Question

Indicate if the following statement is true or false. Explain your arguments from economic viewpoint

“If the production of health care generated positive externalities, the welfare costs of moral hazard would be smaller than those suggested by M. Pauly’s analysis”

Pauly's analysis of the welfare effects of moral hazard assumes that consumption of health care does not increase with income, however, empirical evidence suggests it does.

Answer 1

The given statement regarding Pauly's analysis of the welfare effects of moral hazard is True.

As Pauly's analysis is assumed that the increase in income does not imply the increase in health care related consumption but empirical studies suggest that there is relative increase involved.

In the statement the positive externalities refers to the positive benefits of health care production on parties who didn't chose the particular action. The price equilibrium doesn't truly show the effects in terms of cost or benefit health care product or services might have. The welfare cost of moral hazard refers to the cost involved in otherwise neutral situation where people might expose themselves to more risk if they are insured or if someone else will bear the loss or expense.

So, with healthcare production at equilibrium and increase in income there will be a income transfer effect with items like health insurance. There will be added consumption to the health care buying behavior as the income of healthy and well to do people will get transfered to ill section or parties of the economy.

So if we remove or do not consider this price of health care consisting welfare loss then the welfare cost will be lower.