Deck 22: Asymmetric Information in Competitive Markets

Question 1

Expected utility theory predicts that individuals will fully insure in actuarily fair markets so long as their tastes are state-independent.How might adverse selection result in some individuals under-insuring?

Answer 1

Under adverse selection,a separating equilibrium will have the following feature: Low cost types will be offered a menu of insurance contracts that is actuarily fair but not complete -- i.e.full insurance will not be offered at rates that are actuarily fair for low cost consumers because this would draw high cost consumers into the market.

Question 2

Suppose a competitive market with adverse selection has settled into a pooling equilibrium where everyone is offered the same price.If firms then screen consumers,the outcome may and may not be more efficient.

Answer 2

True
If screening costs are low,then it is efficiency enhancing to screen; if they are too high then not.

Question 3

In a competitive separating equilibrium,low cost consumers of insurance will not fully insure because insurance rates offered to them are not actuarily fair.

Answer 3

False
Low cost consumers may not fully insure because,in a separating equilibrium,they are not offered a full menu of actuarily fair insurance policies.The zero profit condition still implies that competitive firms would offer actuarily air rates -- jut not the option of full insurance.

Question 4

In the presence of adverse selection (due to high and low cost consumers),firms will employ screens to get information about consumers so long as this leads to a more efficient competitive equilibrium.

Question 5

Whenever there is adverse selection without signaling or screening,there will be a missing market.

Question 6

Adverse selection in insurance markets results in missing markets because people engage in riskier behavior once they are insured.

Question 7

Consider two types of rules that might govern an otherwise unregulated health insurance market: (1)Insurance companies can price-discriminate against the sick and old; (2)insurance companies cannot price discriminate against the sick and old.Explain why,in equilibrium,insurance may be very expensive for the sick and old regardless of which case we find ourselves in.

Question 8

Suppose a competitive market with adverse selection has settled into a pooling equilibrium where everyone is offered the same price.If full markets are re-established through signals,the new equilibrium will be more efficient than the original pooling equilibrium.

Question 9

Whether or not a separating equilibrium exists in a competitive market with adverse selection depends on what fraction of consumers is of the high cost type and what fraction is of the low cost type.

Question 10

Whenever there is adverse selection,there will be missing market.

Question 11

In a competitive market with high cost and low cost consumers (where firms are unable to tell consumer types apart),any screening costs incurred by firms will be passed on to low cost consumer but not to high cost consumers.

Question 12

Regardless of whether or not screening or signaling occurs in markets with adverse selection,the equilibrium will always be less efficient than an equilibrium in the same competitive market if there were no asymmetric information.

Question 13

Explain the following statement: "In health insurance markets,moral hazard implies individuals will consume too much health care,whereas adverse selection implies too little health care will be consumed."

Question 14

If all consumers are willing to buy insurance at the zero-profit pooling price,there cannot be a separating equilibrium.

Question 15

In equilibrium,consumers will incur costs to signal their type (in markets with adverse selection)only if this results in a price that is lower than the pooling equilibrium price.

Question 16

If firms successfully gather information about consumers before offering them insurance,and if this leads to a separating equilibrium,efficiency is restored.

Question 17

If a pooling equilibrium exists in an insurance market,no separating equilibrium can exist.

Question 18

A pooling equilibrium in insurance markets is inefficient because everyone buys too little insurance (relative to the efficient amount).

Question 19

Whether or not a pooling equilibrium exists in a competitive market with adverse selection depends on what fraction of consumers is of the high cost type and what fraction is of the low cost type.

Question 20

Firms that employ statistical discrimination in the labor market will earn higher profits in expectation than firms that do not discriminate (and have no effective screens).

Question 21

Suppose ordinarily half your class would get an A and half would get a B,with A students having a 25% chance of getting an A and B students having a 25% of getting an A.It costs $100 to persuade the instructor to raise a B grade to an A.A student is willing to pay $40 to insure she will get her usual grade and $70 to insure she will get a higher grade than usual.
a.If all students buy insurance that guarantees them an A,what is the zero profit price for an insurance company that offers A insurance.
b.Will grade insurance be sold in equilibrium?
c.Who would buy insurance and at what price if the insurance companies could tell what type of student each student is?
d.Is either the result in (b)or (c)efficient?

Question 22

Suppose ordinarily half your class would get an A and half would get a B,with A students having a 25% chance of getting an A and B students having a 25% of getting an A.It costs $100 to persuade the instructor to raise a B grade to an A.A student is willing to pay $40 to insure she will get her usual grade and $70 to insure she will get a higher grade than usual.
a.Who would buy insurance and at what price in a competitive equilibrium?
b.Suppose it costs $5 to truthfully signal your type and $10 to falsely signal what type of student you are,and if an insurance company receives no signal,it will interpret this as a signal that you are a B student.What would be the competitive outcome now?
c.Suppose a new teacher comes in -- and this teacher is willing to change a grade for just $60.How does your answer to (a)change?
d.How would your answer to (b)change?
e.Can you change something in the problem that would result in only A-students buying insurance?