the purpose of this simulation is to create a competitive market and to observe the market as it...

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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


The Players and the Goals

In this experiment, there are CONSUMERS and INSURERS.

INSURERS sell INSURANCE.

CONSUMERS buy FOOD and INSURANCE.

2


Consumers

Each consumer has $20 to spend.

A unit of food costs $1.

3

$20

The more food the consumer eats, the happier the consumer becomes.


Consumers: The Catch

Each consumer faces some risk of badness.

4

vs.

If badness befalls the consumer, the consumer loses all of the purchased food.

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Consumers: The Insurance

But, consumers can purchase insurance contracts from the insurance companies.

5

Each contract pays the consumer $1 if badness befalls that consumer. The consumer automatically buys food with the $1.


Consumers: Example

Suppose a consumer can purchase insurance contracts at a price of $0.50 each (the price of food is always $1 each).

6

$20

Suppose that the consumer spends $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

















Consumers: Example

If badness does not befall the consumer, the consumer eats 15 units of food and is very happy.

7

Very Happy !

!

















Consumers: Example

If badness does befall the consumer, the 15 units of food disappear, each insurance contract pays $1. The consumer automatically buys food and the consumer is somewhat happy.

8

Somewhat Happy
























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.

9


Insurers

Each insurer can write as many insurance contracts as liked and charge any price.

10


Insurers

If badness does not befall the consumer, the insurer walks away with the money the consumer paid for the contracts.

11

$ $ $

$ $ $


Insurers

If badness does befall the consumer, the insurer pays the consumer $1 for each contract the insurer sold the consumer.

12


Insurers: Example

Suppose an insurer sells Consumer A six contracts for $0.60 each, and sells Consumer B five contracts for $0.30 each.

13

The insurer collects $3.60 from Consumer A and $1.50 from Consumer B.

$3.60

$1.50

$5.10

Revenue =


Insurers: Example

Suppose badness befalls Consumer B but not Consumer A.

14

The insurer owes Consumer B $1 for each contract Consumer B purchased.

$5.00

$5.10

Revenue =

$5.00

Cost =

$0.10

Profit =


Insurers: Example

Suppose badness befalls Consumer A but not Consumer B.

15

The insurer owes Consumer A $1 for each contract Consumer A purchased.

$6.00

$5.10

Revenue =

$6.00

Cost =

$0.90

Loss =

(Insurers do not need cash reserves to cover policies.)


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.

16

www.antolin-davies.com 17

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%


The Objects

18

= insurance contract(s)

Contracts Sold Buyer Suspected Risk (0.1 to 0.5 )

Total Revenue Expected Cost (contracts x risk )

Expected Profit (revenue - cost )

= sales register


Contracts

19

12 6

$4.80

Customer 6 purchases 12 contracts from insurer for $0.40 each.

The total cost is the number of contracts multiplied by the agreed price per contract.


Register

20

Contracts Sold BuyerSuspected Risk

(0.1 to 0.5 )Total Revenue

Expected Cost (contracts x risk )

Expected Profit (revenue - cost )

12

6 $4.80

0.3

$3.60

$1.20

The register is for your own use in tracking your expected costs.

Feel free to cross out and re-enter information when your suspected risk for a consumer changes.

12

6 0.5

$4.80

$6.00

-$1.20

Only give your agent one contract form at a time. Otherwise, you’ll likely miss recording sales.


The Mechanics

21

Agent

Insurers Consumers

Head Office $0.50

Prices are per contract.You may buy multiple contracts.


The Mechanics

22

Agent

Insurers Consumers

Head Office


The Mechanics

23

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 your expected profits.Judge risk based on offer prices.


Risk Types

24


Risk Type Prob. Of Badness Risk Type Prob. Of BadnessConsumer #1 3 30% Consumer #19 1 10%Consumer #2 2 20% Consumer #20 4 40%Consumer #3 5 50% Consumer #21 3 30%Consumer #4 1 10% Consumer #22 2 20%Consumer #5 4 40% Consumer #23 5 50%Consumer #6 3 30% Consumer #24 1 10%Consumer #7 2 20% Consumer #25 4 40%Consumer #8 5 50% Consumer #26 3 30%Consumer #9 1 10% Consumer #27 2 20%Consumer #10 4 40% Consumer #28 5 50%Consumer #11 3 30% Consumer #29 1 10%Consumer #12 2 20% Consumer #30 4 40%Consumer #13 5 50% Consumer #31 3 30%Consumer #14 1 10% Consumer #32 2 20%Consumer #15 4 40% Consumer #33 5 50%Consumer #16 3 30% Consumer #34 1 10%Consumer #17 2 20%Consumer #18 5 50%


Ready to begin…

26


Agent

Head Office

Head Office:Keep track of your expected profits.

Consumers: Buy some insurance. All remaining money goes to food.

Insurers: Sell insurance to maximize expected profit.

Consumers:Keep track of your spending. You only have $20!


Accounting Phase

Consumers report:• Contracts purchased, cost, and from which

insurer(s)

28


1 no 18.8 3 18.82 no 17.5 6 17.53 no 12.2 20 12.24 no 19.1 4 19.15 no 15.8 12 15.86 YES 17.1 9 9.07 no 20.0 0 20.08 YES 17.9 19 19.09 no 19.5 5 19.510 no 16.5 14 16.511 no 18.5 10 18.512 no 17.0 10 17.013 no 16.4 11 16.414 no 20.0 0 20.015 YES 20.0 0 0.016 no 18.5 7 18.517 no 19.4 3 19.418 YES 15.8 15 15.019 no 20.0 0 20.020 no 19.1 18 19.121 no 18.5 6 18.522 YES 18.8 5 5.023 no 18.0 5 18.024 no 20.0 0 20.025 no 16.8 13 16.826 YES 16.0 20 20.027 YES 20.0 0 0.028 no 19.5 3 19.529 no 20.0 0 20.030 no 18.4 8 18.431 YES 18.2 10 10.032 no 20.0 0 20.033 YES 15.1 14 14.034 no 18.2 6 18.2

ConsumptionFood Purchased ContractsBadnessConsumer


Insurer Premia Indems Profit1 $3.15 $11.00 ($7.85)2 $7.10 $5.00 $2.103 $4.10 $8.00 ($3.90)4 $1.95 $0.00 $1.955 $2.65 $2.00 $0.656 $4.00 $4.00 $0.007 $1.50 $8.00 ($6.50)8 $2.00 $0.00 $2.009 $4.55 $7.00 ($2.45)10 $3.65 $5.00 ($1.35)11 $3.15 $0.00 $3.1512 $12.70 $36.00 ($23.30)13 $3.60 $6.00 ($2.40)14 $8.20 $0.00 $8.2015 $1.60 $0.00 $1.60


Mandated Insurance

Concerned that some consumers do not have enough insurance coverage, the law stipulates that an insurer may not sell fewer than 50 contracts to a buyer unless the buyer has already purchased at least 50 contracts (from any insurer) this round.

31


Risk Types

32


Ready to begin…

34


Agent

Head Office


Consumers: Buy some insurance. All remaining money goes to food.

Insurers: Sell insurance to maximize profit. You may not sell a buyer fewer than 50 contracts.



Accounting Phase


insurer(s)


1 no 20.0 0 20.02 no 12.5 50 12.53 YES 7.5 50 50.04 YES 20.0 0 0.05 no 15.0 50 15.06 YES 15.0 50 50.07 no 20.0 0 20.08 no 5.0 50 5.09 no 20.0 0 20.010 YES 15.0 50 50.011 no 12.5 50 12.512 YES 17.5 50 50.013 YES 15.0 50 50.014 no 14.8 54 14.815 no 14.0 51 14.016 no 20.0 0 20.017 no 12.5 50 12.518 YES 10.0 50 50.019 no 20.0 0 20.020 no 12.0 55 12.021 no 12.5 50 12.522 no 15.0 60 15.023 YES 15.0 50 50.024 no 20.0 0 20.025 YES 14.0 70 70.026 no 12.5 50 12.527 no 12.5 50 12.528 no 10.0 50 10.029 no 10.0 50 10.030 YES 17.0 50 50.031 no 17.5 50 17.532 no 17.5 50 17.533 YES 12.5 50 50.034 no 20.0 0 20.0

BadnessConsumer Contracts ConsumptionFood Purchased


Insurer Premia Indems Profit1 $17.50 $50.00 ($32.50)2 $15.00 $0.00 $15.003 $0.20 $0.00 $0.204 $15.00 $0.00 $15.005 $15.00 $0.00 $15.006 $22.50 $0.00 $22.507 $2.50 $0.00 $2.508 $0.00 $0.00 $0.009 $30.00 $50.00 ($20.00)10 $10.00 $0.00 $10.0011 $9.00 $50.00 ($41.00)12 $25.50 $260.00 ($234.50)13 $3.50 $10.00 ($6.50)14 $5.00 $70.00 ($65.00)15 $5.00 $30.00 ($25.00)


Mandatory Insurance

Concerned that some consumers do not have any insurance, the law requires that all consumers buy not less than 50 contracts this round.

39


Risk Types

40


Ready to begin…

42


Agent

Head Office


Consumers: Buy some insurance. All remaining money goes to food. You must buy at least 50 contracts.

Insurers: Sell insurance to maximize profit.



Accounting Phase


insurer(s)


1 no 12.5 50 12.52 no 7.8 50 7.83 no 7.5 50 7.54 no 13.3 50 13.35 YES 10.0 50 50.06 no 10.0 50 10.07 no 17.5 50 17.58 no 7.5 100 7.59 no 14.0 60 14.010 no 17.5 50 17.511 no 0.0 400 0.012 no 17.5 50 17.513 YES 15.0 50 50.014 no 9.5 55 9.515 YES 15.0 50 50.016 YES 7.5 50 50.017 no 10.0 50 10.018 no 10.0 50 10.019 no 15.0 50 15.020 no 10.0 100 10.021 no 12.5 50 12.522 no 15.0 50 15.023 YES 11.0 50 50.024 no 20.0 0 20.025 no 15.0 50 15.026 no 12.5 50 12.527 no 12.5 50 12.528 YES 12.5 50 50.029 no 5.0 50 5.030 YES 10.0 50 50.031 YES 17.5 50 50.032 no 17.5 50 17.533 no 12.5 50 12.534 no 7.5 50 7.5

Contracts ConsumptionFood PurchasedBadnessConsumer


Insurer Premia Indems Profit1 $40.00 $50.00 ($10.00)2 $10.00 $0.00 $10.003 $29.00 $50.00 ($21.00)4 $10.00 $0.00 $10.005 $22.50 $100.00 ($77.50)6 $25.00 $50.00 ($25.00)7 $6.75 $0.00 $6.758 $0.00 $0.00 $0.009 $31.50 $150.00 ($118.50)10 $15.00 $0.00 $15.0011 $12.50 $0.00 $12.5012 $22.50 $0.00 $22.5013 $8.75 $0.00 $8.7514 $29.75 $0.00 $29.7515 $8.75 $0.00 $8.75


Results…

47


0

20

40

60

80

100

120

Type 1 Type 2 Type 3 Type 4 Type 5

Insurance Contracts Purchased

Free Market Mandated Mandatory


0

5

10

15

20

25


Food Purchased



$0.00$0.10$0.20$0.30$0.40$0.50$0.60$0.70$0.80$0.90$1.00

Free Mkt Mandated Mandatory

Insurance Price per Contract


$0.00$0.10$0.20$0.30$0.40$0.50$0.60$0.70$0.80$0.90$1.00


Insurance Profits



0

10

20

30

40

50

60


Insurance Contracts Purchased



0

5

10

15

20

25


Food Purchased



$0.00 $0.05 $0.10 $0.15 $0.20 $0.25 $0.30 $0.35 $0.40 $0.45 $0.50


Insurance Price per Contract


($80.00)

($60.00)

($40.00)

($20.00)

$0.00

$20.00

$40.00

$60.00

$80.00


Insurance Profits



• Forces lower risk people to consume quantities of goods 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.

56

What is the effect of insurance mandates?

(but what if they don’t buy insurance?)


But, we have to do something!Look at what has been happening to the

cost of health care over time!

57


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

58

Source: Bureau of Labor Statistics (www.economy.com)

Price of medical care has increased 349% since 1980 versus 135% for other consumer prices.


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

59


Hospital services + 576%Drugs and supplies + 402%Physician services + 282%Other consumer prices+ 135%



-800%

-600%

-400%

-200%

0%

200%

400%

600%

Colle

ge Tu

ition

Med

ical

Car

e

Hous

ing

Food

Gaso

line

New

Car

s

1 GH

z of

Com

putin

g Po

wer

Grow

th in

Pric

es, 1

980-

2006


$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%.


But, the cost of health care is only half of the picture.

What has been happening to the quality of health care?

62


How do we measure the quality of health care?

1. What is “quality?”

63

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)?


How does one measure the quality of health care?

An easy and composite measure of the effectiveness of health care is the mortality rate.

64

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.


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

65

Source: Statistical Abstract of the United States, 2008, Table 77.

From 1960 to 2006, infant mortality fell 70%.



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%.


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


From 1960 to 2006, the mortality rate fell by 15%.


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

68

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


But, what about the uninsured?

They aren’t sharing in this increased quality of health care.

69


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

70

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.


Source: Bureau of Labor Statistics, Census Bureau

Insured

Uninsured (15% of the population)

How many Americans are uninsured?


Insured

Claim to be Uninsured but

Aren't

Medicaid or SCHIP Eligible

Uninsured

72


(12% of the population)



Insured

Claim to be Uninsured but

Aren't

Medicaid or SCHIP Eligible

Uninsured Less Than 4 Months

18 to 34 and Childless

Uninsured

73


(4% of the population)


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.


0%

5%

10%

15%

20%

25%

30%

Under 18 18 to 24 25 to 34 45 to 44 45 to 54 55 to 64

74


The percentage of uninsured adults is highest among in the years of peak health.


-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

75


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.


A free choice to 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. 76

Voting for the “right” amount of insurance


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.


ExampleInstalling and requiring children to use seatbelts on school buses will reduce the number of child travel deaths. But, it will cost (on average) $2.5 million for every child’s life we save.

Should we install seatbelts on school buses?

The naïve response is: “Yes! You can’t put a value on a child’s life.”

The correct response is: “What do we give up by spending money on seatbelts?”


Spend $2.5 million on: # Lives Saved Annually

Seatbelts on school buses 1Airbags in cars 3Heart transplants 13Malaria prevention 975Midwife training in third world 310,000HIV tests for sex workers 715,000

the purpose of this simulation is to create a competitive market and to observe the market as it...

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