Microeconomics Made Easy
William Yacovissi
Mansfield University
©William Yacovissi All Rights Reserved
 Insurance is generally a system in which the
consumer prepays for some event.
 When the event occurs the consumer pays
no money or some specified small amount
instead of the full amount
 Mostly we insure against bads so we’re not
encouraged to consume the item even
though it’s already paid for.
 Still, insurance companies notice increased
consumption when insurance is present.
That is, people with fire insurance have
more fires.
 We can examine the impact of insurance or any prepaid
plan using a market diagram.
 On the diagram on the next slide, the market would be in
equilibrium at P1 and Q1.
 With insurance the price of the item to the consumer drops
to P2 and consumption increases to Q2
 In order to get Q2 of output, the insurance company ahs to
pay P3.
 Keep in mind that the diagram is drawn in a
way that exaggerates the quantity impact of
the price change.
 In the real world, insurance, taxes, and
subsidies can only be applied in situations
that will have a manageable quantity impact
 A subsidy is when a third party pays for all
or part of the price of something.
 For example, your college education is
subsidized by the state and federal
governments and by Alumni and other
donors to the University.
 The impact of a subsidy is the same as insurance in that
both involve a third party payer.
 As the price to the consumer is lower from P1 to P2, the
quantity demanded increases from Q1 to Q2
 To produce Q2 of the good, suppliers must receive P3 for
that amount of output. So, my salary is higher as a result
of your education being subsidized. The subsidy increase
the demand for college professors.
 A is the opposite of a subsidy. A person is
required to pay more for the item than the market
would charge.
 Looking at the diagram on the next slide, the tax
increases the price from P1 to P2 and reduces the
quantity demanded from Q1 to Q2
 Suppliers only need a price of P3 to produce Q2 of
the good.
 Payment of the tax is split between
consumers and producers in proportion to
the relative strengths of the demand and
 In the diagram the tax is P1 – P3 with
consumers paying P2 – P1 of the tax and
producers paying P1 – P3 of the tax.