Moral Hazard, Market Power, and Second Best Health Insurance

Individual moral hazard engendered by health insurance and monopolistic production are both typical phenomena of drug markets. We develop a simple model containing these two elements and evaluate the market equilibrium on the basis of consumer and social welfare. The consumer welfare criterion suggests that in the market equilibrium individuals purchase too much insurance against the risk of drug expenses. In contrast, the social welfare criterion suggests that individuals should purchase more insurance coverage than they choose to do in the market equilibrium.