Question

Suppose that the market demand for physical therapies is given by the equation P=100-Q. The cost of each therapy is 40.
a. What is the socially optimal number of physical therapies? (2 points)

b. Suppose that the price of physical therapies is 40. Suppose further that patients have insurance that pays for 50% of the price of physical therapies. How many physical therapies will be purchased? What is the amount of deadweight loss from insurance moral hazard? (4 points)

c. How would your analysis of deadweight loss change if the service in question was open heart surgery? (A qualitative response is sufficient.) (2 points)

Answer 1

a. since the cost is constant at 40, the supply curve would be a horizontal line at P=40

Socially optimal number of physical therapies is where D = S

Q = 100 - P (demand curve)

Q = 100 - 40 = 60

So socially optimal number of physical therapies is 60

b. Price with insurance woudl be half of existing price, i.e., 20

Hence Q = 100 - 20 = 80

Deadweight loss from this would be the yellow triangle in the picture below, which is equal to (1/2) * (80 - 60) * (40 - 20) = 200

c. There is not likely to be as much (or any) deadweight loss with the good changing to open heart surgery since those who go in for physical therapy (which is nothing but massage and exercise) will not go in for open heart surgery just because it is cheap