a.) Draw a market where consumers demand health insurance and insurance companies supply insurance at a price of insurance called the premium. Explain why, in this model of the insurance market, the individual mandate will cause health insurance premiums to increase.

b.) The result in a.) and the contents of the article would lead you to conclude that this is not the right way to study the health insurance market with the supply and demand model. To use the supply and demand model to understand the market for health insurance, you should think of the insurance market as a market for risk, where insurance companies buy risk from households. How do insurance companies buy risk from households? They agree to pay for consumers’ medical expenditures in the event that consumers become sick. They thus assume consumers’ risk of requiring medical care. What is the price they pay for risk? They pay for consumers’ expected medical expenditures, and consumers compensate them with the health insurance premium. So ???????????????????? = ???????????????????????????????? ???????????????? ???????? ???????????????? − ???????????????????????????? An important problem with the health insurance market, and the one that the individual mandate is designed to correct, is that insurance companies can’t (or at least it is very difficult) assess the risk of individual consumers (otherwise they would pay less for more risk, by the law of demand). This means they have to offer the same price of risk, via the premium they charge, to all consumers of health insurance. This leads only the highest risk households to sell risk to insurance companies. Why? A household with more health risk has a higher expected cost care and thus receives a higher price for its risk for any value of the insurance premium. Economists call this sort of problem, where only the “worst” segment of suppliers choose to participate in a market, adverse selection. The goal of the individual mandate is to force low risk households to participate in the health insurance market, thus reducing the amount of risk supplied in the market at every price. Now for your problem. Draw the market for risk, where consumers of insurance supply risk and insurance companies demand risk. Show the effects of the individual mandate in your graph. What will happen to the price of risk?

c.) Given what you know about the relationship between the price of risk and insurance premiums, can the individual mandate reduce insurance premiums? Why or why not?

Answer rating: 100% (QA)

Stepl a Just as the price is determined in the same way the premium of the insurance is also determi... View the full answer