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Evaluating Health Care Externality Costs Generated by Risky Consumption Goods

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  • Michael A. Cohen

    (University of Connecticut)

  • Marina-Selini Katsaiti

    (University of Connecticut and University of Athens)

Abstract

We present an overlapping-generations (OLG) macroeconomic model that applies a behavioral interpretation of preferences for goods that generate health risks. In this paper proneness to poor health is viewed as a cognitive miscalculation by economic agents between their expected health state over various consumption bundles and the actual health care they require for their health outcome. To model this the paper borrows insight from prospect theory and applies the reference-dependent preference framework to the specication of out utility model. In our model of the economy individual preferences are decomposed into intrinsic consumption utility and gain-loss utility associated with the miscalculation. Agents in the economy are stratied in their health states as well as their expected health care consumption according to some probability measure over the population. Heterogeneity introduced in this way generates consumers of varied proneness to risk associated with consumption of unhealthy goods because individuals have various marginal valuations of their miscalculation. In such a population, when all agents pay the same insurance premium, health-conscious agents shoulder the health care costs of their less health-conscious counterparts and the less health-conscious are engaged in less healthy consumption than they would if they paid actuarially fair premia. We demonstrate these eects in simulations by comparing the risk pooling equilibria to the actuarially fair pricing equilibria. This paper introduces the mathematical programming equilibrium constraint (MPEC) computational approach to compute model equilibria; we believe this approach is new to heterogeneous agent OLG model simulation.

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2009-43.

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Length: 29 pages
Date of creation: Dec 2009
Date of revision:
Handle: RePEc:uct:uconnp:2009-43

Note: We would like to thank Christian Zimmermann and Dennis Heffley for comments that lead to improvements in this paper. Any errors are ours alone.
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Keywords: Risky Consumption; Health care Cost; Insurance Premia Pricing; Two Sector Model; Obesity.;

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  1. Botond Koszegi & Matthew Rabin, 2004. "A Model of Reference-Dependent Preferences," Method and Hist of Econ Thought 0407001, EconWPA.
  2. Botond Koszegi & Matthew Rabin, 2007. "Reference-Dependent Risk Attitudes," American Economic Review, American Economic Association, vol. 97(4), pages 1047-1073, September.
  3. Botond Koszegi & Matthew Rabin, 2009. "Reference-Dependent Consumption Plans," American Economic Review, American Economic Association, vol. 99(3), pages 909-36, June.
  4. Jay Bhattacharya & Neeraj Sood, 2005. "Health Insurance and the Obesity Externality," NBER Working Papers 11529, National Bureau of Economic Research, Inc.
  5. Bowman, David & Minehart, Deborah & Rabin, Matthew, 1999. "Loss aversion in a consumption-savings model," Journal of Economic Behavior & Organization, Elsevier, vol. 38(2), pages 155-178, February.
  6. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
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