The purpose of this simulation is to create a competitive market and to observe the market as it achieves equilibrium. In this experiment, you will experience real market forces. The same human traits and behaviors that govern real markets exist in the simulation. What are artificial are your surroundings. The market forces are real. 1

The Players and the Goals In this experiment, there are CONSUMERS and INSURERS. INSURERS sell INSURANCE. CONSUMERS buy FOOD and INSURANCE. 2

Consumers Each consumer gets $20 per day. A unit of food costs $1. 3 $20 The more food the consumer eats, the happier the consumer becomes.

Consumers: The Catch Each day, consumers face some risk of badness. 4 vs. If badness befalls the consumer, the consumer loses all of the purchased food for that day.

Consumers: The Insurance But, consumers can purchase insurance contracts from the insurance companies. 5 Each contract pays the consumer $1 worth of food if badness befalls the consumer that day.

Consumers: Example Suppose you can purchase insurance contracts at a price of $0.50 each (the price of food is always $1 each). 6 $20 Suppose that you spend $5 on insurance contracts. The remaining $15 is automatically spent on food. 10 insurance contracts 15 food (Consumers may buy fractions of a unit of food.) $15$5

Consumers: Example If badness does not befall you, then you eat 15 units of food and are very happy. 7 Very Happy !!

Consumers: Example If badness does befall you, the 15 units of food disappear, and each insurance contract pays $1. You automatically buy food, eat it, and are somewhat happy. 8 Somewhat Happy

Decision Consumers: Example The consumer makes one set of decisions that are repeated for each of the three days. Daily outcomes may change due to randomness. Day 1 Day 2Day 3 9

Consumers Each consumer’s goal: Maximize happiness More insurance means  More food when badness befalls.  Less food when badness does not befall.  Too little insurance is bad. Too much insurance is also bad. 10

Insurers Each insurer can write as many insurance contracts as liked and charge any price. 11

Insurers If badness does not befall the consumer, the insurer walks away with the money the consumer paid for the contracts. 12 $$$ $$$

Insurers If badness does befall the consumer, the insurer pays the consumer $1 for each contract the insurer sold the consumer. 13

Insurers: Example You sell Consumer A six contracts for $0.60 each, and sell Consumer B five contracts for $0.30 each. 14 For each of the three days, you collect $3.60 from Consumer A and $1.50 from Consumer B. $15.30 Revenue = $3.60 $1.50 $3.60 $1.50

Insurers: Example Suppose that badness then befalls Consumer B on two of the days, but Consumer A on none of the days. 15 You owe Consumer B $1 for each contract for the two days. $15.30 Revenue = $10.00 Cost = $5.30 Profit = $5.00

Insurers: Example Alternatively, suppose that badness befalls Consumer A on each of the three days, but Consumer B on none of the days. 16 You owe Consumer A $1 for each contract for the three days. $15.30 Revenue = $18.00 Cost = $2.70 Loss = (Insurers do not need cash reserves to cover policies.) $6.00

Insurers Each insurer’s goal: Maximize expected profit Insurers can ask whatever prices they like for contracts  Too low a price is bad. Too high a price is also bad. 17

18 Type 1 10% Badness There are five types of consumer. Each faces a different probability of badness. Type 2 20% Type 3 30% Type 4 40% Type 5 50%

The Objects 19 = insurance contract(s) = sales register

Contracts $4.80 Customer 6 purchases 12 contracts from insurer 4 for $0.40 each. This contract generates $4.80 daily income for three days for the insurer.

Register $ $3.60$1.20 The register is for your own use in tracking your expected costs. Only give your agent one contract form at a time. Otherwise, you’ll likely miss recording sales. You will need to estimate consumers’ risks.

The Mechanics 22 Agent InsurersConsumers Head Office $0.50 Prices are per contract. You may buy multiple contracts.

The Mechanics 23 Agent InsurersConsumers Head Office

The Mechanics 24 Agent InsurersConsumers Head Office Consumers: Keep track of how much you have spent. You need to save cash to buy food and you only have $20. Head Office: Keep track of risk estimates and expected profits. Advise the agent on setting prices. Agent: Try to estimate consumers’ risks based on how many contracts they want and the prices they are willing to pay.

Risk Types 25

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Ready to begin… 27

28 Consumers:You have $20. Buy some insurance (if you want). All remaining money goes to food. Insurers:Sell insurance to maximize expected profit.

Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s) 29

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Mandated Insurance Concerned that some consumers do not have enough insurance coverage, the government requires that an insurer may not sell fewer than 50 contracts to a consumer unless the consumer has already owns at least 50 contracts. 32

Ready to begin… 33

34 Consumers:You have $20. Buy some insurance (if you want). All remaining money goes to food. Insurers:Sell insurance to maximize expected profit. You may not sell fewer than 50 contracts to a consumer unless that consumer already owns at least 50 contracts.

35 Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s)

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Mandatory Insurance Concerned that some consumers do not have any insurance, the government requires that all consumers buy at least 50 contracts. 38

Ready to begin… 39

40 Consumers:You have $20. You must buy at least 50 contracts. All remaining money goes to food. Insurers:Sell insurance to maximize expected profit.

41 Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s)

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Results… 44

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Equilibrium results… 49

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Forces people to consume quantities of goods and insurance that they may not want to consume. Transfers wealth from low risk to high risk people. A better solution is simply to tax the low risk people, give the money to the high risk people and let them buy what they want. 54 What is the effect of insurance mandates? (but what if they don’t buy insurance?)

But, we have to do something! Look at what has been happening to the cost of health care over time! 55

56 Source: Bureau of Labor Statistics ( Price of medical care has increased 349% since 1980 versus 135% for other consumer prices.

57 Source: Bureau of Labor Statistics ( Hospital services+ 576% Drugs and supplies+ 402% Physician services+ 282% Other consumer prices+ 135%

58 Source: Bureau of Labor Statistics (

59 Source: Bureau of Labor Statistics and Bureau of Economic Analysis ( Price Indices (1954=400) From 1954 to 2009, the cost of the Federal government (on a per person basis) rose 2800%. Over the same period, the cost of medical care rose only 2000%.

But, the cost of health care is only half of the picture. What has been happening to the quality of health care? 60

How do we measure the quality of health care? 1.What is “quality?” 61 2.How do we account for health care that has become routine but didn’t exist in the past (e.g., pre-natal care)? 3.How do we weigh qualities across different types of care (e.g., glasses vs. heart transplant)?

How does one measure the quality of health care? An easy and composite measure of the effectiveness of health care is the mortality rate. 62 Some health care may have little or no impact on the mortality rate (e.g., orthodonture). But, it is not unreasonable to assume that the qualities of other types of health care grow at similar rates.

63 Source: Statistical Abstract of the United States, 2008, Table 77. From 1960 to 2006, infant mortality fell 70%.

64 Source: Statistical Abstract of the United States, 2008, Table 110. Deaths by Influenza and Pneumonia (per 100,000 population) From 1960 to 2004, deaths due to influenza and pneumonia fell 60%.

65 Source: Statistical Abstract of the United States, 2008, Table 77. From 1960 to 2006, the mortality rate fell by 15%.

66 Source: Derived from Statistical Abstract of the United States, and the Bureau of Economic Analysis. What does increased cost of health care buy us? 400,000 lives saved annually

But, what about the uninsured? They aren’t sharing in this increased quality of health care. 67

68 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. The percentage of the population that is uninsured has remained stable over time.

69 Source: Bureau of Labor Statistics, Census Bureau (15% of the population) How many Americans are uninsured?

70 Source: Bureau of Labor Statistics, Census Bureau (12% of the population) How many Americans are uninsured?

71 Source: Bureau of Labor Statistics, Census Bureau (4% of the population) How many Americans are uninsured? If we count one-third of this group, the uninsured are between 6% and 8% of the population depending on whether or not we count this group.

72 Yes, but that’s still 6% to 8% of the population who are uninsured. What about them? Who are they?

73 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. On average, the uninsured are adults who are in their healthiest years.

74 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. The growth in the uninsured is commensurate with the hypothesis that, as the price of health care rises, the more healthy willingly choose not to be insured.

A free market purchase is a vote, but with three important differences. Political vote:One size fits all. Free market vote:Multiple sizes for multiple recipients. Political vote:Speed of change is driven by the election cycle. Free market vote:Speed of change is driven by the accounting cycle. Political vote:Signal is distorted because the vote is for a “bundle” of issues embodied by one candidate. Free market vote:Signal is clear because the vote is for a specific issue. 75 Voting for the right amount of insurance

76 Can one place a value on a human life? (and, if yes, is it wrong to do so?) Yes, it is possible. No, it is not wrong to do so.  Almost everyone does it almost every day.

Pick One: Small Car or SUV Ford Escort$20,000 Driver deaths per million vehicles148 Ford Explorer$30,000 Driver deaths per million vehicles76 Source: Insurance Institute for Highway Safety (2007). Deaths are on a per year basis. Assumes 10-year vehicle life. Those who choose the Escort to save $10,000 reveal that they value their lives at less than $14 million.

Seat Belts on School Buses It costs (on average) $2.5 million for every child’s life saved.  Should we install seatbelts on school buses?

Spend $2.5 million on:# Lives Saved Annually Seatbelts on school buses1 Airbags in cars3 Heart transplants13 Malaria prevention975 Midwife training in third world310,000 HIV tests for sex workers715,000 If our concern is saving lives, then we should not spend money for seatbelts on school buses because every 1 life saved will be offset by 715,000 lives we might otherwise have saved.