AP1. [19 points total] Insurance plan death spiral. A large employer provides insurance to employees and charges them any premium it chooses. However, the employer must try to cover the expected medical expenditures of those who it insures. = 1 equal to P = The employer offers one insurance contract to all employees, and charges them an initial premium at time T 10. After T 1, for all subsequent periods the employer charges employees a premium that equals the average cost of the people who buy insurance in the previous year. - Think about the graphical framework for adverse selection we studied in Class 6. Assume that consumer demand is characterized by: and assume that marginal and average P= 25-0.8 Q cost are characterized by: MC = 25 - 1.2 Q AC = 25 0.6 Q Suppose that there are 20 consumers, and that demand exceeds marginal cost there, so that: emax = 20 (If you like, imagine Q indexing thousands of consumers.) a) [3 points] With the initial price P = 10, what is the initial quantity of insurance sold to employees? What are the average and marginal costs at that quantity? Show your work. AP1. [19 points total] Insurance plan death spiral. A large employer provides insurance to employees and charges them any premium it chooses. However, the employer must try to cover the expected medical expenditures of those who it insures. = 1 equal to P = The employer offers one insurance contract to all employees, and charges them an initial premium at time T 10. After T 1, for all subsequent periods the employer charges employees a premium that equals the average cost of the people who buy insurance in the previous year. - Think about the graphical framework for adverse selection we studied in Class 6. Assume that consumer demand is characterized by: and assume that marginal and average P= 25-0.8 Q cost are characterized by: MC = 25 - 1.2 Q AC = 25 0.6 Q Suppose that there are 20 consumers, and that demand exceeds marginal cost there, so that: emax = 20 (If you like, imagine Q indexing thousands of consumers.) a) [3 points] With the initial price P = 10, what is the initial quantity of insurance sold to employees? What are the average and marginal costs at that quantity? Show your work