Lecture 2 Flashcards
social protection
These are policies that aim to protect everyone, but particularly the most vulnerable, by providing insurance against adverse events
Why does the government spend so much on social protection?
adverse selection means that in some circumstances private insurance markets fail
-insurance markets fail to provide insurance= provide less than people are willing to buy
-fails in a way whoch leads to inequalities
why do we need insurance
-Insurance allows you to smooth consumption so that you get the
same amount whether you end up in the good or bad state of the
world
-You pay a firm a premium and in return they give you money if you
end up in the bad state (if an adverse event occurs)
why do people value insurance
future is uncertain and it provides consumprtion smoothing= same flow of consumption and uility
Consumption and utility
Consumption smoothing
utility is increasing in consumption, but the rate at which it increases is decreasing, this means the marginal utility of income is higher when you have little income, and decreases as your income increases
-the transfer of consumption from periods when consumption is high (marginal utility of income is low), to periods when consumption is low (high marginal utility is high will increase utility
-Individuals value (and so will be willing to pay for) insurance in order
to smooth their consumption across states of the world (from good times to bad times)
LEADING TO CONSUMPTION SMOOTHING
WHEN insurance markets work the goc doesnt need to get involved
-marginal utility is the same even is either state
when do the insurance markets work
-heterogeneity in risks across individuals= Individuals don’t all have the same probability of getting sick
-therefore= symmetric information= in this case insurance companies will charge two different premiums and offer two different payouts, each of which allows that type of person to fully insure themselves
the problem with the private market - symetric information
-In this case private insurance allows individuals to smooth
consumption over states of the world
* but it does not equalize incomes across types of people
* pre-existing conditions will lead to inequality in insurance premia and in expected utility
the insurance market asymetric infrormation= Adverse selection example
This inefficiency (market failure) arises because of the combination of heterogeneity in risks and asymmetric information about those risks
the insurance market is there is asymetric infrormation= Adverse selcetion example
everyone will claim “healthly” in order to pay less= leading to looses for the companies, and disequilibrium in the market
-average price will go up, low risk people will pay more therefore won’t purchase an insurance
-only high risk people will buy an insurance- increasing the price even more which will drive even more people out of the market (more lower risk people)
-more losses for insurance people= higher prices
-market unravels, in the end no insurance is offered, even though
everybody is willing to pay a fair price for insurance
how can the gov adress the adverse selction in the insurANCE MARKET
The government can address adverse selection and improve market efficiency by:
* directly provide the insurance (e.g. universal free healthcare)
* mandate that everybody is required to purchase insurance (e.g. car insurance,
private pensions, health insurance in some other countries)
why would the gov provide social insurance
-market failure due to adverse selection
-redistribution
-externalities- such as consequences on other people
-paternalism
Moral hazard
Moral hazard refers to actions taken by insured individuals in response to insurance that increase the likelihood of adverse outcomes
-this increases the cost of providing
3 types of moral hazard
- Reduced precaution against entering the adverse state
- Increased odds of staying in the adverse state
- Increased expenditures when in the adverse state
-becuase of m hazard the public/private insurace dont provide full insurance
