ACJC H2 ECONS P2 essay Q3 (info failure)

1 Suggested Answers for 2018 Econs H2 Prelims Paper 2 Essay Question 3: 3(a) Explain how imperfect and asymmetric information can lead to market failure in the markets for healthcare services and healthcare insurance. [10] (b) Discuss whether joint provision is the most appropriate policy to correct the market failure in Singapore’s healthcare services. [15] Suggested approach to 3(a) 3(a) Explain how imperfect and asymmetric information can lead to market failure in the markets for healthcare services and healthcare insurance. [10] Question Requirement: • Explain how imperfect information exists in 1) healthcare services market and asymmetric information in the 2) healthcare insurance market • Explain how the sources can lead to market failures. • Use of diagram(s) should help in explanation but not compulsory. Introduction: Market failure exists when resources are not allocated efficiently, therefore leading to welfare loss in the society. Imperfect information exists when the economic agents do not have perfect information about the product/service. Asymmetric information is when one party has more information than the other. There is imperfect information in the market for healthcare services and asymmetric information in the market for healthcare insurance. Therefore, without any form of government intervention, both markets fail. Point 1: Imperfect information leads to under-consumption of healthcare services. Economic agents may have under-estimated the true private benefits for themselves in the consumption of healthca re services, such as vaccinations, doctor consultations. For example, they may not see the doctor when they are sick if they under- estimate the seriousness of their illness. As a result, the virus may spread to other healthy people close to the patient. In other times, the sick person may also over-estimated the costs of consuming the healthcare services, thereby refusing treatments and/or consultations. As rational economic agents, they will only consume healthcare services up to a point when their perceived marginal private benefit is equal to their marginal private cost. However, due to imperfect information, the true private benefits of the consumption of healthcare services is higher than the estimated marginal private benefit, there will be an under-consumption of healthcare services, leading to market failure.

2 As seen from the diagram above, the so cially optimal level of consumption of healthcare services should be where the marginal private benefits (actual) equal to the marginal private cost, Qs. However, because of imperfect information, the market level of consumption is only at Qm, where the marg inal private benefit (perceived) equals to the marginal private cost. As Qm is lower than Qs, there is under-consumption of healthcare services, therefore the market for healthcare services fails. Point 2: Asymmetric information leads to market failure in the healthcare insurance market (adverse selection and moral hazard). In the health insurance market, consumers have to pay insurance premiums when they purchase health insurance. These premiums are often linked to their health status/conditions. The better the health condition, the lower the insurance premium. Therefore, some consumers may hide certain bad habits such as smoking or their true physical medical conditions from the health insurers, in order to pay lower premiums. Without any form of intervention, health insurance companies may not be able to ascertain whether the information provided by the consumers are factual or not. Therein, this means that the consumers will have more knowledge about their own medical conditions than the health insurers. As a result of such asymmetric information, the health insurers may charge higher premiums for all consumers, therefore squeezing out the consumers who indeed have healthy medical status, as they are less willing to pay for such high premiums since they are healthy. It is likely that the market may be left with those who have poor medical health, who are willing to pay the higher premiums if they view that the premiums can be offset by the sum they are insured of. This is a situation of adverse selection. On top of that, after the consumption of health insurance, some consumers may be more reckless in their consumption habits , since they know they are insured. As a result, they may engage in more risky behaviour such as drinking and binge eating, as their medical costs can be claimed from the insurance companies. Insurance companies may end up having to fork out more insured payments, as a result of this moral hazard. This leads to wastage of resources. Conclusion: Benefits / Costs Quantity of health check-ups MPC MPB (perceived) Q M Q s A C B 0 Welfare loss MPB (actual) P AE P M

3 In conclusion, there is market failure in both markets for healthcare services and market for health insurance. The government will have to implement appropriate measures to reduce the imperfect information and asymmetric inform ation in these markets, so as to achieve maximum social welfare and a socially optimal level of resource allocation. Things to note: • It is possible that students may explain asymmetric information in the consumption of medical services, where doctors have more information than the patients, hence leading to over-consumption of prescribed but not necessary treatments. • However, please take note that the focus of asymmetric information is still the result of adverse selection and moral hazard, therefore, it is still crucial for students to explain this in their answers. • In economics, the concept “imperfect information” entails BOTH under/over estimation of benefits/costs AND asymmetric information (where one party has more/less info than the other party). • Students are expected to expla in BOTH situations even if question has only the term “imperfect information”. This means that moral hazard and adverse selection should be included in the answers too. Marking scheme: Level Descriptors Marks L3 For an answer which: • Explains both sources of market failure in the two markets [e.g. explain imperfect information in healthcare services AND asymmetric information in insurance market] • Max of 8m for answers that explain accurately how imperfect information AND asymmetric information lead to market failure only in the market for healthcare services. • Good and accurate use of economic analysis • Has sufficient support with good examples 8 - 10 L2 For an answer which: • Either only explain one source of market failure in either markets (max 6m) [E.g. only imperfect information in healthcare services OR only asymmetric information in insurance market] • Explain either sources of market failures with some use of economic analysis but contain several inaccuracies • Attempts to support answers with some examples 5 - 7 L1 For an answer which: • List the various sources of market failure without economic explanation. • Has no or minimal contextualised to either of the markets • Contains several gross inaccuracies • Does not have any examples used 1 – 4

4 Suggested approach to 3(b) (b) Discuss whether joint provision is the most appropriate policy to correct the market failure in Singapore’s healthcare services. [15] Question requirement: • Explain what it means by joint provision, in the context of Singapore’s market for healthcare services • Explain how joint provision can address the market failure in this market • Explain the limitations/challenges about joint provision • Explain how two other policies are required as well, which can address the limitations posed by joint provision. • Synthesis and make a