Identify an unconsummated wealth creating transaction (or a wealth destroying one) created by some tax , subsidy, price control or other government policy, and than figure out how to profitably consummate it ( or deter it) estimate how much profit you earn by consummating (or deleting) it.

 

Describe a moral hazard problem your company is facing. What is the source of the asymmetric information? Who is the less informed party? Are there any wealth-creating transactions not consummated as a result of the asymmetric information? If so, could you consummate them? Compute the profit consequences of any advice.

Suppose there are two types of people who need health insurance; high-risk and low-risk consumers. High-risk consumers have a relatively high probability of needing expensive medical care and on average incur $2,000 of medical expenses per year. The high-risk consumers would be willing to pay up to $2,500 for insurance that covers all their medical bills. Low-risk consumers would be willing to pay up to $1,400 for full-coverage insurance and on average would incur on average $1,200 in medical bills. Assume 1/3 of all consumers are high-risk and the remaining 2/3 of consumers are low-risk. Consumers know whether they are high-risk or low-risk. The insurance company knows 2/3 of all consumers are low-risk but cannot identify which consumers are low-risk.

If all consumers bought insurance, what price must the insurance company charge to break even in expectation? That is, what price must the insurance company charge so that the expected payments equals the premium?

Which consumers would purchase insurance at that price?

Are there wealth-creating transactions that are not consummated because of the information asymmetry?

If the low-risk consumers were willing to pay $1,500 for the insurance, how would your answers to questions 2 and 3 change?

Suppose there are two types of people who need health insurance; high-risk and low-risk consumers. High-risk consumers have a relatively high probability of needing expensive medical care and on average incur $2,000 of medical expenses per year. The high-risk consumers would be willing to pay up to $2,500 for insurance that covers all their medical bills. Low-risk consumers would be willing to pay up to $1,400 for full-coverage insurance and on average would incur on average $1,200 in medical bills. Assume 1/3 of all consumers are high-risk and the remaining 2/3 of consumers are low-risk. Consumers know whether they are high-risk or low-risk. The insurance company knows 2/3 of all consumers are low-risk but cannot identify which consumers are low-risk.

1. If all consumers bought insurance, what price must the insurance company charge to break-even in expectation? That is, what price must the insurance company charge so that the expected payments equal the premium?

2. Which consumers would purchase insurance at that price?

3. Are there wealth-creating transactions that are not consummated because of the information asymmetry?

4. If the low-risk consumers were willing to pay $1,500 for the insurance, how would your answers to questions 2 and 3 change?