Question 1

In the used car market, the less-informed party is the ________. In the health care market, the less-informed party is the ________.

Accepted Answer

In the used car market, the less-informed party is typically the buyer, who may not have full information about the car's history or condition. In the health care market, the less-informed party is often the seller (healthcare providers), as patients (buyers) may not fully understand their own health conditions or the specifics of the medical services they are receiving.

Question 2

Figure 9.6
-Figure 9.6 represents the market for health insurance. Suppose there are two types of consumers, low-cost consumers with $2,000 average medical expenses per year, and high-cost customers with $4,000 average medical expenses per year. The insurance companies estimate that 40% of its customers are high-cost type. The uninformed side(s) of the market is (are)

Accepted Answer

Insurance companies are the uninformed side because they cannot perfectly distinguish between low-cost and high-cost consumers, hence they face uncertainty regarding the actual risk profile of their customers.

Question 3

Figure 9.6
-Figure 9.6 represents the market for health insurance. Suppose there are two types of consumers, low-cost consumers with $2,000 average medical expenses per year, and high-cost customers with $4,000 average medical expenses per year. If the insurance companies are pessimistic and set their price according to their pessimistic expectations

Accepted Answer

When insurance companies set prices based on pessimistic expectations, they anticipate higher average costs, likely closer to the $4,000 average of high-cost customers. This leads to higher premiums, which low-cost customers (with $2,000 average medical expenses) are less willing to pay, effectively driving them out of the market. Thus, the market will predominantly include only high-cost customers, as they are the ones for whom the insurance pricing aligns more closely with their expected medical expenses.

Question 4

Experience ratings provide firms with an incentive to

Accepted Answer

Experience ratings, which are based on the number of workplace accidents or injuries, provide firms with an incentive to invest in health and safety programs. By reducing the number of workplace accidents, firms can lower their experience rating and potentially reduce their workers' compensation premiums. Therefore, firms are motivated to prioritize the safety and health of their employees.

Question 5

Figure 9.6
-Figure 9.6 represents the market for health insurance. Suppose there are two types of consumers, low-cost consumers with $2,000 average medical expenses per year, and high-cost customers with $4,000 average medical expenses per year. The insurance companies estimate that 40% of its customers are high-cost type. If the insurance companies set the price equal to their average cost per customer, what type of customers will dominate the market?

Accepted Answer

Setting the price equal to the average cost per customer will drive away low-cost customers, as they will be paying the same price as high-cost customers despite having lower medical expenses. This will result in a higher proportion of high-cost customers dominating the market. Therefore, high-cost customers will dominate the market.

Question 6

Asymmetric information in the health insurance market causes prices to ________ and the mix of insured customers to become ________ healthy on average.

Accepted Answer

Asymmetric information in the health insurance market leads to adverse selection, where healthier individuals are less likely to purchase insurance, and sicker individuals are more likely to purchase insurance. This leads to an increase in the overall risk and costs for insurers, causing them to raise prices. Additionally, since healthier individuals are less likely to purchase insurance, the mix of insured customers becomes less healthy on average.

Question 7

If workers have better information about their own ability to work than employers do, which of the following situations is present?

Accepted Answer

Asymmetric information occurs when one party has more or better information than the other party in a transaction. In this case, workers have better information about their own ability to work than employers do, which creates a situation of asymmetric information.

Question 8

Adverse selection occurs in the health insurance market because

Accepted Answer

Adverse selection occurs in the health insurance market because it is difficult for insurance companies to distinguish between high risk and low risk customers. Healthy individuals are less likely to purchase health insurance while sick individuals are more likely to purchase insurance, resulting in a higher concentration of high-risk customers in the insurance pool. This leads to higher premiums for everyone, including low-risk individuals, which may further discourage them from purchasing insurance.

Question 9

Suppose an insurance company determines that the average annual malpractice cost is $10,000 for reckless lawyers and $500 for careful lawyers. If 10% of the lawyers insured by the company are reckless, the company will earn zero economic profit if the price of insurance is

Accepted Answer

If the price of insurance is $500, the company would earn zero profit because the cost of insuring careful lawyers would be covered by their premiums, and the profits from insuring reckless lawyers would offset the company's losses due to malpractice claims. However, if the price is above $500, the premiums from careful lawyers would cover the costs of their malpractice claims, but the profits from insuring reckless lawyers would not be sufficient to offset their losses due to malpractice claims. Therefore, the company requires a higher price to earn a profit. At $1,450, the expected profit from insuring reckless lawyers is 0.1x$10,000 = $1,000, and the profit from insuring careful lawyers is 0.9x$500 = $450, adding up to an average profit of $1,450 per lawyer.

Question 10

Figure 9.6
-Figure 9.6 represents the market for health insurance. Suppose there are two types of consumers, low-cost consumers with $2,000 average medical expenses per year, and high-cost customers with $4,000 average medical expenses per year. Initially the insurance companies estimate that 40% of its customers are high-cost type. Compared to the outcome with pessimistic expectations, how many more customers buy health insurance?

Accepted Answer

Given the lack of specific details about Figure 9.6 and the insurance pricing strategy, a general explanation based on adverse selection in insurance markets can be provided. When insurance companies have pessimistic expectations (assuming a higher proportion of high-cost customers), they set higher premiums to cover the anticipated costs. This discourages low-cost consumers from buying insurance, leading to a market with predominantly high-cost consumers. If the insurance companies adjust their expectations (assuming a lower proportion of high-cost customers or better assessing the risk), they might offer lower premiums, attracting more low-cost consumers into the market. The specific number (1,500 more customers) suggests a scenario where adjusting expectations or improving risk assessment significantly increases the pool of insured, likely by making insurance more attractive to low-cost consumers who previously opted out due to high premiums.

Question 11

Figure 9.6
-Figure 9.6 represents the market for health insurance. Suppose there are two types of consumers, low-cost consumers with $2,000 average medical expenses per year, and high-cost customers with $4,000 average medical expenses per year. The insurance companies estimate that 40% of its customers are high-cost type. If the insurance companies set the price equal to their average cost per customer, what percent of customers who buy the insurance are actually low-cost customers?

Accepted Answer

The answer of  Figure 9.6
-Figure 9.6 represents the market...

Question 12

Recall the Application about federal quality standards in the market for kiwifruit to answer the following question(s).
-Recall the Application. Why were there so many "lemon" kiwifruit in the U.S. market?

Accepted Answer

The answer of Recall the Application about federal quality standards...

Question 13

Suppose a health insurance company notes that almost all of its customers are at a high risk of illness or injury. This is an example of

Accepted Answer

This is an adverse selection problem because the insurance company is seeing a trend where most of their customers are high-risk, meaning that people who are not high-risk are likely opting out of purchasing insurance. This leads to adverse selection for the insurance company as they are insuring a group that is more likely to require medical attention and therefore are likely to have higher healthcare costs.

Question 14

One consequence of imperfect information in the health insurance market is that

Accepted Answer

Imperfect information in the health insurance market may result in adverse selection, where individuals with higher health risks are more likely to purchase insurance. This can drive up the cost of insurance for everyone. Less healthy individuals may have a higher demand for insurance and may be willing to pay a higher price for coverage. As a result, insurers may need to charge higher premiums to cover the expected costs of the sicker population. This creates a market where those who are healthiest may choose not to buy insurance, leading to a pool of insured individuals who are on average sicker and more expensive to cover.

Question 15

Figure 9.6
-Figure 9.6 represents the market for health insurance. Suppose there are two types of consumers, low-cost consumers with $2,000 average medical expenses per year, and high-cost customers with $4,000 average medical expenses per year. If $Y is the price the insurance company would charge if it expected 40% of its customers to be high-cost, the price it would charge if it expected 50% of its customers to be high-cost would be

Accepted Answer

As the percentage of high-cost customers increases, the expected cost for the insurance company also increases. Therefore, in order to cover their expected costs and earn profit, the insurance company would charge a higher price if it expected 50% of its customers to be high-cost compared to if it expected only 40% to be high-cost. Thus, the price charged if it expected 50% of its customers to be high-cost would be greater than $Y.

Question 16

Health insurance companies face an asymmetric information problem because

Accepted Answer

Health insurance companies face an asymmetric information problem because the buyers have superior information concerning their risk of illness or injury. This can lead to adverse selection, where the individuals with a higher risk of illness or injury are more likely to purchase insurance, leading to higher costs for the insurance company. To mitigate this, companies may use underwriting or risk assessment techniques to try to determine the risk profile of each potential customer.

Question 17

Figure 9.6
-Figure 9.6 represents the market for health insurance. Suppose there are two types of consumers, low-cost consumers with $2,000 average medical expenses per year, and high-cost customers with $4,000 average medical expenses per year. The insurance companies estimate that 40% of its customers are high-cost type. If the insurance companies set the price equal to their average cost per customer, what is the insurance companies' average cost per customer ($Y)?

Accepted Answer

The average cost per customer is calculated by taking a weighted average of the costs for low-cost and high-cost consumers: (0.6 * $2,000) + (0.4 * $4,000) = $2,800.

Question 18

Insurance policies in which each firm pays a different price for medical insurance depending upon the past medical bills of the firm's employees are based upon a(n)

Accepted Answer

Experience rating is a method of determining insurance premiums based on the past experience of an individual or group. This is commonly used in medical insurance policies where each firm is charged a different price depending on the past medical bills of the firm's employees. The goal of experience rating is to allocate the cost of medical treatment according to the risk posed by the group, so that insurance companies can charge premiums to accurately reflect the expected cost of providing medical coverage. Community rating charges the same premium rate to all individuals regardless of their age, health status or past medical history. Asymmetric information rating and adverse selection rating are not terms used in the insurance industry.

Question 19

Which practice helps health insurance companies overcome the problem of adverse selection?

Accepted Answer

The experience rating system helps health insurance companies to overcome the adverse selection problem. Under this system, insurance premiums are based on the individual's past health care usage, which helps to prevent healthy individuals from subsidizing unhealthy individuals. Selling insurance only to healthy or unhealthy people (options A and B) would only exacerbate adverse selection.

Question 20

Who is more likely to offer a money-back guarantee: a seller of a lemon or a seller of a plum? Why?

Accepted Answer

The answer of Who is more likely to offer a...

Quiz 9: Imperfect Information, External Benefits, and External Costs

In the used car market, the less-informed party is the . In the health care market, the less-informed party is the .