The figure shows the market for car insurance. If thecompanies can't determine who is a safe or an unsafedriver,Premium (dollars per year)drivers are insured at a premium ofA. only safe drivers: $800B. 150 safe and unsafe; $1,000O C. 150 unsafe; $1,0001000O D. only 100 unsafe drivers; $800800O E. only safe drivers; $1,000DSafe0.100110150Policies (millions)

Answered: The figure shows the market for car…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

The figure shows the market for car insurance. If the
companies can't determine who is a safe or an unsafe
driver,
Premium (dollars per year)
drivers are insured at a premium of
A. only safe drivers: $800
B. 150 safe and unsafe; $1,000
O C. 150 unsafe; $1,000
1000
O D. only 100 unsafe drivers; $800
800
O E. only safe drivers; $1,000
DSafe
0.
100110
150
Policies (millions)

Expert Solution

Step 1

When a company is not able to determine which driver is safe and which is unsafe, then there occurs a situation of asymmetric information which is an information failure when an individual involved in the transaction has more knowledge than the other. In this case, the adverse selection problem, which is one form of asymmetric information, occurs wherein one party, which is the insurance-providing companies, is not able to identify whether the other party, which is the driver, is subject to any risk or not. This problem occurs before the transaction is made.

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