ECO205Y5 Chapter Notes - Chapter 15: The Intercept, Sequential Game, Unobservable

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champagnefish328

24 Aug 2013

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Asymmetric information - in a game with uncertainty, information that one player has but the other does not. The game involves a contract signed between two players in an environment involving uncertainty. The player making the contract offer is called the principal. The player who decides whether to accept the contract or not and then performs under the terms of the contract is called the agent. The agent is typically the party with the private information. The same party might be a principal in one setting and an agent in another. Adverse selection problem occurs when an agent"s type is private information and not revealed. Moral hazard problem occurs when an agent"s action is private information and it is not known how they work or act. When selling a policy the company does not know whether you are a high risk or low risk driver (adverse selection) Since you are insured you are less careful (moral hazard)

Related Questions

7- What steps can be taken by both individuals and companies to generally reduce the cost of external Financing?

1-An inequality in knowledge between two financial parties is called ___________ __________.

symmetrical information ignorance asymmetric information asymmetric investing asymmetric lending

2-When bad credit risks are the ones who most actively seek out a loan they are also the ones most likely to produce an __________ ___________.

immoral outcome unexpected profit adverse outcome adverse rate of return adverse interest rate

3-Asymmetric information and the adverse selection and moral hazard concepts are also crucial problems for the ________________.

health industry professional sports industry automobile industry insurance industry technology industry

4-Important impediments to well-functioning financial markets are created by adverse selection and moral hazard and ___________________ can alleviate these problems.

stock markets financial advisors savants financial intermediaries

5-Improving _________________ is a key role for financial intermediaries because they help financial markets channel funds to people that are a better investment risk.

Economic growth economic expansion economic ineptitude the inflation rate economic efficiency

6-Lending to individuals; ________________ can be minimized because lenders can check the loan applicantâs credit files and credit scores, their employment history, and with the permission of the borrowers, lenders can even verify their income with the internal revenue service.

moral hazard adverse selection inverse selection prudent selection guessing

Project Introduction:

Research and analyze the effects of the following government policies on the market equilibrium.

1. Increases in the Minimum Wage

2. Restrictions on International Trade

3. Pollution Controls

4. Natural Monopolies and Anti-Trust Regulation

ES2550: Project Page 5

When analyzing these policies, include some discussion of the following points when appropriate:

A. What is the purpose of the policy?

B. Provide the rationale for the government policy. In this section, discuss how asymmetric information creates a need for the policy.

C. Note 1: The necessity of the policy should be related to the purpose.

D. Note 2: A discussion of asymmetric information should include defining how the information is unequal between consumers and producers as well as any adverse selection or moral hazard issues involved.

E. The welfare of consumers, producers, and society (the winners and losers) before and after the policy.

F. How does this policy affect the fairness of the distribution of costs and benefits?

G. Does government intervention improve the situation?

Note: Discuss whether government intervention affected the asymmetric information problem, adverse selection, or moral hazard previously discussed.

pucecat546

A health insurance company knows that there are two types of customers (smokers and non-smokers), each facing different health risks. The probabilities of getting sick and the healthcare costs in the case of illness for the two customer types is given in the table below.

Group	Healthcare costs	Probability of getting sick
Smokers	$1200	50%
Non-smokers	$1200	20%

Assume that each customer has a monthly income of $1600 and has a utility function given by U(x)=sqrt(x), where x is the remaining income after medical/health insurance expenses have been paid.

a. Explain the problem of âadverse selectionâ and the problem of âmoral hazard.â Give one example of a market in which adverse selection occurs and one example of a market in which moral hazard can be observed. What is the difference between the two information problems? Explain the consequences of adverse selection and moral hazard for the principal â agent relationship.

b. Discuss in detail the two ways (screening and signaling) in which the principal or the agent can try to resolve the problem of adverse selection. Give an example of screening and signaling and explain how the parties involved benefit from these strategies.

c. For the numerical example above construct the lotteries associated with the income that remains after healthcare expenses have been paid for smokers and for non-smokers (assuming agents do not have health insurance). Calculate the expected utility associated with the lotteries for smokers and non-smokers. Calculate the certainty equivalent of the two lotteries. What is maximum amount that smokers and non-smokers are willing to pay for full insurance? Calculate the actuarially fair health insurance premium for the two groups of customers (i.e. the expected healthcare costs).

dAssume the company cannot distinguish between smokers and non-smokers and offers a full insurance contract to all customers. How much should the company charge for the full insurance contract? Which customer group will purchase full insurance?

silverkangaroo356

ECO205Y5 Chapter Notes - Chapter 15: The Intercept, Sequential Game, Unobservable

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