Consider two individuals that have recently purchased health insurance. They are
ID: 1165815 • Letter: C
Question
Consider two individuals that have recently purchased health insurance. They are now faced with the choice of using their insurance for typical spending, or for drastic overconsumption of resources knowing that someone else will foot the bill. The game below outlines payoffs, not costs, to the individuals. Note that value extracted drops when both are competing to overconsume resources.
Person B
Regular Consumption
Overconsumption
Person A
Regular Consumption
$40, $40
$10, $50
Overconsumption
$50, 10
$15, $15
6A: How would this game differ if the two individuals entered into a contract wherein both agreed to limit their spending to a legally binding definition of “regular consumption of resources”?
6B: Use the games in question #6 to explain Coase’s Invariance Principle?
Person B
Regular Consumption
Overconsumption
Person A
Regular Consumption
$40, $40
$10, $50
Overconsumption
$50, 10
$15, $15
Explanation / Answer
6a) Given that the dominant strategy for both consumer A and B is "Overconsumotion", the Nash equilibrium of the game will be attained at a point where both of them will "overconsume" with payoffs (15, 15) respectively.
However, if both the individuals enter into a contract wherein both limit their spending to regular consumption, both of them will attain a payoff og (40,40), which is 25 points higher for each individual.
6b) According to Coase's Invariance Principle, irrespective of the allocation of property rights, outcomes will be identical either way.
Clearly, in the above case, it does not matter whether individual A suggests entering into a contract or individual B. Both of them will benefit equally and thus the contract will be put in place.