Social Insurance (ch 12) In 1953, ________ of every dollar of federal government spending went to national defense.

Only _________ of every dollar went to Social Security and ________ went to health care. By 2007, _______ of every dollar of federal spending went to national defense, _________ went to Social Security and _________ went to health care. Social Insurance Programs are government interventions that provide __________________________ against adverse events. For most of the federal programs, eligibility is not _________________________________. That is, eligibility does not depend on income or assets. The fundamental tradeoff with social insurance programs:

A. Insurance 1. Types of Insurance a. health insurance:

_______billion in premiums for

b. auto insurance: _______billion in premiums for c. life insurance: _______billion in premiums for d. casualty and property insurance: _______billion in premiums for

2. Why do Individuals Value Insurance? Insurance is valuable to people because of __________________________________________. That is, the marginal utility of consumption falls as the level of consumption rises. Extending this principle, most people would rather have two years of average consumption instead of one year of _________________________________________ and one year of starvation. Consumption Smoothing refers to:

One way that people choose across consumption in states of the worlds is by using present income to buy ____________________________________________________________________________.

3. Expected Utility Theory The central result of Expected Utility Theory is that with _________________________________ pricing, individuals will want to _____________________ insure themselves to equalize consumption in all states of the world.

With actuarially fair premiums, the efficient market outcome is _______________________________ and full consumption smoothing. However, individuals differ in the extent to which they are willing to bear risk. Risk Aversion is: B. Rationale for Social Insurance 1. Information Asymmetry is the difference in information:

George Akerlof¶s ³market for lemons´:

2. Adverse Selection is a situation in which:

It can lead to market failure:

3. Asymmetric Information and Market Failure A risk premium is the amount that risk-averse individuals will pay for:

A pooling equilibrium is a market equilibrium in which:

A separating equilibrium is a market equilibrium in which:

4. The Government and Adverse Selection

C. Other Reasons for Government Intervention in Insurance Markets 1. Externalities

2. Administrative Costs

3. Redistribution

4. Paternalism

D. Social Insurance vs Self-Insurance Self-insurance refers to:

1. Unemployment Insurance as an Example How UI works:

The UI replacement rate is the ratio of UI benefits to _____________________________________ earnings.

The availability of self-insurance determines the value of ____________________________________ to individuals suffering adverse events.

2. The Consumption-Smoothing Role of Social Insurance The importance of social insurance for consumption smoothing will depend on two factors: a. Predictability of the event

b. Cost of the event

E. Moral Hazard Moral Hazard refers to adverse actions taken by individuals or producers in response to:

1. Determinants of Moral Hazard

2. Moral Hazard is Multidimensional a. reduced precaution against entering the adverse state

b. increased odds of entering the adverse state

c. increased expenditures when in the adverse state

d. supplier responses to insurance against the adverse state

3. Consequences

F. Optimal Social Insurance Four basic lessons to keep in mind: 1. Individuals value insurance as a way to ______________ consumption across states of the world. 2. There are several reasons why the market may ___________ to provide the insurance 3. The justification for social insurance depend on whether other consumption-smoothing mechanisms are _______________________________. 4. Expanding insurance has a _________________________________ cost. Optimal SI systems should __________________________ insure individuals against adverse events. - The benefit of SI is the amount of _____________________________________ provided. - The cost of SI is the _______________________________________caused.

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