L11asymmetric_info

L11asymmetric_info - Lecture 11 Asymmetric Information Key...

Info iconThis preview shows pages 1–11. Sign up to view the full content.

View Full Document Right Arrow Icon
Lecture 11: Asymmetric Information
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Key Terms in Lecture • Asymmetric Information • Moral Hazard • Limited liability • Adverse Selection
Background image of page 2
Why don’t consumers have full insurance? We have studied insurance and saw that risk-averse agents want full insurance. Why don’t we observe complete insurance where we do observe insurance? Why don’t we observe (almost) any insurance in many markets? -Administrative costs are too high for low-cost items -Information asymmetries may mean that “fair” insurance is not available -We will study two types of information asymmetry: -1) Moral hazard -2) Adverse selection
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Asymmetric Information • Transactions can involve a considerable amount of uncertainty – can lead to inefficiency, particularly when one side has better information • The side with better information is said to have private information or asymmetric information
Background image of page 4
Asymmetric information • Two models of asymmetric information – A consumer’s actions impact the profits of the insurer but these actions are “hidden” from the firm • called a hidden-action model or a moral hazard model – The consumer has private information before signing the contract • called a hidden-type model or an adverse selection model
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Moral Hazard in Insurance • General idea: – If a person is fully insured, he will have a reduced incentive to undertake precautions – If consumers take fewer actions to avoid risks, then losses are greater than anticipated • Implications: – “Fair” rates must be increased to offset added costs – Some consumers refuse higher price and don’t buy insurance.
Background image of page 6
Moral Hazard in Insurance • The effect of insurance coverage on an individual’s precautions, which may change the likelihood or size of losses, is known as moral hazard • If you pay attention to what’s going on in the world, you’ve heard a ton about moral hazard recently…
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Example of Moral Hazard • You purchase bicycle insurance at fair price reflecting underlying probability of theft – Implies a lower expected cost of theft (for you) – This implies that you have a lower incentive to “take care” and avoid theft • Less incentive to buy an expensive lock • Less incentive to park in a safe area • With insurance, consumer does not bear full costs of neglect: part of cost is borne by the insurance company.
Background image of page 8
Moral Hazard is an Information Problem • If insurance company could cheaply observe behavior, then it could adjust premiums accordingly: – Your rate would depend on your actions • However, your actions are often “hidden.” – The insurance company cannot tell whether consumers are taking appropriate care to avoid losses – They try to deal with this by (1) using deductibles and (2) providing incentive discounts for good behavior
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Moral Hazard Discourages Companies From Offering Full Insurance As we’ve discussed, most losses are not fully random – Consumer behavior will affect frequency and size of most losses
Background image of page 10
Image of page 11
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 12/21/2009 for the course ECON 1211 taught by Professor Govel during the Spring '08 term at Columbia.

Page1 / 33

L11asymmetric_info - Lecture 11 Asymmetric Information Key...

This preview shows document pages 1 - 11. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online