4a. With full coverage, David
faces a marginal charge of zero for additional days in the hospital,
so will elect to remain hospitalized for 8 days.
4b. With insurance that covered
only expenses greater than $1,000, he would face a marginal charge of
$150/day and would choose to stay in the hospital only two days. The
cumulative amount by which the extra cost of an 8 day stay exceeds the
extra benefit will be $450, the area of the upper right hand triangle
formed by the difference between the supply curve and the demand curve
between 2 and 4 days. Thus, the six extra days cost society $900, but
benefit David by only $450. So total economic surplus would have been
$450 higher under the policy that covers only those expenses beyond
$1,000 per illness.
9. The answer is e. Although the
incentive problem does exist under the stated circumstances, it is not
a cause of the free-rider problem.