1. 1 The Games Economists Play: Interactive Public Policy Capital Campus Texas July 9, 2008 copies of this presentation can be found at www.antolin-davies.com

2. Please sit as follows: 1. One person at each consumer station. 2. Two people at each insurer station. Ideally, we need one person who is comfortable with basic math at each insurer station. 2

3. The purpose of this simulation is to create a competitive market and to observe the market as it achieves equilibrium. In this simulation, 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. 3

4. The Players and the Goals In this experiment, there are CONSUMERS and INSURERS. INSURERS sell INSURANCE. CONSUMERS buy FOOD and INSURANCE. 4

5. Consumers Each consumer has $20 to spend. A unit of food costs $1. 5 $20 The more food the consumer eats, the happier the consumer becomes.

6. Consumers: The Catch Each consumer faces some risk of badness. 6 vs. If badness befalls the consumer, the consumer loses all of the purchased food.

7. Consumers: The Insurance But, consumers can purchase insurance contracts from the insurance companies. 7 Each contract pays the consumer one unit of food if badness befalls that consumer.

8. Consumers: Example Suppose a consumer can purchase insurance contracts at a price of $0.50 each (the price of food is always $1 each). 8 $20 Suppose that the consumer spends $5 on insurance contracts. The remaining $15 is automatically spent on food. 10 insurance contracts 15 food

9. Consumers: Example If badness does not befall the consumer, the consumer eats 15 units of food and receives 387 happiness. 9

10. Consumers: Example If badness does befall the consumer, the 15 units of food disappear, each insurance contract pays $1.00 (which buys 1 unit of food), and the consumer receives 316 happiness. 10

11. Consumers Each consumer’s goal: Maximize expected 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. 11

12. Insurers Each insurer can write as many insurance contracts as liked and charge any price. 12

13. Insurers If badness does not befall the consumer, the insurer walks away with the money the consumer paid for the contracts. 13 $$$ $$$

14. Insurers If badness does befall the consumer, the insurer pays the consumer $1.00 for each contract the insurer sold the consumer. 14

15. Insurers: Example Suppose an insurer sells Consumer A six contracts for $0.60 each, and sells Consumer B five contracts for $0.30 each. 15 The insurer collects $3.60 from Consumer A and $1.50 from Consumer B. $3.60 $1.50 $5.10 Revenue =

16. Insurers: Example Suppose badness befalls Consumer B but not Consumer A. 16 The insurer owes Consumer B $1.00 for each contract Consumer B purchased. $5.00 $5.10 Revenue = $5.00 Cost = $0.10 Profit =

17. Insurers: Example Suppose badness befalls Consumer A but not Consumer B. 17 The insurer owes Consumer A $1.00 for each contract Consumer A purchased. $6.00 $5.10 Revenue = $6.00 Cost = $0.90 Loss = (Insurers do not need a cash reserve to cover policies.)

18. 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. 18

19. 19 Type 1 10% Consumer Types 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%

20. 20 Type ? ? Consumer Types Each consumer knows which type he/she is, but insurers don’t. The average probability of badness is 30%.

21. The Objects 21 = 1 dollar = 10 cents (each) = insurance contract(s) = 5 dollars

22. Contracts 22 12 6 $4.80

23. The Mechanics 23 Agent InsurersConsumers Head Office $0.30 Yes

24. The Mechanics 24 Agent InsurersConsumers Head Office

25. The Mechanics 25 Agent InsurersConsumers Head Office

26. Ready to begin… 26

27. Consumers:Buy some insurance. All remaining money goes to food. Insurers:Sell insurance to maximize profit. 27

28. Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s) 28

29. 29

30. 30

31. Mandated Insurance Concerned that some consumers do not have enough insurance coverage, the law stipulates that an insurer may not sell less than 35 contracts to a buyer unless the buyer has already purchased at least 35 contracts (from any insurer) this round. 31

32. Ready to begin… 32

33. Consumers:Buy some insurance. All remaining money goes to food. Insurers:Sell insurance to maximize profit. 33

34. 34 Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s)

35. 35

36. 36

37. Mandatory Insurance Concerned that some consumers do not have any insurance, the law requires that all consumers buy a total of no less than 35 contracts this round. 37

38. Ready to begin… 38

39. Consumers:Buy some insurance. All remaining money goes to food. Insurers:Sell insurance to maximize profit. 39

40. 40 Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s)

41. 41

42. 42

43. Results… 43

44. 44 MandatoryMandated

45. 45

46. 46

47. 47

48. 48 MandatoryMandated

49. 49

50. 50

51. 51

52. 52

53. Forces lower risk people to consume quantities of goods that they may not want to consume. End result is a transfer of 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. 53 What is the effect of insurance mandates?

54. But, we have to do something! Look at what has been happening to the cost of health care over time! 54

55. 55 Source: Bureau of Labor Statistics (www.economy.com) Price of medical care has increased 349% since 1980 versus 135% for other consumer prices.

56. 56 Source: Bureau of Labor Statistics (www.economy.com) Hospital services+ 576% Drugs and supplies+ 402% Physician services+ 282% Other consumer prices+ 135%

57. 57 Source: Bureau of Labor Statistics (www.economy.com)

58. But, the cost of health care is only half of the picture. What has been happening to the quality of health care? 58

59. How do we measure the quality of health care? 1.What is “quality?” 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., dental vs. catastrophic)? 59

60. How does one measure the quality of health care? An easy measure of the effectiveness of health care is the mortality rate. 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. 60

61. 61 Source: Statistical Abstract of the United States, 2008, Table 77.

62. 62 Source: Statistical Abstract of the United States, 2008, Table 77.

63. 63 Source: Statistical Abstract of the United States, 2008, Table 110. Deaths by Influenza and Pneumonia (per 100,000 population)

64. 64 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

65. But, what about the uninsured? They aren’t sharing in this increased quality of health care. 65

66. 66 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.

67. 67 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. Percentage of uninsured has remained relatively constant for the young and the old – the two groups for whom there is the least incentive to tradeoff health care for spending on other things.

68. 68 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. Pattern of uninsured is commensurate with the hypothesis that, as the price of health care rises, the more healthy willingly choose not to be insured.

69. A free choice to 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. 69 Voting for the “right” amount of insurance

70. 70 The Games Economists Play: Interactive Public Policy Capital Campus Texas July 9, 2008 copies of this presentation can be found at www.antolin-davies.com