problem set 10

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Christal Wang Problem Set 10 November 30, 2023 9.19) a) The economic root of the climate change problem involves externalities. Specifically, not knowing how other countries are going to react to climate change and whether our actions will be worthwhile, given what other people/firms choose to do. b) A Pigouvian tax is a tax on a market good with a negative externality. Miller’s solution for climate change is related to this because it is meant to combat carbon dioxide, which is a good with a negative impact on the environment. c) Miller’s proposal is similar to the notion of repeated games, because the same rules and players are interacting with each other each time. Additionally, it forces the different players (which are the different countries in this example) to choose between long-term gain and short-term incentives. d) Proposal’s like Miller’s may face barriers and constraints to getting implemented because climate change is an unprecedented problem. Specifically, it’s hard for many people to understand how crucial it is the take action against climate change and to understand the actual effects of proposals like these, because they have never been implemented before. 10.1) I think that SafetyNet had to close their insurance program because of a moral hazard resulting between the insurer (principal) and the customer who lost their job (agent). This is an example of asymmetric information between the two parties as the insurer cannot be certain as to the circumstances of how their customers lost their jobs. Customers could have been fired for a myriad of reasons, but if customers realized that the lump sum benefit from SafetyNet outweighed the loss of losing their job, they could intentionally underperform and get fired for incompetence. They could also fake their sickness in order to receive the lump sum benefit. Because the payments are rather small compared to the potential size of the lump sum payment, SafetyNet’s insurance model likely closed because the risk of their service was increased because agents’ behaviors could not be properly observed.

10.2) a) Divorce insurance creates an instance of moral hazard because the actions of the married couple cannot be properly observed by the insurer. The asymmetric information could result in married couples intentionally divorcing in order to reap the benefits of insurance. Similarly, if no policies exist to prevent the couple from remarrying after capitalizing on the insurance, the process can be repeated to quickly drive the insurance company out of business. b) Missing a flight creates an instance of moral hazard because the actions of the flier (agent) cannot be properly observed by the insurer. The asymmetric information could result in fliers intentionally missing their flights to obtain insurance benefits. They could also have backup flights planned to ensure their travel plans stay intact or book cheap flights that would result in a profit for the customer if the payment was greater than the flight ticket price. c) Catastrophic long-term medical care creates an instance of adverse selection because the buyers have more knowledge of their individual risk than the sellers. The asymmetric information could result in an overflow of risky buyers that the seller cannot account for. Risky buyers are very expensive for the company, and it may be difficult for the firm to create a perfectly designed policy that ensures a sustainable ratio of risky and “safe” customers. 10.3) The nature of the pet healthcare market offers insight into the structure of American human healthcare. In order to combat the issue of adverse selection, a common solution for human healthcare is to impose health mandates and force consumers to purchase it. However, pets vary greatly in species and healthcare needs. This means health mandates are much more challenging to enforce for the pet market compared to the human market. The US spends so much on healthcare, almost twice as much compared to other nations, because a health mandate is so important to an industry so volatile as healthcare. Without a health mandate, the industry might not be able to sustain itself, an assertion supported by the absence of the pet care industry.

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