Question

The Akerlof model and its lessons can be directly applied to health insurance markets.

a. In health insurance markets, who is analogous to the car buyers? The car sellers?    

b. What would it mean for the health insurance market to unravel? Explain.

c. Who is harmed by asymmetric information in insurance markets? Who is helped? Explain.

d. Suppose private markets offered insurance contracts that committed people to lifetime insurance. For instance, suppose you purchase a policy when you are young, the premiums are fixed for life but you must commit to holding the policy your entire life. The insurance company must pay your medical bills for life. What are pros and cons of such a policy? Do you think these sorts of contracts would work in the real world? Why or why not?

Answer 1

a.)

Insurance company is analogous to the car buyers and insurance policy buyer is analogous to car sellers. Insurance company does not have correct information about the risk profile of policy buyer.

b.)

Health insurance market unravel asymmetric information between the insurance company and policy buyers.

c.)

Insurance companies are harmed by the asymmetric information. While policy holders are helped by the asymmetric information.

d)

Such policies have both pros and cos. such policy will lead to fall in cost of fixing premium again and again. But such fixed premium would cause the moral hazard and people will tend to behave in irrational manner.

Such contracts are less likely to be successful in real world.