Economics: Principles, Problems, & Policies (McGraw-Hill Series in Economics) - Standalone book
20th Edition
ISBN: 9780078021756
Author: McConnell, Campbell R.; Brue, Stanley L.; Flynn Dr., Sean Masaki
Publisher: McGraw-Hill Education
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Question
Chapter 4.A, Problem 3ADQ
To determine
Moral hazard problems and adverse selection problems.
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Students have asked these similar questions
6. Suppose that there are two types of drivers: reckless and safe. Reckless drivers
have a higher probability of accidents with an expected loss to the insurance
company of $5000. Safe drivers have a lower probability of accidents with an
expected loss to the insurance company of $1000. Insurer cannot distinguish
between reckless and safe drivers but know that reckless drivers make up "B"
proportion of all drivers. What single premium should the risk-neutral insurer
charge? Assume that the insurance market is perfectly competitive. Is the above
mentioned problem an example of Adverse Selection or Moral Hazard? Explain.
6. Answer which happens, moral hazard or adverse selection, or nothing happens under each of
the following situations.
[M20]: A driver drives a car rough because s/he has a property insurance of a car.
b. Adverse selection
[M21]: Since a driver cannot distinguish among qualities of cars, s/he may buy a bad one.
a. Moral hazard
c. nothing
a. Moral hazard
b. Adverse selection
c. nothing
[M22]: Banks look for lenders, but most customers who apply for loans seem to have
difficulty repaying them even in assuming they make an identical effort.
a. Moral hazard
b. Adverse selection
c. nothing
4. Consider the market for Citrus used car in which lemons account for 40% of the used cars offered for
sale. Suppose that each owner of an orange Citrus values it at $12,000; he is willing to part with it for a
price of at least $12,000, but not lower than this. Similarly, each owner of a lemon Citrus values it at
$4,000. Suppose that potential buyers are willing to pay more for each type. If a buyer could be confi-
dent that the car he was buying was an orange, he would be willing to pay $15,000 for it; if the car was a
known lemon, he would be willing to pay $5,000.
Suppose that there are many buyers, but a limited number of used cars. What type of used cars -
lemons or oranges - will be offered for sale in the market, and at what prices?
Chapter 4 Solutions
Economics: Principles, Problems, & Policies (McGraw-Hill Series in Economics) - Standalone book
Ch. 4.A - Prob. 1ADQCh. 4.A - Prob. 2ADQCh. 4.A - Prob. 3ADQCh. 4.A - Prob. 1ARQCh. 4.A - Prob. 2ARQCh. 4.A - Prob. 3ARQCh. 4.A - Prob. 1APCh. 4 - Prob. 1DQCh. 4 - Prob. 2DQCh. 4 - Prob. 3DQ
Ch. 4 - Prob. 4DQCh. 4 - Prob. 5DQCh. 4 - Prob. 6DQCh. 4 - Prob. 7DQCh. 4 - Prob. 8DQCh. 4 - Prob. 9DQCh. 4 - Prob. 1RQCh. 4 - Prob. 2RQCh. 4 - Prob. 3RQCh. 4 - Prob. 4RQCh. 4 - Prob. 5RQCh. 4 - Prob. 6RQCh. 4 - Prob. 7RQCh. 4 - Prob. 1PCh. 4 - Prob. 2PCh. 4 - Prob. 3PCh. 4 - Prob. 4PCh. 4 - Prob. 5PCh. 4 - Prob. 6PCh. 4 - Prob. 7P
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Similar questions
- How can moral hazard lead to more costly insurance premiums than one was expected?arrow_forwardIn an insurance system, would you expect each person to receive in benefits pretty much what they pay in premiums or is it just that the average benefits paid will equal the average premiums paid?arrow_forwardMB, MC 10- 8. 6 4 2. Reference: Ref 16-2 O MB, Select one: A. III B. I MC MB₁ MB3 (Figure 16.2) Lilly, who owns the Cigar Bar and Grill, is considering whether to purchase fire insurance. Without insurance, the marginal benefit of precautions to reduce the risk of fire is given by MB₁. Which of the following statements is (are) TRUE? I. With full insurance, the marginal benefit of acting to reduce the risk of fire is given by MB3. C. II D. I and III 10 II. If Lilly purchases fire insurance, whether it is full or partial coverage, the marginal benefits of acting to reduce the risk of fire will increase. Quantity of actions taken to improve fire protection III. With partial insurance, the marginal benefit of acting to reduce the risk of fire is given by MB₂.arrow_forward
- 1)Describe an example of moral hazard that we may run into in the real world. Think of something that is legal and not inherently lethal, yet still demonstrates elevated risk for the participant who would likely act safer if insurance or protection was not available. Explain why someone might take this risky action. What are the benefits to the risky behavior? In your response to two of your peers, explain what an insurance company may do to reduce the likelihood that an individual would take this risk. Keep in mind, that we cannot always just deny coverage if an individual is participating in the risky behavior.arrow_forwardA group of 200 people seek out an insurance company to underwrite health insurance for its members. It expected medical spending for the group is $1,200,000, what will the average premium bn If the health insurance company adds a leading fee of 20 percent? $14,400 $12,000 O $7,200 O $6,000arrow_forwardSuppose John buys a tiger because he wants to be like the cool king guy from The Walking Dead. John can take care to prevent his tiger from eating his neighbors by building a fence. The fence costs less than the expected harm to John’s neighbors that building the fence will prevent. Suppose that John’s neighbors also can take precautions, like wearing tiger-proof armor or carrying large caliber rifles with them at all times. Assume that the cost of these precautions is less than the expected harm from tiger maulings they will prevent, even if John were to build the fence. Given these circumstances, which is likely to be the most efficient rule? A. No liability B. Negligence C. Strict liability D. Strict liability and negligence provide equivalent incentives E. None of the abovearrow_forward
- Suppose John buys a tiger because he wants to be like the cool king guy from The Walking Dead. John can take care to prevent his tiger from eating his neighbors by building a fence. The fence costs less than the expected harm to John’s neighbors that building the fence will prevent. Suppose that John’s neighbors also can take precautions, like wearing tiger-proof armor or carrying large caliber rifles with them at all times. Assume that the cost of these precautions is less than the expected harm from tiger maulings they will prevent, even if John were to build the fence. Given these circumstances, which is likely to be the most efficient rule? Question 41 options: a) No liability b) Negligence c) Strict liability d) Strict liability and negligence provide equivalent incentives e) None of the abovearrow_forwardIf a risk-neutral individual owns a home worth $200,000 and there is a three percent chance the home will be destroyed by fire in the next year, then we know 15. that: a) He is willing to pay much more than $6,000 for full cover. b) He is willing to pay much less than $6,000 for full cover. c) He is willing to pay at most $6,000 for full cover. d) None of the above are correct. e) All of the above are correct.arrow_forwardAn expected utility maximiser owns a car worth £60 000 and has a bank account with £20 000. The money in the bank is safe, but there is a 50% probability that the car will be stolen. The utility of wealth for the agent is u(y) = In(y) and they have no other assets. How much the individual would be willing to pay for a full car insurance, i.e., where the indemnity is equal to the value of the car? O a. At most £40 000. O b. At most £60 000. O c. At most £20000. O d. At most £30 000.arrow_forward
- 12. True or False? Medicaid is a U.S. federal- and state- government-sponsored insurance program that provides insurance to people under age 65 whose incomes fall below a certain threshold (level). O True O Falsearrow_forward17. Suppose a risk-neutral power plant needs 10,000 tons of coal for its operations next month. It is uncertain about the future price of coal. Today it sells for $60 a ton but next month it could be $50 or $70 (with equal probability). How much would the power plant be willing to pay today for an option to buy a ton of coal next month at today's price? (Ignore discounting over the short period of a month.) а. 5 b. 4 с. 3 d. NOTE: I KNOW THAT THE ANSWER IS (A), BUT PLEASE INCLUDE ALL THE STEPS HOW TO SOLVE THE PROBLEM BECAUSE I NEED TO PRACTICE. THANK YOU.arrow_forward24. Consider adverse selection in the car insurance market. Drivers are either risky or safe. The insurance companies cannot distinguish between the two types of drivers, but they know that 50% of all drivers are risky. Insuring a risky driver costs $3,000, while insuring a safe driver costs $1,000. The benefits of insurance is $4,000 for a risky driver and $1,500 for a safe driver. If insurers cannot observe the type of buyer they are insuring, what is the minimum equilibrium price of insurance? a. $1,000 b. $1,500 c. $2,000 d. $3,000 e. $4,000arrow_forward
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