14.01SC | Fall 2011 | Undergraduate

Principles of Microeconomics

Unit 7: Equity and Efficiency

U.S. Social Insurance Programs

« Previous | Next »

Session Overview

The majority of government revenue earned is not spent on explicitly redistributive programs, such as those discussed in previous lectures about efficiency and equity. In fact, the majority of government revenue earned is devoted to social insurance. Social insurance is designed to insure individuals against risk in cases where the private market may not effectively provide such insurance. In this lecture, we will begin to learn about the role of social insurance.

Social Security, launched in 1935, is a US social insurance program. Image courtesy of wisaflcio on Flickr.

Keywords: Taxation; tax cuts; redistribution methods; categorial cash transfers; social security.

Session Activities


Before watching the lecture video, read the course textbook for an introduction to the material covered in this session:

  • [R&T] Chapter 15, “Public Finance and Public Choice.”

Lecture Videos

Check Yourself

Concept Quiz

This concept quiz covers key vocabulary terms and also tests your intuitive understanding of the material covered in this session. Complete this quiz before moving on to the next session to make sure you understand the concepts required to solve the mathematical and graphical problems that are the basis of this course.

Question 1

What is one potential disadvantage of social insurance programs such as Social Security?

It encourages people to retire earlier. check
It insures people from unexpected loss of earning power. close
It is regressive. close
It is subject to adverse selection. close
Check Show Solution

The correct answer is that social insurance programs such as Social Security may encourage people to retire earlier than they would have otherwise, and thus removes productive people from the workforce. Social Security is not subject to adverse selection, because it has universal enrollment (and so it is not possible that only those at high risk of disability or early retirement enroll). It is not regressive (in fact, it is progressive). It does insure people from unexpected loss of earning power, but this is the objective of the policy, not a disadvantage.

Question 2

Which of the following behaviors is an example of moral hazard?

After you buy fire insurance, you are less careful about fire prevention. close
All of these. check
Once you are receiving unemployment, you feel less pressure to search for a job. close
Once you have health insurance, you do not take preventive health measures. close
Check Show Solution

Moral hazard refers to the phenomenon in which insuring an agent against an adverse event (sickness, car accidents, fires, unemployment) then encourages adverse (i.e., reckless) behavior that may make those events more likely. This can occur in any insurance market.

Question 3

Which of the following behaviors is an example of adverse selection?

After purchasing insurance, people sometimes become less cautious. close
People with chronic illnesses are most likely to buy health insurance. check
Younger drivers generally have a greater risk of accidents. close
Younger drivers generally pay higher premiums for auto insurance. close
Check Show Solution

The correct answer is that people with chronic illnesses are more likely to buy health insurance, because their expected benefit from the health insurance is greatest. Becoming less cautious after purchasing insurance is an example of moral hazard. On the other hand, the fact that younger drivers generally have a greater risk of accidents and thus pay higher premiums is not an example of either moral hazard or adverse selection, but reflects the fact that insurance costs typically correspond to relative risk.

Further Study

These optional resources are provided for students that wish to explore this topic more fully.

Other OCW and OER Content

14.41 Public Finance and Public Policy, Fall 2010. MIT OpenCourseWare An in-depth course on the government’s role in the economy.

« Previous | Next »

Course Info

As Taught In
Fall 2011
Learning Resource Types
Lecture Videos
Recitation Videos
Problem Sets with Solutions
Exams with Solutions
Lecture Notes
Exam Materials
Problem Sets