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The purpose of this simulation is to create a competitive market and to observe the market as it achieves equilibrium.
In this experiment, 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.
1
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The Players and the Goals
In this experiment, there are CONSUMERS and INSURERS.
INSURERS sell INSURANCE.
CONSUMERS buy FOOD and INSURANCE.
2
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Consumers
Each consumer gets $20 per day.
A unit of food costs $1.
3
$20
The more food the consumer eats, the happier the consumer becomes.
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Consumers: The Catch
Each day, consumers face some risk of badness.
4
vs.
If badness befalls the consumer, the consumer loses all of the purchased food for that day.
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Consumers: The Insurance
But, consumers can purchase insurance contracts from the insurance companies.
5
Each contract pays the consumer $1 worth of food if badness befalls the consumer that day.
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Consumers: Example
Suppose you can purchase insurance contracts at a price of $0.50 each (the price of food is always $1 each).
6
$20
Suppose that you spend $5 on insurance contracts. The remaining $15 is automatically spent on food.
10 insurance contracts
15 food
(Consumers may buy fractions of a unit of food.)
$15$5
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Consumers: Example
If badness does not befall you, then you eat 15 units of food and are very happy.
7
Very Happy !
!
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Consumers: Example
If badness does befall you, the 15 units of food disappear, and each insurance contract pays $1. You automatically buy food, eat it, and are somewhat happy.
8
Somewhat Happy
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Decision
Consumers: Example
The consumer makes one set of decisions that are repeated for each of the three days. Daily outcomes may change due to randomness.
Day 1
10 insurance contracts 15 food
Day 2
10 insurance contracts 15 food
Day 3
10 insurance contracts 15 food
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Consumers
Each consumer’s goal: Maximize 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.
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Insurers
Each insurer can write as many insurance contracts as liked and charge any price.
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Insurers
If badness does not befall the consumer, the insurer walks away with the money the consumer paid for the contracts.
12
$ $ $
$ $ $
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Insurers
If badness does befall the consumer, the insurer pays the consumer $1 for each contract the insurer sold the consumer.
13
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Insurers: Example
You sell Consumer A six contracts for $0.60 each, and sell Consumer B five contracts for $0.30 each.
14
For each of the three days, you collect $3.60 from Consumer A and $1.50 from Consumer B.
$15.30
Revenue =
$3.60 $3.60$3.60
$1.50 $1.50$1.50
$3.60
$1.50
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Insurers: Example
Suppose that badness then befalls Consumer B on two of the days, but Consumer A on none of the days.
15
You owe Consumer B $1 for each contract for the two days.
$15.30
Revenue =
$10.00
Cost =
$5.30Profit =
$5.00 $5.00
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Insurers: Example
Alternatively, suppose that badness befalls Consumer A on each of the three days, but Consumer B on none of the days.
16
You owe Consumer A $1 for each contract for the three days.
$15.30
Revenue =
$18.00
Cost =
$2.70Loss =
(Insurers do not need cash reserves to cover policies.)
$6.00 $6.00$6.00
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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.
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Type 1
10%
Badness
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%
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The Objects
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= insurance contract(s)
Contracts Sold BuyerSuspected Risk
(0.1 to 0.5 )Total Revenue
Expected Cost (contracts x risk )
Expected Profit (revenue - cost )
= sales register
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Contracts
20
12 6
$4.80
Customer 6 purchases 12 contracts from insurer 4 for $0.40 each.
This contract generates $4.80 daily income for three days for the insurer.
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Contracts Sold Buyer Risk (0.1 to 0.5 )Total Revenue
per DayCost per Day
(contracts x risk )Expected Profit
per Day
Register
21
12
6 $4.80
0.3
$3.60
$1.20
The register is for your own use in tracking your expected costs.
Only give your agent one contract form at a time. Otherwise, you’ll likely miss recording sales.
You will need to estimate consumers’ risks.
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The Mechanics
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Agent
Insurers Consumers
Head Office $0.50
Prices are per contract.You may buy multiple contracts.
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The Mechanics
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Agent
Insurers Consumers
Head Office
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The Mechanics
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Agent
Insurers Consumers
Head Office
Consumers:Keep track of how much you have spent. You need to save cash to buy food and you only have $20.
Head Office:Keep track of risk estimates and expected profits. Advise the agent on setting prices.
Agent:Try to estimate consumers’ risks based on how many contracts they want and the prices they are willing to pay.
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Risk Types
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Risk Type Prob. Of Badness Risk Type Prob. Of BadnessConsumer #1 3 30% Consumer #16 3 30%Consumer #2 2 20% Consumer #17 2 20%Consumer #3 5 50% Consumer #18 5 50%Consumer #4 1 10% Consumer #19 1 10%Consumer #5 4 40% Consumer #20 4 40%Consumer #6 3 30% Consumer #21 3 30%Consumer #7 2 20% Consumer #22 2 20%Consumer #8 5 50% Consumer #23 5 50%Consumer #9 1 10% Consumer #24 1 10%Consumer #10 4 40% Consumer #25 4 40%Consumer #11 3 30% Consumer #26 3 30%Consumer #12 2 20% Consumer #27 2 20%Consumer #13 5 50% Consumer #28 5 50%Consumer #14 1 10% Consumer #29 1 10%Consumer #15 4 40% Consumer #30 4 40%
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Ready to begin…
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Consumers: You have $20.
Buy some insurance (if you want).
All remaining money goes to food.
Insurers: Sell insurance to maximize expected profit.
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Accounting Phase
Consumers report:
• Contracts purchased, cost, and from which insurer(s)
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Food Contracts1 16.0 16 no YES YES 48.02 20.0 0 no no no 60.03 16.5 14 no YES no 47.04 20.0 0 no no no 60.05 18.0 10 no no no 54.06 20.0 0 no no no 60.07 17.0 10 no no no 51.08 14.0 20 no YES YES 54.09 20.0 0 no no no 60.010 18.6 7 no no YES 44.211 18.0 8 no YES no 44.012 16.8 14 no no no 50.413 8.1 17 no no no 24.314 20.0 0 no no no 60.015 15.0 10 YES YES YES 30.016 18.8 5 no YES no 42.517 17.0 10 no YES no 44.018 18.2 4 YES YES no 26.219 20.0 0 no no no 60.020 16.0 10 no no YES 42.021 17.6 8 no no YES 43.222 18.8 8 no no no 56.423 11.4 19 YES YES no 49.424 17.0 15 no no no 51.025 16.0 10 YES YES YES 30.026 18.8 5 no no no 56.327 16.9 9 no no no 50.628 8.5 20 no no YES 37.029 20.0 0 no no no 60.030 14.4 14 YES YES YES 42.0
Maximum 60.0Median 49.9Minimum 24.3
ConsumerTotal
ConsumptionBadness
Day 2Badness
Day 3Daily Purchases Badness
Day 1
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Day 1 Day 2 Day 31 $13.95 $0.00 $8.00 $7.00 ($1.05)2 $46.65 $18.00 $18.00 $10.00 $0.653 $72.75 $0.00 $20.00 $30.00 $22.754 $58.50 $20.00 $44.00 $10.00 ($15.50)5 $59.85 $14.00 $30.00 $40.00 ($24.15)6 $26.70 $5.00 $10.00 $18.00 ($6.30)
InsurerTotal
PremiaIndemnities Total
Profit
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Mandated Insurance
Concerned that some consumers do not have enough insurance coverage, the government requires that an insurer may not sell fewer than 50 contracts to a consumer unless the consumer has already owns at least 50 contracts.
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Ready to begin…
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Consumers: You have $20.
Buy some insurance (if you want).
All remaining money goes to food.
Insurers: Sell insurance to maximize expected profit.
You may not sell fewer than 50 contracts to a consumer unless that consumer already owns at least 50 contracts.
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Accounting Phase
Consumers report:
• Contracts purchased, cost, and from which insurer(s)
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Food Contracts1 5.0 55 YES no YES 115.02 12.5 50 no no no 37.53 15.0 50 YES YES YES 150.04 15.0 50 no no no 45.05 15.0 50 no YES no 80.06 10.0 50 no no no 30.07 20.0 0 no no no 60.08 12.5 50 YES YES YES 150.09 20.0 0 no no no 60.010 12.5 50 no no no 37.511 12.5 50 YES no YES 112.512 10.0 50 no no no 30.013 2.5 50 YES no no 55.014 20.0 0 no no no 60.015 12.5 50 YES no YES 112.516 17.5 50 no YES YES 117.517 12.5 50 no no YES 75.018 7.5 50 no no YES 65.019 20.0 0 no no no 60.020 15.0 50 no no YES 80.021 15.0 50 no YES no 80.022 20.0 0 no no no 60.023 2.5 50 YES YES no 102.524 17.5 50 no YES no 85.025 20.0 0 YES no no 40.026 12.5 50 no YES no 75.027 20.0 0 no YES no 40.028 7.0 50 no YES YES 107.029 20.0 0 no no no 60.030 7.5 50 no no no 22.5
Maximum 150.0Median 62.5Minimum 22.5
Badness Day 3
Badness Day 1
Badness Day 2
Total Consumption
Daily PurchasesConsumer
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Day 1 Day 2 Day 31 $97.50 $100.00 $50.00 $200.00 ($252.50)2 $157.50 $50.00 $0.00 $50.00 $57.503 $0.00 $0.00 $0.00 $0.00 $0.004 $67.50 $50.00 $100.00 $50.00 ($132.50)5 $39.00 $0.00 $50.00 $50.00 ($61.00)6 $210.00 $155.00 $250.00 $155.00 ($350.00)
InsurerTotal
PremiaIndemnities Total
Profit
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Mandatory Insurance
Concerned that some consumers do not have any insurance, the government requires that all consumers buy at least 50 contracts.
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Ready to begin…
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Consumers: You have $20.
You must buy at least 50 contracts.
All remaining money goes to food.
Insurers: Sell insurance to maximize expected profit.
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Accounting Phase
Consumers report:
• Contracts purchased, cost, and from which insurer(s)
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Food Contracts1 2.5 50 no no no 7.52 10.0 50 no no no 30.03 10.0 50 no YES no 70.04 15.0 50 no no YES 80.05 15.0 50 YES YES no 115.06 15.0 50 no no YES 80.07 17.5 50 no no no 52.58 2.5 50 YES no YES 102.59 17.5 50 no no YES 85.010 10.0 50 no no no 30.011 2.5 50 no no no 7.512 15.0 50 no no YES 80.013 5.0 50 YES YES YES 150.014 15.0 50 no no no 45.015 10.0 50 no no YES 70.016 15.0 50 no no YES 80.017 15.0 50 no no no 45.018 7.5 50 YES YES YES 150.019 15.0 50 no no no 45.020 8.0 50 no no no 24.021 15.0 100 no YES no 130.022 10.0 50 YES YES no 110.023 2.5 50 no YES YES 102.524 16.5 50 no no no 49.525 0.0 50 YES YES YES 150.026 12.5 50 no YES no 75.027 8.0 50 no no YES 66.028 7.5 50 YES no no 65.029 12.5 50 no no no 37.530 7.5 50 YES YES YES 150.0
Maximum 150.0Median 72.5Minimum 7.5
Badness Day 1
Badness Day 2
Badness Day 3
ConsumerTotal
ConsumptionDaily Purchases
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Day 1 Day 2 Day 31 $30.00 $0.00 $0.00 $0.00 $30.002 $291.00 $250.00 $200.00 $300.00 ($459.00)3 $60.00 $50.00 $50.00 $50.00 ($90.00)4 $30.00 $0.00 $0.00 $100.00 ($70.00)5 $262.50 $50.00 $200.00 $50.00 ($37.50)6 $181.50 $50.00 $100.00 $150.00 ($118.50)
InsurerTotal
PremiaIndemnities Total
Profit
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Results…
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020406080
100120140160180200
Type 1 Type 2 Type 3 Type 4 Type 5
Contracts Purchased (per person per 3 days)
Free Market Mandated Mandatory
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0
10
20
30
40
50
60
70
Type 1 Type 2 Type 3 Type 4 Type 5
Food Purchased (per person per 3 days)
Free Market Mandated Mandatory
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$0.00
$0.05
$0.10
$0.15
$0.20
$0.25
$0.30
$0.35
$0.40
Free Mkt Mandated Mandatory
Insurance Price per Contract
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-$450.00-$400.00-$350.00-$300.00-$250.00-$200.00-$150.00-$100.00
-$50.00$0.00
$50.00$100.00
Type 1 Type 2 Type 3 Type 4 Type 5
Source of Insurance Profits (all firms per 3 days)
Free Market Mandated Mandatory
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Equilibrium results…
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0
20
40
60
80
100
120
140
160
Type 1 Type 2 Type 3 Type 4 Type 5
Contracts Purchased (per person per 3 days)
Free Market Mandated Mandatory
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0
10
20
30
40
50
60
70
Type 1 Type 2 Type 3 Type 4 Type 5
Food Purchased (per person per 3 days)
Free Market Mandated Mandatory
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$0.00 $0.05 $0.10 $0.15 $0.20 $0.25 $0.30 $0.35 $0.40 $0.45 $0.50
Free Market Mandated Mandatory
Insurance Price per Contract
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($200.00)
($150.00)
($100.00)
($50.00)
$0.00
$50.00
$100.00
$150.00
$200.00
Type 1 Type 2 Type 3 Type 4 Type 5
Source of Insurance Profits (all firms per 3 days)
Free Market Mandated Mandatory
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• Forces people to consume quantities of goods and insurance that they may not want to consume.
• Transfers 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.
54
What is the effect of insurance mandates?
(but what if they don’t buy insurance?)
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But, we have to do something!
Look at what has been happening to the cost of health care over time!
55
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0.0
50.0
100.0
150.0
200.0
250.0
300.0
350.0
400.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
19
8919
9019
9119
9219
9319
9419
9519
9619
9719
9819
9920
0020
0120
0220
0320
0420
0520
06
Price of Medical Care Consumer Prices Excluding Medical Care
56
Source: Bureau of Labor Statistics (www.economy.com)
Price of medical care has increased 349% since 1980 versus 135% for other consumer prices.
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0.0
50.0
100.0
150.0
200.0
250.0
300.0
350.0
400.0
450.0
500.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
19
8919
9019
9119
9219
9319
9419
9519
9619
9719
9819
9920
0020
0120
0220
0320
0420
0520
06
Price of Physicians Services
Price of Hospital Services
Price of Prescription Drugs and Medical Supplies
57
Source: Bureau of Labor Statistics (www.economy.com)
Hospital services + 576%
Drugs and supplies + 402%
Physician services + 282%
Other consumer prices+ 135%
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Source: Bureau of Labor Statistics (www.economy.com)
-800%
-600%
-400%
-200%
0%
200%
400%
600%
Colle
ge T
uitio
n
Med
ical
Car
e
Hou
sing
Food
Gas
olin
e
New
Car
s
1 G
Hz
of C
ompu
ting
Pow
er
Gro
wth
in P
rice
s, 1
980-
2006
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$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Federal Outlays per Person Price of Medical Care
Source: Bureau of Labor Statistics and Bureau of Economic Analysis (www.economy.com).
Price Indices (1954=400)
From 1954 to 2009, the cost of the Federal government (on a per person basis) rose 2800%.
Over the same period, the cost of medical care rose only 2000%.
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But, the cost of health care is only half of the picture.
What has been happening to the quality of health care?
60
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How do we measure the quality of health care?
1. What is “quality?”
61
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., glasses vs. heart transplant)?
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How does one measure the quality of health care?
An easy and composite measure of the effectiveness of health care is the mortality rate.
62
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.
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0.0
5.0
10.0
15.0
20.0
25.0
30.0
1960
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Infant Mortality per 1,000 Live Births
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Source: Statistical Abstract of the United States, 2008, Table 77.
From 1960 to 2006, infant mortality fell 70%.
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Source: Statistical Abstract of the United States, 2008, Table 110.
0.0
10.0
20.0
30.0
40.0
50.0
60.0
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Deaths by Influence and Pneumonia (per 100,000 population)Deaths by Influenza and Pneumonia (per 100,000 population)
From 1960 to 2004, deaths due to influenza and pneumonia fell 60%.
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7.5
8.0
8.5
9.0
9.5
10.0
1960
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Deaths per 1,000 People
Source: Statistical Abstract of the United States, 2008, Table 77.
From 1960 to 2006, the mortality rate fell by 15%.
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1.5
1.7
1.9
2.1
2.3
2.5
2.7
2.9
1960
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Mill
ions
Actual Deaths in the Current Year Deaths at the 1960 Mortality Rate
66
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
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But, what about the uninsured?
They aren’t sharing in this increased quality of health care.
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0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
68
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.
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Source: Bureau of Labor Statistics, Census Bureau
Insured
Uninsured (15% of the population)
How many Americans are uninsured?
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Insured
Claim to be Uninsured but
Aren't
Medicaid or SCHIP Eligible
Uninsured
70
Source: Bureau of Labor Statistics, Census Bureau
(12% of the population)
How many Americans are uninsured?
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Insured
Claim to be Uninsured but
Aren't
Medicaid or SCHIP Eligible
Uninsured Less Than 4 Months
18 to 34 and Childless
Uninsured
71
Source: Bureau of Labor Statistics, Census Bureau
(4% of the population)
How many Americans are uninsured?
If we count one-third of this group, the uninsured are between 6% and 8% of the population depending on whether or not we count this group.
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Yes, but that’s still 6% to 8% of the population who are uninsured. What about
them?
Who are they?
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0%
5%
10%
15%
20%
25%
30%
Under 18 18 to 24 25 to 34 45 to 44 45 to 54 55 to 64
73
Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.
On average, the uninsured are adults who are in their healthiest years.
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-2%
-1%
0%
1%
2%
3%
4%
5%
6%
Under 18 18 to 24 25 to 34 35 to 44 45 to 54 55 to 64
Change in % of Uninsured 1999 to 2006
74
Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.
The growth in the uninsured is commensurate with the hypothesis that, as the price of health care rises, the more healthy willingly choose not to be insured.
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A free market 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. 75
Voting for the right amount of insurance
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Can one place a value on a human life?(and, if yes, is it wrong to do so?)
Yes, it is possible.No, it is not wrong to do so.
Almost everyone does it almost every day.
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Pick One: Small Car or SUV
Ford Escort $20,000
Driver deaths per million vehicles 148
Ford Explorer $30,000
Driver deaths per million vehicles 76
Source: Insurance Institute for Highway Safety (2007). Deaths are on a per year basis. Assumes 10-year vehicle life.
Those who choose the Escort to save $10,000 reveal that they value their lives at less than $14 million.
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Seat Belts on School Buses
It costs (on average) $2.5 million for every child’s life saved.
Should we install seatbelts on school buses?
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Spend $2.5 million on: # Lives Saved Annually
Seatbelts on school buses 1
Airbags in cars 3
Heart transplants 13
Malaria prevention 975
Midwife training in third world 310,000
HIV tests for sex workers 715,000
If our concern is saving lives, then we should not spend money for seatbelts on school buses because every 1 life saved will be offset by 715,000 lives we might otherwise have saved.