This preview shows page 1. Sign up to view the full content.
Unformatted text preview: ve the actions of the consumer...and we will still have the trade-off. What does this imply about the types of insurance contracts that will be offered? In general, insurance companies will not want to offer the consumer "complete insurance". They will always want the consumer to face some of the risk. This is why most insurance contracts include a "deductible", which is an amount that the insured party must pay in any claim. By making the individual pay some part of the claim, the insurance company can make sure that the consumer has some incentive to take care. This differs from our previous market analysis where the amount of a good traded in a competitive market is determined by the condition where demand = supply. In the case of moral hazard, a market equilibrium has the property that:  each individual would like to buy more insurance (i.e. fully insure themselves against loss), and  the insurance company would like to sell more insurance if they could know that the consumer was taking care, but, the trade does not occur because if the consumer could fully insure then they would rationally choose to take less care. SUMMARIZING ADVERSE SELECTION AND MORAL HAZARD Adverse selection refers to situations where one side of the market cannot observe the "type" or quality of the goods on the other side of the market. For this reason it is sometimes called a hidden information problem. Equilibrium in a market involving hidden information will typically involve too little trade taking place because of the externality between the "good" and the "bad" types of goods. 329 Moral hazard refers to situations where one side of the market cannot observe the actions of the other side of the market. For this reason it is sometimes called a hidden action problem. Equilibrium in a market involving hidden action typically involves some form of rationing firms would like to provide more than they do, but they are unwilling to do so since it will change the incentives of their consumers. STEPPING INTO "THE REAL WORLD?" Equilibrium outcomes in these markets will appea...
View Full Document
- Spring '10