Finish Problem Set 1

Econ 5860: Health Economics Professor Kurt Lavetti

Ohio State University

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Spring 2018

Problem Set 1

Due Date: Feb 2, 2017 by the beginning of class

Please submit assignments on (preferred) or on paper in class.


A. True/False Explain. Indicate whether each of the following statements is true or false and

then explain why you think this. Include in your explanation any pertinent institutional details

and economic reasoning (including appropriate graphs and equations). Please provide concise,

clear answers with minimal irrelevant detail. Explanation is required. (5 points each).


1. Suppose you are interested in estimating the elasticity of demand for medical care. A good way to do this would be to compare people who are healthy to people who are sick,

and estimate how prices affect the amount of additional care that sick people choose to



2. In Figure 1 below, an individual with high levels of education has marginal efficiency of

investment given by MECC. The marginal efficiency of investment for an individual with

low levels of education is given by MECH.



3. In the Grossman model, the optimal choice of health status decreases as people get older.

4. According to the model of rational addiction, if the tax on an addictive good increases, it could lead to an increase the number of non-addicted consumers who try the addictive





B. Analytical Problems: Please show all calculations for full credit.


5. (12 points) Suppose you are collecting data from a country like Japan where the government sets the price of health care. Each prefecture in Japan has a different set of

prices. Data from 1999 are displayed in the following table:



Region Outpatient

Visits Price per


Tokyo 1 per month 25 Yen

Hokkaido 1.5 per month 10 Yen



a. What is the arc price elasticity of demand for health care in Japan based on these data?

b. Suppose that incomes are generally much higher in Tokyo than in Hokkaido. Is the correct demand function more elastic or more inelastic than your answer to the

previous question? Justify your answer.


c. Using your estimated elasticity from part a, what would the demand for health care be if the price in Tokyo were raised to 30 Yen per visit?


d. Using your estimated elasticity from part a, what would the demand in Hokkaido be if the price were lowered to 5 Yen per visit?


6. (8 Points) Washington State decides to introduce a tax on the sale of marijuana. Assume the elasticity of demand is -0.75, and that supply is perfectly elastic.


a) If the tax increases the price of marijuana by 60%, what will happen to the amount that is sold?


b) Suppose marijuana is addictive, and that consumers who choose to buy it are rational addicts. Explain what the theory of rational addition predicts will happen to the

quantity sold today if the tax increase begins next year. (Note: the theory of rational

addiction says nothing about stockpiling goods to avoid paying taxes, so that is not

the answer I am looking for.)


c) (Extra Credit Question) Suppose there is a legal market with perfectly elastic supply that pays the tax, and a secondary black market that evades the tax. The elasticity of

supply in the black market is 1 (the number doesn’t matter, just assume that it’s

neither perfectly elastic nor perfectly inelastic), and assume that after the tax it’s

cheaper to buy from the black market at low market quantities. Draw an example of

what the market supply curve would look like. (Hint: the market supply curve

represents the lowest price at which you could buy a given quantity of a good.) Now

suppose the state is short on money so they raise the tax rate. Show using a supply-

demand diagram what will happen to total tax revenue.