Summary Health Economics week 3
3.1 Moral Hazard
= risk-increasing behaviour of parties if they are not directly at risk for their actions/ the
consequences
1. An individual faces some risk of a bad event X, and his actions can increase or decrease its
likelihood.
2. The individual buys an insurance contract that will help pay some or all of the costs of X if it
occurs. The price of X to the individual is now lower – this price distortion means the
individual does not face all the consequences of his actions.
3. In response to the price distortion, the individual changes his behavior in a way that
increases the chances of X or increases the costs of recovering from X
Ex ante: Behavioural changes that occur before an insured event happens, which make that event
more likely *skipping vaccin
Ex post: Behavioural changes that occur after an insured event happens and make recovering from
that event more expensive *demanding surgery instead of medication
An insurance company cannot observe this behaviour change –there is an information asymmetry.
Otherwise the contract would have been written to discourage the riskier behaviour.
The individual’s riskier behaviour creates a social loss, because the costly event X occurs more than it
would have without insurance.
Graphical representation
Bob loves cheeseburgers, but is at risk for a heart attack
Without insurance: the cost for each burger includes the price of the burger+ an increased change of
a heart attack.
With insurance: the cost for each burger declines, since the insurer picks up the costs of a heart
attack.
In this case, social loss takes the form of extra money, labour, time, and effort that others expend on
caring for heart attacks caused by cheeseburger overconsumption.
With insurance, the effective price to Bob of each cheeseburger falls
from PU to PI, and his consumption of cheeseburgers spikes from QU
to QI.
Point A is the socially efficient equilibrium where the individual
perfectly balances the marginal cost and benefit of each additional
cheeseburger.
Point B is the privately efficient outcome with insurance where the
individual perfectly balances the marginal benefit of each
cheeseburger against the insurance-subsidized price he actually faces.
The social loss (represented by the shaded triangle in the figure) is a result of ex ante moral hazard
, The vertical distance between PU and PI shows the extent of price distortion. This distance affects
the social loss from moral hazard; a small price distortion cannot induce much moral hazard, even if
the demand curve is relatively elastic.
The angle between the demand curve DC and
the vertical represents the extent of price
sensitivity. The larger this angle is, the more
responsive behaviour is to price distortions and
the larger the social loss from moral hazard.
Bob bears very little of the cost of his heart
attack treatments, and since he is quite price-
sensitive he responds with even more frequent
trips to the local burger joint. This results in a
large social loss.
What determines the magnitude of MH?
1. The extent of price distortion is a function of the completeness of the insurance
The fuller the insurance, the greater the price distortion
*In a partial insurance contract, Bob must pay a positive amount out of pocket, so medical care is not
completely free to him. This means the price distortion is smaller, and the MH is less severe
2. The extent of price sensitivity depends on the nature of the risk being insured and how
controllable it is.
* Some risks are impossible to control and are never the result of carelessness; these are called
natural hazards. For example, Huntington disease
Moral hazard due to insurance occurs if and only if three conditions hold:
1. The cost of a risky or wasteful action to an individual is reduced, usually as a consequence of
insurance
2. Asymmetric information prevents an insurer from adequately pricing the action
3. That individual responds to the price distortion by changing his behaviour, taking more risks
or demanding more covered goods and services.
Empirical evidence Moral Hazard
Ex-ante MH
– RAND HIE: people on free insurance plan were more likely to show up at the hospital with
broken bones or drug abuse
– Ghana: insured households were less likely to use mosquito nets
– Seguro Popular: low-income Mexicans assigned to receive free insurance were less likely to
get a flu shot and go to cancer screening
Ex-post MH
– Stanford employees: after a change that required 25% co-pay, visits to the doctor declined by
24%
– RAND HIE: those on free insurance plan were more likely to visit a hospital
– Germany: introducing deductibles decreased health expenditures
