Question

Explain how the presence of asymmetric information could result in a market failure in a private health insurance market. Feel free to use a supply and demand diagram to illustrate the effect of asymmetric information.

Answer 1

We know that Asymmetric information means that one party/person has more or better information than the other party/person when making decisions and transactions. The imperfect information causes an imbalance of power to take the perfect decision. Accurate information is essential for sound economic decisions. When a market experiences an imbalance it can lead to market failure. In a private health insurance market, the sick individual or the patient has the superior knowledge of his/her medical needs which gives him/her an asymmetric information advantage to buying the health insurance.  But at the same time, the insurance seller has not the perfect information regarding the health condition or the medical requirements needed by the sick individual. Here the insurance buyer has the perfect information but the insurance seller has not the perfect information resulting in a market failure.  

In the above figure, the insurance seller has not the perfect information which leads to supply-side market failure and the insurance buyer will able to buy the insurance in a lower price than he/she willing to pay.