Econ 344
Problem Set #3
Assigned: Tu. Feb 22, 2011
Due: Tu. Mar. 1, 2011
Corresponding Chapters:
Part I
1.
2
3
4
5.
Multiple Choices (2*9=18 points)
When people behave in ways that involve increased risk because they have insurance,
this is known as
a)
adverse selection.
b)
moral hazard.
c)
asymmetric information.
d)
a HMO.
b
Health care markets may be inefficient because of
a)
poor information.
b)
adverse selection.
c)
moral hazard.
d)
all of the above.
e)
none of the above.
d
An actuarially fair return means
a)
returns on investments are indexed to the stock market.
b)
returns on investments have to be positive.
c)
benefits received, on average, would be equal to the premiums paid.
d)
premiums for insurance are generally paid by the government.
e)
none of the above.
c
When the average buyer of an insurance policy is likely to have higher risk than
others in his class, this is known as
a)
adverse selection.
b)
moral hazard.
c)
asymmetric information.
d)
a HMO.
e)
none of the above.
A
Asymmetric information generally implies
a)
information between parties is not equal.
b)
all parties are fully informed.
c)
information is costless.
d)
information is too costly to transmit.
e)
a and c.
a
6. Which of the following is a moral hazard effect of Social Security?
a. Retirees die sooner than they would without Social Security.
b. Workers retire sooner than they would without Social Security.
c. Retirees buy less health insurance than they would without Social Security.
d. Workers work longer and become more unhealthy than they would without Social
Security.
e. Retirees suffer on-the-job injuries more as a result of Social Security.
Answer: B (Page 369)
7. Which of the following was a recommendation or action of the Greenspan Commission in
1983?
a. Social Security benefits should be cut.
b. Social Security benefits should be means-tested to a greater degree.
c. Individuals should be able to put their taxes into private retirement accounts.
d. Both a and b are correct.
e. Both b and c are correct.
Answer: A (Pages 370-371)
.
8. Vouchers allow students to
A) get free lunches at public schools.
B) go to public schools at reduced rates.
C) receive discounts on school supplies like pens and paper.
D) all of the above
E) none of the above
Ans: e
9.
A pay-as-you-go system means
a)
you pay for your dinner as you go to the table to eat.
b)
current working citizens pay for current retired citizens.
c)
there is no need for taxes since current workers pay for current retirees.
d)
retirees are paid from accounts that have accumulated with interest over their
working lives.
e)
all of the above.
b
10. By providing a fixed level of education, the government intervention can lead to
which of the following?
a) crowding out of private spending
b) an increase in total spending on a child’s education
c) a reduction of total spending on a child’s education
d) all of th above are correct
e) both a and b are correct
d
11. If a politician were to suggest that Social Security benefits should be means-tested, which
of the following approaches is that politician suggesting?
a.
b.
c.
d.
e.
.
12.
Raising taxes
Extending the base of taxable wages
Raising the retirement age
Lowering benefits for all recipients
Lowering benefits for higher-income groups
Answer e
Having a Social Security program makes people less inclined to save for their own
retirement.
U
III. Open questions
(ch 13) 8. What are the political and economic ramifications of investing a large part of the
Social Security trust fund in the stock market, as has been recently proposed?
Historically, stock market returns have been higher than the return on government bonds,
so investing savings in the stock market might seem like a good idea. At the same time,
CHAPTER 13 / Social Security - 3 -
stocks do carry greater risks, at least somewhat (or completely, depending on who you
believe!)
offsetting this benefit. There are several possible economic ramifications of this policy.
For example, it is possible that investing in stocks instead of government bonds would
shift excess savings from the government to private firms. This would potentially be a boon
for the economy, leading to higher investment and more rapid growth. The political
ramifications
are potentially more pernicious. The Social Security trust fund is large, and investing it
in stocks would make the government a major shareholder of many corporations. If
politicians
had active control of which companies to invest in, this could lead to several kinds of
abuses, including politicians using promises of investment (or threats of noninvestment) to
exert control over private companies.
2.
2. Expected utility of insurance (18 pts)
Johnny is considering whether to buy health insurance His utility is given by U(I)= √I
where I is his yearly income equal to $25,000. However there is a 5% chance that he’ll fall
sick with a avian flu virus which will cost him $5000.
a. what is his expected utility of not buying any insurance?
EU = .05* √(25000-5000) + .95 √(250000) = 157.28
b. what is the actuarially fair premium for the health insurance in this case?
.05(5000) + .95(0) =250
c. Assuming that the premium is actuarially fair, what is th expected utility associated with
buying full insurance (ie insuring all $5,000 of potential loss)? What is the expected utility
associated with insuring only half of the loss ($2500)? Is Johnny going to choose full
insurance or partial insurance?
Full Ins .05 *√(20000-250+5000) +.95 √(25000-250) =157.32
Partial .05 * √(20000-125 +2500) + .95 (25000-125) = 157.31
Full insurance is preferred.
4. Social Security Reform (16 pts.)
a) What is the difference between pay as you go and fully funded social security systems? What
is the reason Social security may be in trouble?
Pay-as-you-go system---current workers supporting current retirees
Fully funded---tax current workers and invest for their retirement
SS trouble is demographics are pushing system toward insolvency
b) Name at least three incremental reform proposals
-raise payroll taxes
Expand taxable wages
Raise retirement age
Lower benefits
c.Name at least two fundamental reform proposals and briefly discuss the problems associated
with each.
Invest the trust fund into stock market
privatization
d) Do you think making social security voluntary will work? explain
.
unlikely
the new budget set lies entirely below the old indifference curve, and the family must be
worse off. With the solid indifference curve, the family can be better off. Intuitively, there
are two competing forces at work here. The first is that they would be poorer if they didn’t
change their choice—as a result of paying higher taxes. The second is that because
they now get $6,000 in voucher funds that they can spend on either private education or
public education, they can move to a private school without giving up the education subsidy.
Which force has a bigger effect depends on their preferences.