Week 9

Question 1

Adverse selection definition

Answer 1

is where market participants who have more information trade selectively to the detriment of others.

Question 2

How is risk modelled?

Answer 2

Lottery

Question 3

Risk-neutral consumer definition

Answer 3

A risk-neutral customer is someone who doesn’t care about risk. They only focus on the average outcome, or expected value, when making decisions.

Question 4

Risk-averse consumer definition

Answer 4

A risk-averse customer is someone who avoids risk and prefers safer, more predictable options, even if those options might offer smaller rewards

Question 5

Screening

Answer 5

is a strategy used by one party (usually the buyer) to gather information about the other party (usually the seller) in order to reduce the problems caused by adverse selection.

Question 6

Signalling

Answer 6

describes the efforts of the more informed party (consumers) to reveal information about themselves to the less informed party (the insurance company)

e.g a degree from a presitgious uni demostrates key skills

Question 7

Moral hazard

Answer 7

occurs when one party in a transaction takes risks or behaves in a way that is risky or reckless because they do not have to bear the full consequences of those actions.

Question 8

Examples moral hazard

Answer 8

insurance, banks and financial institutions

Question 9

Adverse Selection or Moral Hazard?

Answer 9

To distinguish between adverse selection and moral hazard, ask whether:
Information is hidden (adverse selection) or the action is hidden (moral hazard)
The problem arises before a transaction (adverse selection) or after (moral hazard)