Question

What were Rothschild & Stiglitz(1976) research problem, data, results, and their conclusions or lessons.

Answer 1

PLEASE SEE THE ATTACHEMENTS IN THE ALPHABETICAL ORDER.

Explanation:

conclusions or lessons.

We began this research with the hope of showing that even a small amount of imperfect information could have a significant effect on competitive markets. Our results were more striking than we had hoped: the single price equilibrium of conventional competitive analysis was shown to be no longer viable; market equilibrium, when it existed, consisted of contracts which specified both prices and quantities; the high-risk (low ability, etc.) individuals exerted a dissipative externality on the low-risk (high ability) individuals; the structure of the equilibrium as well as its existence depended on a number of assumptions that, with perfect information, were inconsequential; and finally, and in some ways most disturbing, under quite plausible conditions equilibrium did not exist. Our analysis, and our conclusions, extend beyond the simple insurance market described above. The models of educational screening and signaling studied by, among others, Arrow (1973), Riley (1975), Spence (1973, 1974), and Stiglitz (1971, 1972, 1974a, 1975b), are obvious examples. The other papers in this symposium describe models that can be profitably studied using our techniques and our concepts. Models in which communities choose the level of public goods and individuals choose among communities on the basis of the menu of public goods and taxes that the different communities offer, provide a less obvious but, we think, important case.9 Do these theoretical speculations tell us anything about the real world? In the absence of empirical work it is hard to say. The market on which we focused most of our analysis, that for insurance, is probably not competitive; whether our model may partially explain this fact is almost impossible to say. But there are other markets, particularly financial and labor markets, which appear to be competitive and in which imperfect and asymmetric information play an important role. We suspect that many of the peculiar institutions of these labor markets arise as responses to the difficulties that they, or any competitive market, have in handling problems of information. Establishing (or refuting) this conjecture seems to provide a rich agenda for future research.

INTRODUCTION, problem statement

Economic theorists traditionally banish discussions of information to footnotes. Serious consideration of costs of communication, imperfect knowledge, and the like would, it is believed, complicate without informing. This paper, which analyzes competitive markets in which the characteristics of the commodities exchanged are not fully known to at least one of the parties to the transaction, suggests that this comforting myth is false. Some of the most important conclusions of economic theory are not robust to considerations of imperfect information. We are able to show that not only may a competitive equilibrium not exist, but when equilibria do exist, they may have strange properties. In the insurance market, upon which we focus much of our discussion, sales offers, at least those that survive the competitive process, do not specify a price at which customers can buy all the insurance. they want, but instead consist of both a price and a quantity-a particular amount of insurance that the individual can buy at that price. Furthermore, if individuals were willing or able to reveal their information, everybody could be made better off. By their very being, high-risk individuals cause an externality: the low-risk individuals are worse off than they would be in the absence of the high-risk individuals. However, the high-risk individuals are no better off than they would be in the absence of the low-risk individuals. These points are made in the next section by analysis of a simple model of a competitive insurance market. We believe that the lessons gleaned from our highly stylized model are of general interest, and attempt to establish this by showing in Section II that our model is robust and by hinting (space constraints prevent more) in the conclusion that our analysis applies to many other situations.

BASIC MODEL

Most of our argument can be made by analysis of a very simple example. Consider an individual who will have an income of size W if he is lucky enough to avoid accident. In the event an accident occurs, his income will be only W - d. The individual can insure himself against this accident by paying to an insurance company a premium ai, in return for which he will be paid '2 if an accident occurs. Without insurance his income in the two states, "accident," "no accident," was (W W - d); with insurance it is now (W - a1, W - d + a2), where a2 = a2 - al. The vector a = (a,, a02) completely describes the insurance contract.'