4. Consider a simplified model of preventive care. Suppose that there is only on

Question

4. Consider a simplified model of preventive care. Suppose that there is only one disease, flu, which can be eliminated by taking a flu shot, with a cost of $100. The probability of getting flu is 0.3. Without insurance, the cost of treating the flu is $500. If one buys insurance with a 10% co-pay rate, the treatment cost is $650. The consumer is risk averse with a risk-aversion parameter of-0.002. Part A. Without insurance: a. Calculate the expected cost. b. Calculate the variance and associated risk premium. c. What is the net benefit of taking the flu shot? Will you take the shot?

Explanation / Answer

A. The expected cost will be $650 per instance.

(500+ 10% co-pay rate)

B. The probability of getting sick sick is 99.7:0.3

If one doesn't get sick he will lose $100, but if he claims he will get a benefit of $400.

C. The net benefit of taking a shot = $650-$100 = $550

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