Question 1

Insurance companies address adverse selection by _____ prospective clients.

Accepted Answer

Insurance companies address adverse selection by monitoring signals of prospective clients. Adverse selection occurs when individuals with a higher likelihood of making claims are more likely to seek insurance coverage than those who are less likely to make a claim. By monitoring signals, such as age, health status, and occupation, insurers can adjust premiums or deny coverage to those who present a higher risk of making claims.

Question 2

Rihanna would like a better car, and she considers selling her old one by advertising on Kijiji. She decides against it because the used cars listed on Kijiji are underpriced. This example illustrates the problem of:

Accepted Answer

Adverse selection refers to the problem of asymmetric information where only the seller knows the true value of the product being sold. In this case, Rihanna has information about the condition and value of her car which potential buyers on Kijiji may not be aware of. As a result, she may receive lower offers due to the underpriced cars listed on the website, leading to adverse selection.

Question 3

Buyers of used automobiles are not privy to the same information as sellers are. Private information in this case does NOT lead to:

Accepted Answer

The answer of Buyers of used automobiles are not privy...

Question 4

In which situation is moral hazard MOST likely to be a problem?

Accepted Answer

Moral hazard occurs when one party takes risks knowing that another party will bear the cost of those risks. Hiring a new manager to work the night shift involves placing trust in an employee who may have the opportunity to shirk responsibilities or engage in risky behavior, knowing that the consequences will be faced by the employer. This situation presents a greater likelihood for moral hazard than the other options given.

Question 5

State Farm sells life insurance through affiliated companies and outlets that make up one of the largest insurance companies in the United States. State Farm addresses the problem of moral hazard by:

Accepted Answer

State Farm requires a deductible, which incentivizes insured individuals to take reasonable precautions to avoid losses. This reduces the likelihood of moral hazard, where individuals who are insured may become less careful or take greater risks knowing that they have insurance protection to fall back on. By requiring a deductible, State Farm encourages insured individuals to take more responsibility for avoiding losses, reducing the risk of moral hazard.

Question 6

Insurance companies often require deductibles to:

Accepted Answer

Insurance companies require deductibles to minimize moral hazard, which is the tendency for people to take greater risks when they are not personally responsible for the consequences. By requiring a deductible, individuals have some financial responsibility for their own health care costs, which can reduce unnecessary medical expenses and help control overall healthcare costs. This also helps to discourage individuals from submitting claims for minor healthcare expenses, which can result in higher premiums for everyone.

Question 7

You hardly ever lock your car because you have insurance. This illustrates the problem of:

Accepted Answer

The fact that the individual is taking greater risks because they have insurance protection against negative outcomes is an example of moral hazard. The individual is less incentivized to take precautions and protect themselves against potential risks.

Question 8

When Allstate sells fire insurance policies, it often include deductibles:

Accepted Answer

Allstate includes deductibles in their fire insurance policies to minimize moral hazard, which refers to the tendency for people to take greater risks when they are insured. By having a deductible, the insured person has to bear some of the cost of the loss, which means they are less likely to take unnecessary risks that could lead to a fire. It also helps to ensure that the insured person has a financial stake in preventing fires and minimizing damage if a fire does occur.

Question 9

Common strategies used to address the problem of adverse selection include screening of buyers, signaling by sellers, and _____.

Accepted Answer

Using third party verifiers, such as credit rating agencies or independent auditors, can provide unbiased information about buyer quality and can help alleviate concerns about adverse selection.

Question 10

Common strategies used to address the problem of adverse selection include using a third party verifier, signaling by sellers, and _____.

Accepted Answer

Screening of buyers involves gathering information about buyers to determine their level of riskiness, thereby reducing adverse selection. Actuarial delimitation involves using statistical tables to determine an individual's likelihood of being a high-risk customer, which is a strategy to address moral hazard, not adverse selection. Physical localization does not address adverse selection. Moral hazard planning involves creating incentives that encourage individuals to behave in a way that reduces the risk of negative outcomes, which is a strategy to address moral hazard, not adverse selection.

Question 11

Common strategies used to address the problem of adverse selection include using a third party verifier, screening of buyers, and _____.

Accepted Answer

Signaling by sellers is a common strategy to address the problem of adverse selection. It involves sellers providing information or signals about the quality of their product to potential buyers to reduce the information asymmetry and increase the likelihood of a mutually beneficial transaction. Hence, option B is the correct choice. The other options such as actuarial delimitation, physical localization, and moral hazard planning do not directly address the problem of adverse selection.

Question 12

Car insurance companies often offer policies that combine high deductibles and low premiums. Policies with high deductibles are typically purchased by individuals who self-identify as:

Accepted Answer

Individuals who choose policies with high deductibles and low premiums are typically low-risk drivers who do not anticipate frequently filing claims. By opting for a higher deductible, they accept more of the financial burden in the event of an accident, in exchange for lower premium costs. High-risk drivers are usually compelled to purchase policies with lower deductibles and higher premiums because they are more prone to accidents and claims.

Question 13

(Scenario: The Market for Experienced Vehicles) Use Scenario: The Market for Experienced Vehicles. Adverse selection occurs in the used-car market because of:
Scenario: The Market for Experienced Vehicles
In the used-car market, cars of poor quality are called lemons, while cars of good quality are called plums. Suppose that the probability of obtaining a lemon is 60%, and the probability of obtaining a plum is 40%. Also, assume that a plum is worth $15,000 and that a lemon is worth $3,000.

Accepted Answer

Adverse selection occurs in the used-car market because the seller has more information about the car they are selling than the buyer. In this case, the seller knows whether the car is a lemon or a plum, while the buyer does not. This information asymmetry leads to adverse selection, as buyers are more likely to end up with a lemon due to the seller's hidden knowledge.

Question 14

An advantage of employment-based insurance to the individual is that it:

Accepted Answer

Employment-based insurance receives favorable tax treatment, as the premiums paid by the employee are typically excluded from taxable income. This can lead to lower out-of-pocket costs for the individual and make the insurance more affordable. Adverse selection (choice B) is not necessarily decreased by employment-based insurance, as it may still attract those who are sicker and need more medical care. Market efficiency (choice C) is not significantly impacted by the type of insurance an individual has. Lower premiums (choice A) may be possible with employer-based insurance, but this is not always the case and does not apply to all individuals.

Question 15

Two consumers apply for life insurance with the same insurance company. George is a police officer who skydives in his spare time. Keira is a librarian who makes quilts in her spare time. The insurance company knows that both consumers are 40 years old, but the company has no information about occupations or hobbies. How does private information in this situation create an adverse selection problem? How could the insurance company address this problem?

Accepted Answer

The answer of Two consumers apply for life insurance with...

Question 16

Nathan has decided to take a road trip in a rental car. He has the minimum amount of personal car insurance to rent a car but decides to pay a little extra to the rental car company to completely insure himself against any damage to the car. How might Nathan's purchase of the additional insurance create a moral hazard problem?

Accepted Answer

The answer of Nathan has decided to take a road...

Quiz 20: Decisions With Private Information