ECON 200 Chapter Notes - Chapter 10: Information Asymmetry, Vehicle Insurance, Adverse Selection

31 views2 pages

lemonsnail891

25 Feb 2015

School

University of Maryland

Department

Economics

Course

ECON 200

Professor

Cindy Clements

For unlimited access to Textbook Notes, a Class+ subscription is required.

Document Summary

Complete information- state of being fully informed about the choices that relevant economic actors face. Information asymmetry- a condition in which one person knows more than another. Information asymmetries can also cause problems after selection has occurred and the two parties have entered into an agreement. Problem often arises when one person entrusts a task to another person. Principal- a person who entrusts someone with a task. Agent- a person who carries out a task on someone else"s behalf. Moral hazard- the tendency for people to behave in a riskier way or to renege on contracts when they do not face the full consequences of their actions. Can be avoided by correcting the information asymmetry through better monitoring, but not always possible to correct. Moral hazard and adverse selection avoiding confusion. Careless drivers are more likely to buy auto insurance voluntarily (adverse selection); drivers with auto insurance may be more likely to be careless (moral hazard)

Related Questions

A health insurance company knows that there are two types of customers (smokers and non-smokers), each facing different health risks. The probabilities of getting sick and the healthcare costs in the case of illness for the two customer types is given in the table below.

Group	Healthcare costs	Probability of getting sick
Smokers	$1200	50%
Non-smokers	$1200	20%

Assume that each customer has a monthly income of $1600 and has a utility function given by U(x)=sqrt(x), where x is the remaining income after medical/health insurance expenses have been paid.

a. Explain the problem of âadverse selectionâ and the problem of âmoral hazard.â Give one example of a market in which adverse selection occurs and one example of a market in which moral hazard can be observed. What is the difference between the two information problems? Explain the consequences of adverse selection and moral hazard for the principal â agent relationship.

b. Discuss in detail the two ways (screening and signaling) in which the principal or the agent can try to resolve the problem of adverse selection. Give an example of screening and signaling and explain how the parties involved benefit from these strategies.

c. For the numerical example above construct the lotteries associated with the income that remains after healthcare expenses have been paid for smokers and for non-smokers (assuming agents do not have health insurance). Calculate the expected utility associated with the lotteries for smokers and non-smokers. Calculate the certainty equivalent of the two lotteries. What is maximum amount that smokers and non-smokers are willing to pay for full insurance? Calculate the actuarially fair health insurance premium for the two groups of customers (i.e. the expected healthcare costs).

dAssume the company cannot distinguish between smokers and non-smokers and offers a full insurance contract to all customers. How much should the company charge for the full insurance contract? Which customer group will purchase full insurance?

silverkangaroo356

http://scholar.harvard.edu/files/lewis/files/aer2e1012e42e1535.pdf

Read the paper Asymmetric Information, Adverse Selection and Online Disclosure: The Case of eBay Motors available in the Learning Materials folder (scroll down to the bottom). Respond to the following questions:

a. When you, as a consumer, buy used goods online (or think about buying online) are you sure that the purchased item will have the quality advertised by the seller? Explain.

b. How does eBay create value? Explain.

c. What potential contracting problems exist on eBay and how does eBay address these problems?

d. What is the main principle-agent problem that occurs in used goods online markets that the paper is referring to? Describe the problem in detail.

e. What is the main theory (or hypothesis) that the author proposes which helps buyers and sellers transact online?

f. How does the author make sure that the differences in observed transaction prices are due to differences in the quality of the cars sold? Explain.

emeraldtortoise550

ECON 200 Chapter Notes - Chapter 10: Information Asymmetry, Vehicle Insurance, Adverse Selection

Document Summary

Get access

Related Documents

ECON 200 Chapter Notes - Chapter 10: Adverse Selection, Stamen, Opportunity Cost

ECON 200 Lecture 11: Oct 15, 2018

ECON 200 Lecture Notes - Lecture 19: Hernán Cortés, Society Of Jesus, Infant Mortality

Related Questions