The welfare economics of moral hazard.

Pauly's analysis of the welfare effects of moral hazard assumes that consumption of health care does not increase with income, however, empirical evidence suggests it does. For health insurance contracts that pay off by reducing price, the income effect is represented by the additional health care consumed because of income transfers from those who remain healthy to those who become ill. This implies a different decomposition of demand than the standard Hicksian decomposition. When the effect of income transfers is removed, the price-related welfare loss is smaller than either the loss suggested by Pauly's analysis or a Hicksian decomposition.