Chapter 22, Problem 1CQQ

To determine

Example of adverse selection.

Answer to Problem 1CQQ

Option ‘b’ is the correct answer.

Explanation of Solution

Option (b):

Elaine, the buyer of health insurance knows more about her own health problems than the insurance company. The price of health insurance reflects the costs of an unhealthier person than an average person. So, Jerry who is healthy may observe the high price of insurance and decide not to buy it. Thus, option ‘b’ is correct.

Option (a):

Inspite of getting a health insurance, Elaine is not imperiling herself to illness. Hence, option ‘a’ is incorrect.

Option (c):

Health insurance does not signal the health issues of a person. Hence, option ‘c’ is incorrect.

Option (d):

The insurance company is not asking the parties for their health information. Hence, option ‘d’ is incorrect.

Economics Concept Introduction

Concept introduction:

Adverse selection: Adverse selection refers to a situation where there is a lack of information existing in the market before the economic transaction takes place, thereby resulting in an undesired outcome.

Moral hazard: Moral hazard refers to changes in the behavior of people after they have entered into a transaction that makes the other party in the transaction worse off.

Signaling: Signaling is an action taken by an informed party to reveal private information to an uninformed party.

Screening: Screening refers to the action of one party in the process of finding the required skill and information of other party.