Question

Arguably the natural disaster will also affect the risk premium x: Briefly discuss how the risk premium might be affected and describe the implications for the short run equilibrium value of output.

Answer 1

Natural Disasters have an indirect effect on insurer and the insured . In the present day world , the frequency of natural disasters is augmenting be it in the form of atmospheric disaster(cyclones,hurricane etc),aquatic disaster(floods,tsunami etc),terrestrial disaster (eg - earthquake) or the recent biological disaster (pandemic CORONA VIRUS) . This has exerted pressure on the insurance companies to borne the costs of repair , health expenses, damages etc to their policy holders on frequent basis. Such catastrophes leads to a potential; increase in demand of the insurance policies as people want to be safe against such frequent and sabotaging circumstances. This directly calls for an INCREASE IN RISK PREMIUM. An increased risk premium will allow the insurance companies to return to profitability and also there will be not much resistance from the buyer side as they want to secure themselves from uncertain situations.

Implications on short run equilibrium value of output -:

1. Natural disasters deteriorate the production capacity of tangible as well as intangoible assets in the short run.
2. The Consumption level also decreases leading to indirect impact on production levels(lower from before).
3. A higher risk premium diverts money of the consumer and may therefore lower the production levels in short run . (However, this risk premium is invested in the market leading to multiuplier effect in long run).
4. In short run, the production equilibrium is surely disrupted as there is dearth of capital and other financial resources.
5. The real income of the population declines in short run.