Week 3 - Demand for insurance and Competitive/ unfair insurance Flashcards
What are the characteristics of a perfectly competitive insurance market?
Free entry and exit, homogenous insurance products, perfect information, and a large number of insurance firms.
What is the expected economic profit in a perfectly competitive insurance market?
Zero.
How is the profit of one insurance firm calculated in this market?
As the difference between the collected premium (๐๐พ) and the payments in case of accident (๐๐๐พ).
What happens to the insurance firmโs costs if no accident occurs?
The firm doesnโt suffer any cost if no accident occurs (with probability 1โ๐๐).
How do we algebraically represent the profit equation?
What is the equation if the market is competitively perfect and profit is 0?
What is the price of โfairโ insurance in a perfectly competitive market?
The price of one unit of wealth insured is equal to the probability of the accident occurring.
How is the price of โfairโ insurance calculated?
By setting the price of insurance equal to the probability of the accident occurring.
How does โfairโ insurance ensure sustainability for insurance firms in a competitive market?
By collecting premiums equal to expected payouts, firms can cover their costs without making excess profits, maintaining market balance.
What is another rational response to uncertainty besides insurance?
Diversification.
What does diversification involve in the context of uncertainty?
Creating a portfolio of contingent (consumption) goods to spread risk.
What is the purpose of risk spreading or mutual insurance as a rational response to uncertainty?
To reduce individual risk by sharing it across multiple parties or assets.
Why is diversification considered a rational response to uncertainty?
Because it minimizes the risk of large losses by not relying on a single source of income or asset.
