Adverse Selection (L8)

Question 1

market for lemons

Answer 1

idea that when insurers know a person’s risk and set the premium accordingly, only the sickest people will purchase it, creating a “market death spiral”

Question 2

adverse selection

Answer 2

result of information asymmetry between a buyer and a seller – the buyer (of insurance) have more information about their lifestyle, health, etc. that they can hide from an insurer – insurer doesn’t know how much to charge high risk individuals for their insurance because they don’t know that they’re high risk

Question 3

asymmetric information

Answer 3

a situation in which agents in a potential economic transaction do not have the same information about the quality of the good being transacted

Question 4

theoretical predictions on how adverse selection effects insurance market

Answer 4

1. Positive correlation between risk and coverage – people with higher health risk more likely to be insured
2. Adverse selection death spiral
3. Bulk markups – theoretical prediction on how insurance companies respond

Question 5

adverse selection death spiral

Answer 5

successive rounds of adverse selection that destroy an insurance market.