1. ECO 5550/6550 Exam Dr. Allen C. Goodman October 27, 2014

2. Question 1 Consider Bonnie and Clyde and their production of QALYS. The drawing is to scale. a.(4 points) In the graph, please label and indicate the maximum number of QALYs that Clyde can produce. Total resources available are 50. Who is more productive? Why? b.(4 points) What is the principle for maximizing the output of QALYs for the two? Why? Calculate the total output of QALYs for the two, if the sum is maximized. c.(4 points) Calculate the cost/QALY in part c. d.(4 points) Suppose that society determines that Clyde must have at least 10 QALYs. Calculate the most QALYs that Bonnie can obtain, and evaluate whether this is the most cost-effective allocation of resources. 017 Clyde Bonnie 13 a. Clyde’s max is 13 (2) Bonnie is more productive. Max = 17, Clyde’s max = 13 (2) b. Equalize MP or slope = -1. (2) B=13 C= 8.5 Total = 21.5 (2) c. Cost = 50/21.5 = 2.33 (4) d. Line (2) Bonnie has 10.8; Clyde has 10 Not cost effective. 20.8 < 21.5. (2)

3. Question 2 Consider a project to reduce water pollution. We measure its quantity by the percentage of pollutants removed, so quantity ranges `from 0 to 100. The drawing is to scale. a.(4 points) Suppose we are currently removing 30% of the pollutants. Mark the appropriate levels on the graph. Is 30% an efficient allocation? Why or why not? b.(4 points) Consider two projects. Project A will remove 50%, and Project B will remove 60%. Would they pass a Benefit/Cost analysis? Why? c.(4 points) Between Project A and Project B, which is more efficient? Why? d.(4 points) Consider two projects again. Project A will remove 50% and Project C will remove 90%. Again, which is more efficient and why? 01020 30405060708090 $ Pollution Reduced in Percent MB 50% MC 25% 75% MB’ MC’ a. Points (2) Not efficient, MB > MC (2) b. Yes (2) TB > TC – look at areas (2) c. B is more efficient (2) Loss triangle for B is smaller than for A (2) AB d. A is more efficient (2) Loss triangle for C is greater than for A (2) C

4. Question 3 We spent considerable time on information. Here are some questions about it. a.(4 points) Discuss briefly the distinction between “symmetric” and asymmetric information in a transaction. Apply it to an instance where you go to the doctor with a sudden ear infection. b.(4 points) In the figure on the right, please calculate the average (mean) level of insurance expenses. c.(4 points) If the insurer and the insured both know the distribution of expenses, but do NOT know which point they are on, will a market develop? If so, what will be the premium; if not, why not? d. (4 points) Suppose that some smokers “sneak into the market” and buy the insurance from companies that do not know that they smoke. What will happen to the market? Why? a.Symmetric = same information Asymmetric = different (2) This is asymmetric. You don’t know; doctor does. b. Mean = 5000. (4) c. Yes, a market will develop. (2) Premium will be $5,000 (2) d. Expenses will be too high (2) Good risks will be priced out of market, and market will collapse (2)

5. Question 4 Ms. Roy gave a presentation on flu vaccination. Here are a few questions. a.(4 points) Discuss the nature of influenza (the flu), and why we need a new vaccine every year. b.(4 points) Why do most communities offer a “public health” response rather than simply allowing the population to act in their own best interest? c.(4 points) In the graph to the right, discuss why the supply becomes very inelastic at quantities greater than Q E * d. (4 points) Starting at quantity Q E *, what is the impact of a sudden increase in demand. Compare this with the impact of a sudden decrease in demand. a. Contagious, virus mutates so it is different each year (2 each) b. If it is contagious, not enough people will get vaccine because they don’t realize that they give it to each other (4) c. Producers build capacity each year. They have a limited amount of capacity, so at a high quantity, supply get inelastic. (4) d. Sudden increase  not much increase in quantity but big price increase. (2) Sudden decrease  not much price decrease, but big quantity decrease. (2)

6. Question 5 Here are some questions about risk. The graph is to scale. a.(3 points) Suppose that Elvin starts with a W = 30. If he gets sick, his W will fall to 10. Put in these points, and show his expected utility. b.(3 points) What is Elvin’s attitude toward risk, as indicated on this graph? Why? c.(3 points) Suppose Elvin’s probability of illness if 0.25. Show this point, and indicate the utility change due to the risk. d.(3 pints) If Elvin buys an actuarially fair insurance policy, how much will he spend and how will his utility change? Why? e.(4 points) Indicate Elvin’s consumer surplus graphically and in dollars if he buys an actuarially far policy. Wealth Utility 1020300 50 100 150 200 U(W)

7. Question 6 Here are some questions about demand and insurance. The graph is to scale. a.(4 points) Suppose that the market price per visit is $150. Calculate the equilibrium price quantity, and total expenditures. b.(4 points) If there is a 33.3% coinsurance rate (consumer pays one- third), draw the new effective demand curve, and show the new equilibrium quantity and total expenditures. What percentage does the consumer pay? c.(4 points) Calculate the increased utility (under the demand curve) with the 33.3% coinsurance rate. d.(4 points) Calculate the overall loss to society due to the contract-induced moral hazard. Explain why. $ N of visits 510150 50 100 150 200 Demand Loss Gain

8. Question 7 Name these cities a.(2 points) __Detroit (2 points) b.(2 points) __Chicago (2 points) Extra credit (2 points). What’s so great about the Great Lakes? a.ANYTHING (2) a. b.