ECON True/False for Final

There are no possible utility function in which a person is indifferent between actuarially fair, full insurance and actuarially fair, partial insurance.

FALSE. A completely risk-neutral person with a linear income-utility curve would be indifferent between these contracts.

If people demand a self-commitment device, it must be Pareto self-improving; otherwise it would not be demanded by utility-maximizing economic agents.

FALSE. A device might be harmful to a future self, but is still purchased because the present self benefits from it.

Insurance mandates do little to combat the problem of adverse selection.

FALSE. A mandate, which is a legal requirement that everyone in a population purchase an insurance contract, confronts adverse selection by effectively banning it. Even robust customers who would prefer to opt out are legally required to buy into the system.

A typical value function is concave due to risk aversion.

FALSE. A typical value function has both concave and convex parts.

The Akerlof model indicates that government intervention is the only way to solve the adverse selection problem.

FALSE. Adverse selection will occur as long as an information asymmetry persists. If a government or other organization - like a consumer watchdog group or even a private company - dismantles the information asymmetry, adverse selection will cease.

Phase II drug trials are conducted on animals, while Phase III drug trials are conducted on healthy volunteers. Both are required for FDA approval.

FALSE. Animal testing typically happens before Phase I trials, which feature healthy volunteers.

An uninsured patient who incessantly visits his doctor because he always thinks he is getting sick is an example of moral hazard.

FALSE. Assuming the patient is truly uninsured and must pay the full cost of his treatment, then he faces no price distortion and his actions do not constitute moral hazard.

The certainty effect and subcertainty are opposite phenomena.

FALSE. Both the certainty effect and subcertainty arise from people's observed tendency to overvalue certain outcomes (and implicitly, underweight outcomes that are just shy of certainty).

In the model, buyers know the utility function of sellers, but do not know anything about the general quality of cars for sale.

FALSE. Buyers do not know anything about the quality of a particular car, but they know how the quality distribution of all cars.

Risk-averse consumers always prefer insurance that is actuarially fair but not full to full insurance that is actuarially unfair - but the opposite is true for risk loving consumers.

FALSE. Consider uninsurance, which is technically actuarially fair but defi- nitely not full. Sometimes, risk-averse consumers will prefer full insurance to uninsurance, even if it is actuarially unfair.

If health disparities exist within a country, then it cannot be operating on its health production frontier.

FALSE. Countries whose subpopulations vary widely in income levels or in their preferences for unhealthy habits may appear to be productively inefficient on average, even though each individual subpopulation with the country is on the health production frontier.

Although a firm prediction of Akerlof's model, the adverse selection death spiral has never been observed in practice.

FALSE. Cutler and Reber (1998) find evidence of an adverse selection death spiral at Harvard, and evidence of other death spirals has been observed in insurance markets in New Jersey and California

In the U.S., drug companies receive a patent of 100 years for each drug they develop. This allows them a prolonged legal monopoly on the sale of that drug.

FALSE. Drug companies receive a patent of 17 years for each new drug that is deemed an original innovation. This does allow a prolonged legal monopoly

A consumer with declining marginal utility of income will never prefer actuarially fair, partial insurance to actuarially unfair, full insurance.

FALSE. Even someone risk averse might forgo full insurance if it is too expensive

Ex post risk is typically much lower than ex ante risk because uncertainty is largely eliminated by the purchase of an insurance contract.

FALSE. Ex-post risk is greater than ex-ante risk due to moral hazard. Having health insurance encourages people to take more risks and consume more health care.

All perceived probabilities are weighted lower than actual probabilities.

FALSE. Extremely low perceived probability is weighted higher than extremely low actual probability.

The take-up rate of health insurance among people with good jobs (that is full-time jobs that have lasted longer than a year) has declined in recent years, and this is an important reason for the increase in uninsurance rates over those same years.

FALSE. Farber and Levy (2000) find that more and more US employers are offering peripheral, part-time jobs without health insurance, and this is explaining rising uninsurance.

The imposition of federally mandated maternity benefits had no effect on the mean wages of female workers.

FALSE. Gruber (1994) found that this law depressed the wages of female workers of childbearing age. This is evidence of wage pass-through.

If a government wishes to maximize the rate of pharmaceutical innovation, it should offer non-expiring patents to drug companies.

FALSE. Horowitz and Lai (1996) and Gallini (2002) argue that very strong patent protections can actually decrease the overall level of innovation by discouraging established drug companies to make new products and deterring subsequent innovation by other companies.

Consider an HIV patient who recently started HAART therapy and whose health is improving rapidly as a result. Viatical settlement firms will offer him more money for his life insurance policy than they would have before he started HAART because his health outlook is much better.

FALSE. If he is healthier, his life insurance policy is less valuable to viatical firms

Economists agree that any intervention at time t which improves the utility of people at time t is necessarily a good intervention.

FALSE. If that intervention helps present selves but hurts future selves, some economists would argue that it is not necessarily a good intervention.

Indicate whether the statement is true or false, and justify your answer. Be sure to state any additional assumptions you may need. 1. If members of a society have transitive preferences, then that society as a whole must also have transitive preferences.

FALSE. In a shocking 1951 paper, economist Ken Arrow (1921-) proved that societies do not necessarily have transitive preferences, even when all its members do. His finding is known as Arrows Impossibility Theorem.

Scholars who study managed care organizations tend to pick managed care plans over more traditional health insurance plans.

FALSE. In a survey of 17 academic institutions, Studdert et al. (2002) find that managed care experts were significantly less likely to enroll in an HMO than philosophers, mathematicians, and law professors.

The goal of health policy is to maximize health, wealth, and equity.

FALSE. In an ideal world, all three goals would be attainable at once, but in practice, it is impossible to have everything. Any attempt by a nation to move closer to one of these three goals necessarily involves a tradeoff that moves that nation further away from some other goal.

Besides the common practice of charging copayments, health insurers have no successful strategies for combating moral hazard.

FALSE. Insurance customers can also use coinsurance, deductibles, and monitoring techniques to reduce moral hazard. Coinsurance and deductibles combat moral hazard by reducing price distortions; monitoring reduces moral hazard by mitigating information asymmetries.

It would be easy for private health insurers to eliminate moral hazard by redesigning insurance contracts, but they are prevented from doing so by strict government regulations (at least in most developed countries).

FALSE. Insurmountable information asymmetry is the cause of moral hazard, not regulations on insurance contract design. Even in an unregulated market, insurers would have no easy way of telling whether their customers are always washing their hands or avoiding friends with the flu.

If a country is productively efficient and hence on its own health production frontier, it is spending the optimal amount of money on health care.

FALSE. It is possible, for example, that the marginal dollar spent on education or parks produces more utility for the population than the marginal dollar spent on health care. Such a country is said to be allocatively ineffi- cient since it spends too much on health care relative to other productive activities. Since the country is on its health production frontier, shifting money to other activities will reduce health, but increase the overall welfare of the population. The opposite is also possible - the country on its health production frontier spends too little on health care and too much on other activities.

A primary cause of increasing uninsurance in the U.S. over the past decade is that more employers are deciding to stop providing health insurance coverage entirely.

FALSE. Many employers are still providing coverage, but there has been an increase in "peripheral" jobs - like part-time jobs or temp jobs - that are not eligible for coverage.

The primary sources of funding for Medicaid are payroll taxes (paid by workers), and premiums, deductibles, and copayments (paid by patients).

FALSE. Medicaid is designed to be free or nearly free for its patients, so it is almost entirely financed by taxpayers.

Moral hazard is mostly a problem in countries with universal insurance programs like the United Kingdom.

FALSE. Moral hazard can arise in any insurance contract, even outside the context of a universal or public insurance program.

An all-you-can-eat buffet is a classic example of moral hazard, because a price distortion induces overconsumption.

FALSE. Moral hazard only occurs in the presence of asymmetric information. The restaurant could easily charge customers marginal costs for the food they eat, so the fact that they choose not to do so indicates there is something economically valuable about the all-you-can-eat system. Put another way, banning all-you-can-eat buffets would not increase social welfare.

Phase III clinical trials are a minor part of the drug development process in the United States.

FALSE. Phase III trials, which feature many human subjects, can take years and cost tens of millions of dollars. This is the phase where the drug company generates the data it hopes to use to get its drug approved by regulatory agencies like the FDA.

Health systems focused on promoting equity typically have purely private insurance markets.

FALSE. Private insurance markets often result in some uninsurance, which can leave some members of society without affordable access to health care if they are diagnosed with cancer or diabetes for instance. Conversely, universal public insurance does further the goal of equity.

Risk-averse individuals have a concave value function for prospective gains and a convex value function for prospective losses.

FALSE. Risk-averse individuals have concave value functions for prospective gains and losses. Loss-averse individuals have concave value functions for prospective gains and convex value functions for prospective losses because they are risk-averse when it comes to gains and risk-seeking with losses.

The Food and Drug Administration (FDA) decides whether to approve a drug for use in the U.S. based in part on whether each drug is cost-effective in the treatment of some disease.

FALSE. The FDA does not consider cost-effectiveness; drugs must be shown to be safe and effective at treating a certain condition.

Suppose that a state grants Medicaid benefits to a worker only if his income is between $5,000 and $10,000 a year. This will not result in a work disincentive because those who are not working at all cannot receive any benefits.

FALSE. The disincentive effect applies to anyone who is at risk of losing Medicaid if they start working more. Someone earning $9,999 per year has a major disincentive to take on more work.

Loss aversion is the economics of jealousy: people value what they do not have more than what they do have.

FALSE. The endowment effect claims that people value an item more if they have it than if they do not.

The endowment effect leads to a stronger status quo bias, because trades are more likely to occur.

FALSE. The endowment effect means trades are less likely to occur.

A previously-uninsured man who enrolls in his workplace health insurance plan after being diagnosed with multiple sclerosis is an example of moral hazard.

FALSE. The man was uninsured before he was diagnosed, so his disease is in no way attributable to a price distortion induced by insurance. Meanwhile, we have no indication that the man's behavior changes once he obtains insurance. This is much better described as an example of adverse selection.

If the quality of cars is normally distributed rather than uniformly distributed, the market will not unravel.

FALSE. The market may still unravel under these conditions.

During prospect theory's editing stage, the operation of segregation always occurs before the operation of simplification.

FALSE. The order of operations varies by question as well as the actor.

The primary source of funding for the Medicare program is from premiums assessed on the elderly population, which is the primary population enrolled in the program.

FALSE. The primary source of funding is from payroll taxes on the employed population, most of whom are under age 65 and not on Medicare.

Prospective payment systems align the interests of doctors and their patients.

FALSE. The shift towards prospective payment systems has turned some doctor-patient relationships adversarial by making health care providers partly responsible for containing costs. This introduces a note of distrust - patients now have to worry that their doctors might prioritize reducing costs over improving their patients' health.

Pauly (1974) shows that the socially optimal level of insurance in a market is either full or none, depending on whether moral hazard or risk aversion predominates.

FALSE. The socially optimal level of insurance balances the positive effects of insurance (risk reduction) with the negative effects of insurance (moral hazard). It is possible that this balance could be achieved with a partial insurance contract.

If buyers care sufficiently more about cars than do sellers, then there are prices at which transactions can occur. In that scenario, there is no longer any adverse selection (although there still may be some information asymmetry).

FALSE. There are prices at which transactions can occur under these conditions, but there is still adverse selection because worse cars are offered for sale and better cars are not.

After the American health reform plan is fully implemented in 2014, there will be no more uninsured people in the U.S.

FALSE. There will still be 20 million people without health insurance, including people who opt out of buying insurance through a health insurance exchange.

One of the major predictions of the Rothschild-Stiglitz model is a positive correlation between risk and insurance coverage. This has never been observed in practice due to the confounding influence of moral hazard.

FALSE. This is a prediction of the Rothschild-Stiglitz model, but it has been confirmed in several contexts, including Dutch families seeking supplemental private insurance (van de Ven and van Vliet 1995) and young graduates joining the American workforce (Cardon and Hendel 2001).

Suppose an individual prefers to drink beer during college but enjoys wine more during middle age. This is a classic example of time-inconsistent preferences.

FALSE. Time inconsistency refers to time preferences that change from period to period, not changing preferences for different goods or activities.

If a person discounts utility from future periods, her preferences are time inconsistent because she does not value utility in all periods equally.

FALSE. Time inconsistency refers to time preferences that change from period to period, not differential time preferences in a single period.

There is no such thing as "too much competition" in the private hospital market.

FALSE. Too much competition can be a problem in hospital markets due to information asymmetries between doctors and patients, and the ubiquity of insurance. Too much competition can exacerbate inefficient quality competition, lead to a medical arms race, and drastically increase the costs of health care.

Individuals who always make decisions consistent with completeness, transitivity, and independence are exhibiting bounded rationality.

FALSE. Under bounded rationality, people are hindered by cognitive limitations and as a result they do not always make decisions consistent with completeness, transitivity, and independence.

Under partial insurance, income in the sick state with insurance is higher income in the healthy state

FALSE. Under partial insurance, income in the sick state, even with insurance is still lower than income in the healthy state, but some income is still transferred from the healthy to the sick.

Ultimately, the market unravels because buyers are risk averse. If buyers were risk neutral, there would always be prices at which cars would sell.

FALSE. We are already assuming that buyers are risk neutral. It is true that the market would be more likely to unravel with risk-averse buyers, because uncertainty about car quality is more likely to dissuade them from buying cars.

In employer-sponsored health insurance in the U.S., employers pay the largest share of the costs of health insurance.

FALSE. While it is nominally true that many employers pay a portion of health insurance premiums for their workers, in equilibrium the wages of workers reflect the employer subsidy. It is more accurate to say that workers pay for their employer-sponsored health insurance plans, both through assessed premiums and through lower wages. 1

A country operating below its own health production frontier is said to be productively inefficient.

TRUE. A country that is below its own health production frontier is said to be productively inefficient since it could spend less on health care and achieve the same health outcomes, or spend the same on health care and achieve better health outcomes.

A risk-averse individual prefers a certain outcome to an uncertain outcome with the same expected income

TRUE. Alternatively, we can say that U(E[I]) > E[U(I)]. That is, the individual prefers the utility she would get from her expected income to the expected utility she will get from her actual (uncertain) income

Contrary to the predictions of welfare economics, people are willing to pay to have constraints place on themselves.

TRUE. Although there are circumstances where time-consistent, rational people would place constraints on themselves (for example, in a negotiation), the widespread use of commitment mechanisms does suggest that people are not perfectly time-consistent.

Cost-sharing is used to combat moral hazard at the expense of equity.

TRUE. Cost-sharing (such as the use of deductibles, coinsurance, and copayments) controls moral hazard in a way that is sometimes more politically palatable than CEA. But it also makes health care less accessible for patients.

Whether a prospect is coded as a gain or as a loss can depend on how that prospect is framed.

TRUE. Empirical evidence says that the framing of a question can dramatically alter how changes in wealth are coded.

Evidence indicates that exponential discounting functions are very rare in humans.

TRUE. Frederick et al. (2002) summarize the evidence that humans are not typically exponential discounters.

Suppose that a long-time nicotine addict who is trying to quite smoking decides he wants a cigarette, but his friends successfully restrain him. The friends' intervention has an ambiguous effect on the addict's welfare.

TRUE. From a classic revealed-preference perspective, any restraint on a person harms him (or at least does not benefit him). But from the perspective on the hot brain/cold brain model, the decision to restrain a hot-brained individual may actually help that individual in the long run.

On average, observed mortality rates are higher for people who buy life insurance than for people who do not. This is best taken as evidence in favor of adverse selection in life insurance markets.

TRUE. He (2009) finds that this is the case, although other studies of life insurance come to opposite conclusions.

In the 2010 American health reform law, one primary mechanism for financing the expansion of health insurance to the uninsured involves reducing planned Medicare expenditures.

TRUE. However, the law does not specify how or where Medicare cuts will occur.

In the Akerlof model, suppose that the price of used cars is P and the quality of used cars (X) held by sellers varies between 0 and 100. Suppose further that sellers' utility is given by U_S=M+a∑_i^n▒X_i where M is the number of units of video games, which sell at $1 per game, and a is a utility function parameter that is strictly less than one (a < 1). Then sellers will offer cars with quality Xi= P on the market.

TRUE. If a < 1, then sellers get more utility from P dollars than from a car with quality P. Therefore, they will offer cars of quality P for sale.

The fact that high-risk customers are usually less risk-averse than low-risk customers helps counteract adverse selection.

TRUE. If low-risk customers are more risk averse and tend to demand more insurance, this is an example of advantageous selection that counteracts adverse selection.

Barriers to care erected by managed care organizations, such as requiring patients to visit gatekeeper physicians prior to seeking specialist care, can increase consumer welfare.

TRUE. If managed care tactics effectively combat moral hazard, they can increase consumer welfare because there is less wasteful care for consumers to finance.

A woman who uses her fireplace only after she buys homeowner's insurance is an example of moral hazard.

TRUE. If the woman faces a price distortion due to the insurance and would not have used her fireplace otherwise, then this decision is an example of moral hazard.

According to the hot brain/cold brain model, individuals usually have time consistent preferences but sometimes lapse momentarily into a time-inconsistent frames of mind.

TRUE. In the hot brain/cold brain model, time inconsistency only arises when the hot brain takes over. The hot brain and cold brain disagree about how to value current present utility relative to future utility.

In the U.S. Medicare program, by statute, the government is not permitted to take cost-effectiveness criteria into account when deciding whether to cover new medical technologies.

TRUE. Medicare must pay for any treatment that is "safe, effective, noninvestigational, and appropriate" - cost is not taken into account.

If a health insurance company could somehow monitor everything a customer does and thinks, it could create a full-insurance contract with no moral hazard.

TRUE. Moral hazard depends entirely on information asymmetry between insurer and customer.

The fact that more free-plan participants logged ER visits for broken bones than cost-sharing plan participants in the RAND Health Insurance Experiment is evidence of moral hazard.

TRUE. Moral hazard occurs when health insurance induces customers to be less careful with their health or induces them to seek more treatment when they do get hurt.

When the price elasticity of demand for health care is zero, health insurance coverage induces no moral hazard.

TRUE. Moral hazard only occurs if a price distortion induces a change in behavior. If the price elasticity is zero, behavior does not change as a result of being insured.

Medicare Part D, which was implemented in 2006, is the federal insurance program for the elderly in the US that provides for prescription drug coverage.

TRUE. Parts A, B, C are concerned with hospital and outpatient coverage, not drug coverage.

There is a massive body of evidence that humans prefer a fixed amount of utility now to that same amount of utility later.

TRUE. Several studies have documented this fact, which implies that time discounting does exist.

In 2010, there were nearly 40 million people in the U.S. who went without health insurance for the entire year.

TRUE. Sixty million people lacked health insurance for at least some part of the year.

In an actuarially fair insurance contract, the insurance premium equals the probability of sickness times the payout amount.

TRUE. Such an insurance contract yields zero profit in expectation

Cawley and Philipson (1999) find that in life insurance markets, there is a bulk discount (that is, people buying larger policies pay lower per unit prices). They conclude that this finding is inconsistent with the RothschildStiglitz model.

TRUE. The Rothschild-Stiglitz model predicts bulk markups in markets with asymmetric information.

The approval of Vioxx, a painkiller that was taken off the market in 2004 because it was implicated in several cardiac arrests, is an example of Type I error by the Food and Drug Administration.

TRUE. The approval of Vioxx is an example of an undesirable drug being approved.

When insurance is fair, in a sense, it is also free

TRUE. The customer's expected income does not change from buying the contract, so she effectively pays nothing for it. Despite the fact that the premium r is positive in an actuarially fair contract, the price is actually zero. Thus, we reach the counter-intuitive conclusion that the premium associated with an insurance contract is not its price.

Medicaid creates a work disincentive effect even for people currently not working at all.

TRUE. The disincentive effect applies to anyone who is at risk of losing Medicaid if they start working more.

Expected utility theory offers one possible valuation function that satisfies the properties of completeness, transitivity, and independence of preferences under uncertainty.

TRUE. The expected utility function is a value function where v(x) = u(x).

Queues can help equitably reduce moral hazard.

TRUE. The hassle of waiting in line constitutes a non-financial cost that all patients "pay" when they want care. Therefore queues can replace financial cost-sharing arrangements as a way to limit moral hazard. A queue-based system may also be more equitable than a cost-sharing one if it means that rich or poor alike must wait in the same line for care.

Insurance represents a transfer of wealth from healthy states to sick states.

TRUE. The nature of the insurance contract is that the individual loses income in the healthy state and gains income in the sick state relative to the state of no insurance. The risk-averse individual willingly sacrifices some good times in the healthy state to ease the bad times in the sick state.

Nearly half of expenditures on health care in the United States are government financed.

TRUE. This is mostly a consequence of the creation of Medicare and Medicaid in the 1960s.

Most economists think that innovation is not random, and that pharmaceutical companies can steer their research toward profit opportunities.

TRUE. This is the basis for induced innovation. Acemoglu and Linn (2004) and Finkelstein (2004) find amply evidence of induced innovation in American pharmaceutical markets.

After passage of the Kefauver-Harris Amendment in 1962, the number of new chemical entities introduced into the U.S. market by pharmaceutical companies dropped substantially.

TRUE. This is the evidence found by Peltzman (1973). After the amendment, it became much more expensive to bring drugs to market because companies had to demonstrate their offers were both safe and effective.

Price controls decrease the innovation rate for drugs but make existing drugs more affordable.

TRUE. This is the major tradeoff to consider when deciding whether to institute price controls.

In some markets, adverse selection develops over time as customers learn about their own risk levels.

TRUE. This makes sense, because adverse selection relies on asymmetric information. This phenomenon is in evidence in the Israeli car insurance market (Cohen 2005).

In the model of insurance and uncertainty discussed the chapter, an individual exhibits declining marginal utility of income if And only if she is risk-averse.

TRUE. Under this simple model, the shape of the income-utility curve determines one's taste for risk. If the individual exhibits declining marginal utility of income, her income-utility curve will be concave and she will be risk averse.

The U.S. government has harnessed the power of induced innovation to create cures for orphan diseases.

TRUE. When the U.S. government passed the Orphan Drug Act in 1983, innovation in that sector increased rapidly. This is an example of induced innovation because drug companies responded to tax incentives.