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Problem: This is a highly stylized example of an insurance market. Suppose there are just two risk types, A and B, and their probabilities of different levels of medical spending are as shown in the table below (similar to Table 7.1 on page 89 of Reinhardt's book). In this example, we will not be concerned about moral hazard; probabilities and medical spending levels are the same whether or not one has insurance.
Table 1. Probabilities of Different Levels of Medical Spending
Size of Medical bill
Fraction of Type A Fraction of Type B
Expected to Incur Expected to Incur
Bill Such a Bill Such a Bill
$0 0.851 0.5295
$5,000 0.12 0.34
$25,000 0.02 0.09
$100,000 0.009 0.0405
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