The Economics of Information

The Economics of Information - The Economics of Information...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
The Economics of Information Asymmetrical Information and Agency The assumption in economics is typically that individuals have perfect information about their relative choices. As we saw last time, if there is uncertainty, markets for insurance arise. One of the side effects of health insurance is the over consumption caused by the reduction in risk to the consumer (moral hazard). In this section we will talk about two more problems that arise with lack of information: the case of information asymmetry is when one party of a transaction has private information. We will see that this causes problems in the market. This occurs in two places: in the market for insurance the consumer may have better information about his health than the insurer, and thus the market for insurance may operate inefficiently. Secondly, physicians may have better information about the health of the patient, and thus may be able to exploit this (this, known as Supplier Induced Demand (or SID) will be addressed later Asymmetric Information and the Lemons Principle The guy who first described the problem applied it to the used car market, so it makes sense to begin there, then we will move to the market for health insurance. The idea is that the sellers of used care have better information about the quality of the car than the buyer. If the buyers know the distribution of quality then when a seller offers a car at a particular price the buyer infers something about the quality and so adjusts his/her willingness to pay. In the end only lemons are offered for sale. This is known as Adverse Selection – when the good products are pushed out of the market by the inferior ones. Note this is NOT the same as imperfect information, if both were in the dark about the quality of cars, the market would work just fine. This problem is solved (or reduced) in the market of used cars through: --Markets for information – you can pay a mechanic to give an assessment of a used car --Reputation --Warranties I. let’s first look at the theory of adverse selection as it applies to health insurance
Background image of page 1

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

View Full Document Right Arrow Icon
The above figure shows how this might work in the simplest case in healthcare. For simplicity assume perfectly competitive, risk neutral firms offering a single insurance contract. Risk-averse individuals differ only in their (privately known) probability of incurring loss. Also there are no other frictions (i.e., administrative or loading costs, something we’ll come back to). The vertical axis represents price (and expected cost) of the contract and the horizontal axis indicates the quantity of insurance demand. Since this is an either or situation (an assumption we can relax) the quantity of insurance is the fraction of insured individuals. With risk neutral insurers with no admin costs the social (and firms’) costs associated with providing insurance are the expected claims (payouts on policies). The demand curve above reflects the cumulative distribution of individuals’ willingness to pay for the
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 12

The Economics of Information - The Economics of Information...

This preview shows document pages 1 - 3. Sign up to view the full document.

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