Question

5. Name and describe two sources of government failure related to government intervention in markets. Provide one example of each failure in health insurance or health care markets.

Answer 1

5. Market failure refers to failure of competitive market to allocate resources efficiently or distribute goods efficiently. In the case of market failure, pareto optimality conditions are not satisfied. Causes of market failure:

a) Externalities: These can be defined as an impact of production and consumption of products affecting the third party. Externalities can be either positive or negative.

b) Public good: These are the goods that are characterised by non-excludability and non-rivalry. By non-excludability, it means that a good that benefits an individual can be used by others too to derive the same benefits. Non-rivalry implies that the enjoyment of using a product does not reduce the satisfaction of those who have been using it from a certain time. Example: Defense.

c) Information asymmetry: It deals with the study of decisions in transactions, where one party has access to more or better information than others. Due to information asymmetry, the following two problems occur:

(i) Adverse selection: This implies taking the advantage of asymmetric information before transaction. For example, a person may be more eager to purchase life insurance due to health problems than the person who is healthy.

(ii) Moral hazards: This implies taking the advantage of asymmetric information after transaction. Moral hazard refers to situation where one side of market cannot observe action of the other. For this reason it is sometimes called hidden action problem. For example, if someone has car insurance he may commit theft by getting his car stolen to reap the benefits of the insurance.