of being healthy or
sick affect their plan choice (1 point)?
Answer:
If the consumer is healthy, the consumer will have expected medical spending of $2000.
From part 1, we know that total consumer spending will then be $4000 under Plan 1
and $8200 under Plan 2.
If the consumer is sick, total consumer spending will be $11,000 under Plan 1, and
$9,200 under Plan 2.
Therefore, expected consumer spending under Plan 1 is as follows:

E[consumerspend, P lan1] = 0.8(4000) + 0.2(11, 000)


= 3200 + 2200
= 5400

Expected consumer spending under Plan 2 is:


ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

E[consumerspend, P lan2] = 0.8(8200) + 0.2(9200)


= 6560 + 1840
= 8400

The consumer will choose Plan 1.


If the consumer knew they would be healthy for sure, they would choose Plan 1.
If the consumer knew they would be sick for sure, they would choose Plan 2.
Plan 1 is more favorable if healthy; Plan 2 if sick. As the likelihood of being healthy
increases, Plan 1 becomes more favorable.

Grading: 2 points each for the right equations for calculating expected consumer
spending under Plan 1 and Plan 2 but wrong answer as to which the consumer will
choose to minimize expected consumer spending.
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

Question 5 (20 points)

Please answer the following qualitative questions related to material from class.

1. (6 points) What were the two main goals of the Affordable Care Act (2 points each)?
Has each goal been accomplished (1 point each)?
Answer:
The two main goals of the ACA were to expand access to health insurance, and lower
healthcare costs.
Access has expanded through people buying insurance on the exchanges and provision
of Medicaid coverage to newly eligible people in the states that chose to expand Med-
icaid. The rate of uninsurance in the US fell after the implementation of the ACA.
It is hard to say for certain how healthcare costs have been affected by the ACA
without knowing the counterfactual. But it is doubtful that the ACA has been effec-
tive in cutting costs, given that cost-cutting provisions have tended to be repealed or
delayed. For example, the Cadillac tax on expensive health insurance plans (intended
to deter high cost plans) has been delayed, and the Independent Payment Advisory
Board (IPAB), intended to cut Medicare costs, has been repealed before it could take
effect.

2. (4 points) How has Medicaid changed under the Affordable Care Act (2 points)?
Name a challenge with these changes (2 points).
Answer:
Before the ACA, Medicaid coverage was available to people with low enough incomes
who belonged to certain groups (e.g. pregnant, blind, disabled, parents). In some
states childless adults could not qualify no matter how poor.
The ACA called for Medicaid to be made available to people with incomes up to 133%
of the federal poverty level (FPL), or 138% counting a 5% waiver. Eligibility became
based on income alone, and not on membership in a particular group.
A challenge with these changes is that in 2012 the Supreme Court made the Medicaid
expansion optional, in the sense that the states could choose whether or not to par-
ECON 157: Health Economics Midterm 2 Solutions Dr. Snider

ticipate.

Grading: Either 133% or 138% should be counted as correct when describing the
Medicaid expansion.

3. (10 points) We discussed differences in medical spending across regions in class when
covering technology and the price of health care. We used an example from the
Dartmouth Atlas study focusing on Miami and La Crosse, Wisconsin to exemplify
differences in health care spending across regions in Medicare. Using two separate
clearly labeled health care production possibility frontier (PPF) graphs illustrate the
two cases where (i) both of these cities are spending efficiently, but on different PPFs
(3 points) and (ii) where both cities have the same PPF and one city is spending
inefficiently and the other efficiently (3 points). Each PPF graph should have health
spending on one axis and health outcomes on the other. Provide a reason why Miami
and La Crosse might both be spending efficiently (2 points). Provide a reason why one
city might be spending inefficiently compared to the other, and name the inefficient
city (2 points).
Answer:
Graph (b) represents the case where both cities are spending efficiently, but on differ-
ent PPFs. Graph (a) represents the case where both cities have the same PPF, and
one city is spending efficiently, the other inefficiently.
Miami and La Crosse may both be spending efficiently if people are less healthy in
Miami, such that it takes greater resources to attain the same health outcomes in
Miami compared to La Crosse. Another reason could be that healthcare costs more
in Miami because the cost of living is higher.
Miami may be more inefficient than La Crosse if extra care (e.g. tests, procedures) is
done without improving outcomes.