Question

Consider Tom, who is eligible for government health insurance and consumes two goods, "insurance" and "all other goods." Health insurance and other goods trade off dollar for dollar (there is no tax advantage to health insurance). Assume that a person receiving government health benefits is not allowed to purchase supplemental private insurance. (a) Suppose that public insurance provides $M worth of benefits. Draw the budget constraint showing the trade off between health insurance and other goods. Suppose that Tom chooses private coverage despite being eligible for government health insurance. Draw a possible indifference curve that could correspond to Tom's choice.

Answer 1

The budget constraint for the trade-off between government health insurance and all other goods would be a straight line with a slope of -1. Tom's indifference curve would be drawn above and to the right of this budget constraint, indicating his higher utility for private insurance over government-provided insurance.

Step-by-step explanation:

When illustrating Tom's trade-off between government health insurance and all other goods, the budget constraint would typically be a straight line if health insurance and other goods trade off dollar for dollar. This line would have a slope of -1, indicating that for each dollar spent on insurance, there is one dollar less to spend on other goods. If public insurance provides $M worth of benefits, this would be represented by a vertical intercept at $M on a graph with insurance on the vertical axis and all other goods on the horizontal axis. Tom forgoes these benefits if he chooses private health insurance.

An indifference curve representing Tom's preference for private coverage over government insurance would lie above the budget constraint line, passing through the point representing the private insurance Tom chooses. This indifference curve would show a combination of insurance and other goods that provides Tom with the same level of utility as the potential combinations along the budget constraint, but at a higher utility level since he prefers the private insurance, despite its cost, over the free government insurance.