Type II diabetes is a costly and potentially debilitating disease. Recently, the total costs incurred by a person with type 2 diabetes over their lifetime were estimated to be $85,000, due to direct treatment of the disease and complications such as nerve damage, amputations, and strokes. Consider a simplified model of the health insurance market, where diabetes is the only future health risk people face. Suppose there are 1000 people classified as “normal weight” and 1000 people classified as “overweight.” Normal weight people face a 20% chance of developing type II diabetes in their lifetime, and overweight people have a 30% chance. Suppose that an individual can expect to earn $2,000,000 over his or her lifetime. Furthermore, suppose that individuals spend all their money on consumption yu(c)=c. Ignore any intertemporal consideration of interest rates, inflation or discount factors, i.e. r=0. Suppose insurance companies can measure a person's weight before offering them an insurance contract and price their contract based on the result. Assume that the only costs the insurance company faces are payments for medical costs if a person develops diabetes, that insurance companies are risk neutral, and that the market for providing insurance is perfectly competitive. What insurance contract prices will be offered? p(normal weight)= ?? p(overweight)= ?? What will be the consumer and producer surplus in this market? CS= ?? PS = ??

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To determine the insurance contract prices and the consumer and producer surplus in this simplified health insurance market we need to consider the pr... View the full answer