17-Imperfect information and insurance

  1. In a standard market you couple a willing buyer with a willing seller, but at times information is imperfect.
    1. For example, you see a car that is selling for 1/3 the market price.
      1. Ones first instinct would be to buy the cheapest, but;
      2. On a second thought “is there something wrong with it?”
    2. An employer is trying to hire an employee and it has come down to two applicants with one willing to work at half the price
      1. One would ask is he lazy? Or;
      2. Is he clueless
    3. Markets attempt to reduce risk with a variety of different methods
      1. Warranties, guarantees and service contracts
      2. Trademarks are intended to identify the maker to insure quality
      3. Resume’s licenses and certificates
      4. Financial capital, credit reports, collateral
      5. Reputation
    4. Gov’t makes companies list ingredients on packages, and make sure claims in ads are true
  2. Insurance markets rely heavily on information
    1. Insurance markets spread risk over a group
      1. An event related to the type of insurance is spread over a group
        1. The type of risk is known
        2. Exactly who it will be is not
      2. Everyone must pay into a common pool
        1. Most payouts will be concentrated to a small(relatively) percentage of the group with larger claims
        2. What the average person pays in must at least be equal to what the average person gets out
    2. What if the chance of bad events weren’t random but based on habits
      1. Moral hazard-people who have insurance have less incentive to avoid problems0
      2. Adverse selection-those who are more likely to have a bad event are more likely to have insurance
    3. Addressing moral hazard and adverse selection:
      1. Co-payments and deductibles
      2. Increase the pool to increase more people and create a more diverse demographic
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