UNIVERSITY OF OTAGO EXAMINATIONS 2007

ECONOMICS
ECON306

ECONOMICS OF HEALTH AND EDUCATION

Semester 2

(TIME ALLOWED: 2 HOURS)

This examination paper comprises 9 pages.

Candidates should answer questions as follows:

SECTION A: Answer ALL 40 questions. [40 marks]

SECTION B: Answer BOTH questions. [35 marks]

Note: Question 42 offers a choice.

The following material is provided:

Multi-choice answer sheet.

Use of calculators:

No restriction on the model of calculator to be used, but no device with communication

capability shall be accepted as a calculator.

(Subject to inspection by the examiners.)

Candidates are permitted copies of:

Nil.

Other Instructions:

Hand in your multi-choice answer sheet attached to your answer book/s.

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 2 ECON306 Economics of Health and Education

SECTION A [40 marks]

Answer ALL 40 questions on your multi-choice answer sheet by choosing the

answer that is ‘most correct’. Each question is worth 1 mark.

1. In New Zealand, spending by the government on health care and education respectively
accounts for approximately what proportion of total government spending?
(a) 2.5% each
(b) 5% each
(c) 10% each
(d) 20% each

2. After 1750, death rates in the Western world fell dramatically. According to McKeown (1976),*
which of the following played a relatively insignificant role in causing death rates to fall?
(a) Medical advances.
(b) Public health measures, such as sewerage systems and improved hygiene.
(c) Improved human nutrition.
(d) None of the above.

3. What is ‘iatrogenic illness’?

(a) Illness of the eye.
(b) Illness caused by iatro-genetic factors.
(c) Illness caused by not enough iron in the blood supply.
(d) Illness caused by doctors.

4. Suppose you have to pay a $20 fee and wait 15 minutes (worth $5 to you) to see your doctor.
Your ‘true’ price elasticity of demand ― i.e. recognising both of these opportunity costs ― is
equal to –1.5. Suppose the fee doubles to $40. With respect to this rise, what would be your
‘observed’ elasticity if you (mistakenly) ignored the time cost when calculating your observed
elasticity?
(a) –1.0
(b) –1.2
(c) –1.5
(d) –1.8

5. Why do private health insurance markets tend to fail?

(a) Moral hazard.
(b) Diseconomies of small scale with respect to administration costs, etc (i.e. natural
monopolies).
(c) Adverse selection.
(d) All of the above.

6. What are ‘psychic’ externalities?

(a) External costs and benefits to society from having clairvoyants around.
(b) External costs and benefits associated with caring about other people.
(c) External costs and benefits from being at risk of catching diseases from other people.
(d) External costs and benefits from curing other people.

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*
T. McKeown, The Modern Rise of Populations, London: Edward Arnold, 1976.
 3 ECON306 Economics of Health and Education

7. A private (or ‘Coasian’) solution to the problem of internalising a positive health care
externality would involve the large number of affected individuals voluntarily subsidising other
people’s consumption of health care. This tends not to work. Why not?
(a) Because, with the large number of people affected by the externality, the free rider problem
arises.
(b) Because governments always step in and prevent such a private solution.
(c) A private solution will work, and usually does.
(d) Because people tend not to be affected by other people’s consumption of health care.

8. What is the main idea behind the so-called Positive Theory of Government Intervention
(usually with respect to regulation)?
(a) Regulation is a positive-sum game (i.e. that benefits everyone).
(b) Regulation is in the public interest.
(c) Regulation arises due to firms’ desire to use regulation as a shield against competition.
(d) Regulations are introduced to overcome the free rider problem.

9. Why does the Supplier-Induced Demand Hypothesis, if it is true, represent a serious threat to
mainstream economic theory?
(a) Because it means that suppliers can get consumers to demand more health care.
(b) Because it undermines demand and supply analysis, in particular by invalidating the
independence of demand and supply.
(c) Because it means that policy makers should try to limit the number of doctors working in
an area.
(d) Because it means that the government should increase the number of doctors graduating
from medical schools and also increase the number of immigrants who are doctors.

This information relates to questions 10 – 12.

Suppose your utility (U) function is U = 3  √Y. Your income (Y) when you are well is $4900.
There is a 40% chance that you will get sick (and a 60% chance that you will stay well), which will
cost you all of your income in lost earnings.

10. What is the maximum premium you would be willing to pay for health insurance to cover your
cost of being sick?
(a) $4900
(b) $3460
(c) $3136
(d) $1960

11. What is your risk premium?

(a) $948
(b) $1176
(c) $1960
(d) $3460

12. What is the certainty equivalent of your income distribution associated with getting sick and
staying well respectively?
(a) $784
(b) $1764
(c) $2940
(d) $2990
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 4 ECON306 Economics of Health and Education

13. Which of these utility functions represents a person who likes risk (i.e. a ‘risk lover’)?
(a) U = ½  Y2
(b) U = ½  √Y
(c) U = ½  Y
(d) U = ½  Y½

14. What can an insurer do when faced with the adverse selection problem (as insurers almost
always are)?
(a) Try to force low-risk people to stay in the insurance scheme somehow.
(b) Keep high-risk people out of the insurance scheme somehow.
(c) Offer insurance on a group basis to everyone (both low and high risk).
(d) All of the above.

15. Which of the following are possible explanations for the observation that doctors tend to charge
their rich patients more than their poorer patients?
(a) Rich patients are more expensive to treat than poorer patients because they are more likely
to seek redress if something goes wrong.
(b) Rich patients have higher time costs than poor patients and so they ‘get more done’ when
they visit their doctors.
(c) Doctors are engaging in 1st-degree price discrimination and are simply trying to maximise
their profits.
(d) All of the above.

16. Suppose you are the manager of a hospital and you notice that the doctors are four times as
productive as the nurses, but they cost only three times as much as the nurses. You would
therefore be tempted to increase the number of doctors you hire and decrease the number of
nurses. Unfortunately the doctors, who are very powerful in your hospital, won’t let you do this
– as they do not want their marginal productivity to fall (which would put downwards pressure
on their wages). This situation, in essence, corresponds to which of these models of hospital
behaviour?
(a) The ‘physician control’ model.
(b) The ‘managerial expense preference’ model.
(c) The ‘quantity-maximisation’ model.
(d) The model whereby services with low price elasticity of demand are used to cross
subsidise high elasticity services.

17. In the ‘quantity-quality trade off’ model of hospital behaviour, why is there a trade off
eventually between the quantity of services produced and their quality?
(a) As the quality of the hospital’s output rises, eventually the average cost of production rises
by more than the decrease in consumers’ willingness-to-pay for the additional quality.
(b) As the quality of the hospital’s output rises, eventually the average cost of production rises
by less than the decrease in consumers’ willingness-to-pay for the additional quality.
(c) As the quality of the hospital’s output rises, eventually the average cost of production rises
by more than the increase in consumers’ willingness-to-pay for the additional quality.
(d) As the quality of the hospital’s output rises, eventually the average cost of production rises
by less than the increase in consumers’ willingness-to-pay for the additional quality.

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 5 ECON306 Economics of Health and Education

18. Which of these statements is true?

(a) Health systems based predominantly on private health insurance offer the greatest range of
services relative to other types of health system.
(b) Social insurance health systems suffer from the ‘tax illusion’.
(c) Public systems require a relatively small government bureaucracy to manage them.
(d) Private insurance systems spend relatively small amounts on administration.

19. With respect to the amount of money they spend on health care per capita and as a proportion
of GDP, which of these types of health system tend to spend the least?
(a) Private insurance health systems ― i.e. the US’s system.
(b) Public health systems ― e.g. New Zealand’s system.
(c) Social insurance health systems ― e.g. Germany’s system.
(d) It is impossible to generalise.

20. What was the main (official) objective of New Zealand public hospitals between 1993 and
1996 (i.e. during the regime sometimes referred to as the ‘Purchaser-Provider Split’)?
(a) To treat as many patients as possible subject to the budget constraint.
(b) To maximise the quality of the health care they provided.
(c) To operate as successful businesses (including generating a return on capital).
(d) To maximise the number of staff employed.

21. In the context of health economics, what does PBMA stand for?
(a) Programme Budgeting Marginal Analysis
(b) Performance Based Managerial Analysis
(c) Provider Budgeted Medical Activities
(d) Process Based Mission Assurance

22. Suppose you were comparing two treatments for which it is easy to arrive at valuations of both
their costs and consequences (‘benefits’) in monetary terms. Which method of economic
evaluation would be best for comparing them?
(a) Cost-minimisation analysis
(b) Cost-effectiveness analysis
(c) Cost-utility analysis
(d) Cost-benefit analysis

23. Suppose a treatment costs $90 now and generates $115 worth of savings in a year’s time. What
is the treatment’s internal rate of return (IRR)?
(a) 15%
(b) 18%
(c) 28%
(d) 32%

24. Suppose your risk of falling from your skateboard and breaking your wrist is 10%, but if you
wear a wrist guard this risk is halved. If you are willing to pay $80 for the wrist guard, what
does this imply is the value you put on avoiding a broken wrist?
(a) $80
(b) $400
(c) $800
(d) $1600

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This information relates to questions 25 - 29.

The net benefits from four treatments, T(1), T(2), T(3) and T(4), in each of three possible ‘states of
nature’, S(1), S(2) and S(3), are given by this table:

S(1) S(2) S(3)

T(1): 2 10 7
T(2): 9 16 6
T(3): 14 2 18
T(4): 20 7 5

25. Which treatment is best according to the maximin criterion?

(a) T(1)
(b) T(2)
(c) T(3)
(d) T(4)

26. Which treatment is best according to the maximax criterion?

(a) T(1)
(b) T(2)
(c) T(3)
(d) T(4)

27. Which treatment is best according to the minimax regret criterion?

(a) T(1)
(b) T(2)
(c) T(3)
(d) T(4)

28. Which treatment is best according to the Laplace criterion?

(a) T(1)
(b) T(2)
(c) T(3)
(d) T(4)

29. Which treatment is best with an index of pessimism of 0.6?

(a) T(1)
(b) T(2)
(c) T(3)
(d) T(4)

30. The EQ-5D health state classification system has five dimensions with three levels on each
dimension. In addition to ‘Dead’, how many health states can be represented by the EQ-5D?
(a) 15
(b) 125
(c) 243
(d) 256

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 7 ECON306 Economics of Health and Education

This information relates to questions 31 - 35.

Paul fell off his bike and damaged his neck. Without treatment his health-related quality of life
(HRQoL) is expected to be 0.75 for the rest of his life. Paul is expected to live for another 50 years
regardless of which of the following two treatments he receives.

Neck surgery: Costs $16,000 immediately and increases Paul’s HRQoL to 1.0 for the rest of his
life, but requires annual checkups costing $300 each (paid at the end of each year).

Physiotherapy: Costs $1000 per year (paid at the end of each year) and increases Paul’s HRQoL to
0.95 for the rest of his life. In 10 years’ time he will also need a minor procedure
costing $3000 (paid at the end of that year).

For the following questions, assume a discount rate (r) of 5% per annum and note that the present
value of an annuity of a per annum for n years at r rate of discount is given by the formula:

– (or, equivalently, a[ – ])

31. What is the present value of the cost of Neck surgery?

(a) $16,300.00
(b) $21,476.78
(c) $24,169.15
(d) $31,000.00

32. What is the present value of the cost of Physiotherapy?

(a) $20,097.67
(b) $24,169.15
(c) $27,503.23
(d) $53,000.00

33. What are the present values of the QALYs gained from Neck surgery and Physiotherapy
respectively?
(a) Neck surgery = 4.56 QALYs; Physiotherapy = 3.65 QALYs
(b) Neck surgery = 4.56 QALYs; Physiotherapy = 10 QALYs
(c) Neck surgery = 18.26 QALYs; Physiotherapy = 17.34 QALYs
(d) Neck surgery = 13.69 QALYs; Physiotherapy = 17.34 QALYs

34. What are the costs per QALY (in present value terms) for Neck surgery and Physiotherapy
respectively?
(a) Neck surgery = $1718.14 per QALY; Physiotherapy = $1825.59 per QALY
(b) Neck surgery = $6792.32 per QALY; Physiotherapy = $14,515.83 per QALY
(c) Neck surgery = $3672.34 per QALY; Physiotherapy = $2319.21 per QALY
(d) Neck surgery = $4705.71 per QALY; Physiotherapy = $5504.42 per QALY

35. Which of these conclusions is true?

(a) All else being equal, Physiotherapy and Neck surgery are equally cost effective.
(b) All else being equal, neither Physiotherapy nor Neck surgery are cost effective.
(c) All else being equal, Neck surgery is a more cost-effective treatment than Physiotherapy.
(d) All else being equal, Physiotherapy is a more cost-effective treatment than Neck surgery.
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 8 ECON306 Economics of Health and Education

36. Based on the information in the table below, for a risk-averse decision maker, which of the
following health care projects is/are best?
(a) P(1)
(b) P(2)
(c) P(2) or P(3)
(d) It is impossible to say, as there is not enough information provided here.

 
(return) (risk)
P(1): 10 5
P(2): 21 5
P(3): 12 3
P(4): 17 6

37. When applied to the distribution of health care resources, the Utilitarian value judgement (or
‘ethical position’) translates to treating
(a) all people equally, no matter how sick they are.
(b) first the people who are most in need (i.e. the sickest).
(c) people in random order.
(d) first the people who would benefit the most from treatment.

38. Education is often regarded as a ‘merit’ good. What is a merit good?

(a) A good that ‘society’ feels individuals should consume but that they would not choose to
in sufficient quantities if the decision were left to the individuals themselves.
(b) A good that is non-rivalrous and non-excludable; i.e. one person’s consumption does not
prevent others from consuming it, nor can people be prevented from consuming the good.
(c) A good that is both an investment and consumption good, and so it is more useful than
other types of good.
(d) A good that imposes low deadweight losses (DWLs) when taxed, and so it is the ideal type
of good for governments to levy taxes on.

39. What is the main economic reason for the Student Loans Scheme (SLS) being run by the
government rather than commercial banks?
(a) The government makes money from the SLS through the tax system.
(b) Commercial banks are unwilling to lend to students, even at high interest rates, because
most students do not have sufficient collateral.
(c) Commercial banks do not like students (e.g. because of things like riots in Hyde and Castle
Streets).
(d) The government wants students to receive the best education possible.

40. Which of the following is not predicted by the Human Capital Theory of education?
(a) Old people will demand less education than younger people (ceteris paribus).
(b) The lower the age-earnings differential associated with education, the less education will
be demanded (ceteris paribus).
(c) The higher the age-earnings differential associated with education, the more education will
be demanded (ceteris paribus).
(d) The higher the foregone earnings while a person is studying, the more education she will
demand (ceteris paribus).

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 9 ECON306 Economics of Health and Education

SECTION B [35 marks]

Answer the following TWO questions (note that Question 42 offers you a
CHOICE). Marks for each question are shown.

41. (a) Use Wagstaff’s (1986)* four-quadrant model to explain why well-educated people tend
to have better health than less well-educated people (all else being equal), even though
well-educated people may consume less health care.
[10 marks]

(b) Suggest an alternative theoretical explanation (i.e. unrelated to Wagstaff’s model) for
this positive correlation between education and health.
[5 marks]

42. Answer ONE of these question (do NOT answer both):

EITHER: “To economists, human life is not of infinite value.” Explain this statement, and
discuss how estimates of the ‘value of life’ are arrived at.

OR: Use Spence’s (1973)# model of education as a ‘signal’ (or a ‘screen’) to carefully
explain why making it any easier academically to obtain a university degree would
not be in the interests of so-called ‘high productivity’ students/workers (relative to
their ‘low productivity’ counterparts).
[20 Marks]

*
A. Wagstaff (1986), “The demand for health: theory and applications”, Journal of Epidemiology and
Community Health, 40, 1-11.
#
M. Spence (1973), “Job market signaling”, The Quarterly Journal of Economics, 87, 355-74.